Direct Listings v2.0, F45 SPAC update and Why Steve Smith should quit cricket
(The first part of this post is down in the weeds of finance and securities law, I think it’s because I am missing Matt Levine)
Direct Listings v2.0
I had written about the IPO v DL v SPAC paradigm a few months back. The post analysed factors that issuers need to weigh before making the decision on which route to take to go public.
Here is an overview of where it landed
Now, you will notice that Direct Listing has been placed way over on the left on the ‘Need for Capital’ criteria. That’s because till a couple of months ago - an issuer could not raise any new funds via a DL.
Well, that’s no longer the case.
Here’s a timeline to jog your memory
Just to be clear - the Asana and Palantir IPOs were under the Direct Listing route but they did not raise any capital (similar to Spotify and Slack)
Again to recap - what the Spotify direct listing did and why - here’s a summary by Cleary Gottlieb
The Spotify direct listing facilitated sales by affiliate and non-affiliate shareholders directly on the NYSE with no traditional underwriting. Unlike the typical IPO, there was no offering of a specified amount of stock at a specified public offering price, but instead an opening price was established on the exchange reflecting the balance of buy and sell orders, and then trading commenced.
The two main changes in the rules that SEC permitted in 2018, which allowed for DLs were
Rule changes addressed how to determine the opening trading price in the absence of underwriters and an IPO price
Rule change addressed technical matters of how to establish that a company will have sufficient public float for listing purposes
After Slack’s successful IPO using the Direct Listing method - the NYSE started working on a proposal to allow issuers to also raise capital via DLs. It made its initial proposal in Dec 2019 - this was promptly rejected by the SEC. The reasons were not entirely clear.
NYSE submitted a revised proposal in June 2020 - which finally received SEC’s blessings in August 2020. Following the approval NASDAQ also submitted its proposal to get a similar system going on its bourses.
Here’s a summary of the minimum requirements for issuers to take the DL route with a capital raise. The attempt is to ensure that the issuer is of reasonable size and the offering has sufficient public float
A company can qualify for a Primary Direct Floor Listing in two ways:
by selling at least $100 million in market value of shares in the opening auction on the first day of trading on the NYSE; or
if the aggregate market value of the shares that the company sells in the opening auction on the first day of trading and of the shares that are publicly held immediately prior to listing totals at least $250 million, with the market value calculated using a price per share equal to the lowest price in the price range set by the company in the Securities Act registration statement.
In either case, the company must have at least 400 security holders holding round lots and 1.1 million publicly held securities outstanding as of the time of listing, and the price per share must be at least $4.00.
A company undertaking a Primary Direct Floor Listing must use a new type of limit order, an “Issuer Direct Offering Order” (“IDO Order”), subject to the following requirements:
only one IDO Order may be entered on behalf of the company and only by one NYSE member organization;
the limit price of the IDO Order must be equal to the lowest price of the price range established by the company in its Securities Act registration statement (with the price range defined as the “Primary Direct Floor Listing Auction Price Range”); the IDO Order must be for the quantity of shares offered by the company, as disclosed in the prospectus in the Securities Act registration statement;
an IDO Order may not be cancelled or modified; and an IDO Order must be executed in full in the Direct Listing Auction
A couple of issues have been identified with the proposed rules
The pool of candidates for direct primary listings, is expected to be limited due to the need for companies seeking a listing to meet all of the listing standards at the time of listing, including 400 round lot holders
A Direct Listing within a “Primary Direct Floor Listing Auction Price Range” makes the direct listing