Looking to participate in a company’s first stock offering to the public? As Coinbase prepares its DPO, understand the differences between direct public offerings (DPOs), initial public offerings (IPOs), and special-purpose acquisition companies (SPACs).
The initial public offering (IPO) market has been active—some would say hot—in recent days. CNBC reported that 2020 was the busiest year since 2014, with a total of 218 new listings. And 2021 could be even hotter, considering there have already been 95 new listings as of March 30, according to IPO tracker Renaissance Capital.
Meanwhile, another trend in recent days—institutional interest in cryptocurrencies—has helped bitcoin and others set new record highs.
It’s against that backdrop that Coinbase, the largest crypto exchange in the U.S., is expected to be directly listed on Nasdaq on Wednesday.
Maybe you’ve seen some references in the media to the “Coinbase IPO date.” That’s not entirely accurate, because Coinbase, (or COIN—its symbol once it’s on the Nasdaq) is taking a path to trading called a “direct public offering” (DPO) that could allow it to cut the cost of going public and become available to more investors sooner.
Further down, we’ll address the difference between an IPO and a DPO, what investors need to know about each, and why Coinbase is taking the second path. First, a little about the company.
Coinbase operates an online exchange where buyers and sellers can meet to trade Bitcoin and other cryptocurrencies. It also offers crypto investors a “wallet” where they can safely store their digital currency. The Coinbase platform now has over 56 million users worldwide and has transacted more than $456 billion, according to the company’s filing with the Securities and Exchange Commission (SEC). This will be the first cryptocurrency exchange to go public.
The financial performance of Coinbase as a company could depend more on interest in the crypto space rather than the performance of the crypto assets themselves. While the two may go hand in hand, it’s possible its performance could depend on volume of the crypto markets. For investors wondering how the stock might trade, it’s likely to be more of a play on activity or interest in the space. It also might be at least one step removed from the volatile prices of Bitcoin and other cryptos.
The DPO comes soon after Coinbase Q1 earnings last week, when the company said its monthly transacting users have grown 117% quarter-on-quarter, helping it secure a net income of $800 million since the start of 2021. The user base includes institutional firms and retail clients.
As Coinbase goes public, there’s been a resurgence in cryptocurrencies. Bitcoin recently jumped above $60,000 for the first time. The average price of Coinbase shares traded on Nasdaq’s private market last month was $343.58. According to Forbes, valuation of the stock could be $100 billion once it goes public.
So why would a company like Coinbase choose a DPO instead of an IPO? Let’s consider the differences.
Initial public offerings (IPOs) use a broker, while direct public offerings (DPOs) offer a more direct approach. Both, however, are ways in which companies can sell shares for any reason. Although DPOs are not as common as IPOs, each way of making shares public comes with potential advantages and disadvantages for both the average investor and the company itself.
A DPO means cutting out the middle man (typically a major financial institution that helps bring an IPO to market). This can be a major way of avoiding costs. Also, a DPO means the company is just selling existing shares, not issuing new ones. This means it’s less likely to dilute existing shares, and it’s not raising new capital. A company like Coinbase that opts for a DPO is just making investment possible for the public using only its existing shares. This potentially says something about their capital position, since they aren’t issuing additional shares to raise new capital.
Here are some more of the differences between IPOs and DPOs.
The traditional way for companies to go public is through an IPO backed by at least one investment bank.
Institutional and other large investors typically have first access to the shares before market open, and the general public is essentially a step behind them. So the average investor may miss out on any early gains from an IPO, whereas inside institutional investors can take full advantage.
With an IPO, an opening price is set beforehand, and the main goal is usually to raise outside capital. The underwriting process by an investment bank is usually longer than with a DPO, but the bank’s backing also provides the firm with an idea of how much capital will be raised before investors make a commitment for the offering.
Many of the largest public companies trading today opened to public trading through an IPO, including Alibaba (BABA), Visa (V), and Facebook (FB)—which were among the largest IPOs of all time.
Direct public offerings, also known as direct listings, are not as common as IPOs, but some companies prefer this strategy when going public. That’s partly because they can avoid underwriting costs. Also, some experts believe a direct listing can offer greater liquidity and better price discovery.
With DPOs, companies may have more control over the terms of their offerings because they aren’t working with an investment bank. As a result, all investors have equal access to the shares (instead of some investors getting early access, as with IPOs). The price of shares at the open is determined purely by the market, not a preset price.
Instead of aiming to raise new outside capital, a DPO allows current owners to convert their stakes into stock they can sell. Because companies avoid the underwriting process, a direct listing is usually faster and less expensive. The price movement can also be less volatile, since no new shares are hitting the market. If there’s a lot of interest and demand, the price might go higher, but of course there’s no guarantee. Also, there’s no “lockup period”—which for IPOs typically lasts 90 to 180 days and prevent employees and other insiders from selling their stock when the company goes public. Sometimes the end of a lockup means softness in a stock. People investing in a DPO don’t have this potential speed bump ahead.
Of course, the flip side is that these offerings don’t provide the backing of a financial institution. They can sometimes have more volatile outcomes once the stock starts trading. Several well-known companies, such as tech firms Slack Technologies (WORK) and Spotify Technology (SPOT) opted to skip the IPO process for the DPO approach when they opened to public trading. Also, because people who already own existing shares can sell them on the public exchange immediately when a DPO occurs, new investors might face selling pressure that weighs on prices even the very first day of trading.
And then there are special-purpose acquisition companies (SPACs), aka “blank-check companies.” SPACs have been around for a long time, but they’ve become more popular in recent days after several high-profile SPAC success stories.
Technically, though, a SPAC isn’t an alternative to an IPO or DPO. In general, investors access SPACs upon (or after) a public offering such as an IPO. A SPAC is a company in the developing stage—with no real business plan other than to engage in a merger or acquisition within a specific time frame. It’s essentially a pool of funds created to buy another company (similar in fashion to many private equity funds). SPACs are designed to be flexible, if not a bit secretive. Although some SPACs disclose the specific industry where they seek to make an acquisition, SPACs do not pre-identify possible acquisition targets. For this reason, underwriters do not undertake any due diligence on acquisition targets.
But the risks don’t stop there. Per Securities and Exchange Commission (SEC) rules, a SPAC must typically complete an acquisition within 18 to 24 months and must use at least 80% of its net assets for any such acquisition. If it fails to do so, it must dissolve and return to its investors their “pro-rata” share of assets in escrow.
So what’s the allure? Sure, SPACs are highly speculative, but the lower regulatory bar can dramatically shorten the time it takes to get funding. In a disruptive, fast-growing industry such as electric vehicles and related technologies, a SPAC can help more speculative-focused investors get in at or near the ground floor. Just do your homework before jumping in.
Whether you invest in a newly listed company through an IPO or a DPO, there are several potential risks and benefits to consider.
On the plus side, IPOs and DPOs that succeed can offer investors a rapid rate of return as the market determines the company’s value. For example, shares of Zoom Video (ZM) doubled on its April 2019 IPO and then hopped along awhile, but shares took off to the upside in the 2020 coronavirus-related “stay-at-home” economy.
However, newly public companies sometimes see shares tank on their debut. In the case of social media giant Facebook (FB), shares crashed in the months following its hyped 2012 IPO. It took a while, but eventually they came back and now trade several orders of magnitude above the IPO level.
When you consider investing in an IPO or DPO, remember to look beyond a company’s brand and consider its business operations. Just because you like a company’s product doesn’t necessarily mean the stock is a good investment. Make sure you know the key financial metrics: the company’s debt, profit, and revenue trends.
Newly public companies tend to perform better when the overall market is doing well and less impressively when the broader market slumps. New publicly traded companies can at times carry more risk than more established publicly traded companies, so it’s important to assess your risk tolerance prior to making any investments.
Still, IPOs and DPOs—and even SPACs—have the potential to offer significant returns, which makes them an interesting idea to consider for many investors.
Even though companies with new offerings won’t have a lengthy history of public information available to investors, you should still be able to learn about key financial metrics by reviewing the detailed prospectus that becomes available prior to the IPO or DPO. That certainly applies to Coinbase, a relatively new company that does business in a very volatile industry.
If you intend to participate, make sure you carefully read Coinbase’s public filings and understand its business model before venturing in. Also, you might want to wait a few days or longer to watch where the price goes. Consider making smaller trades at first if you do intend to participate.
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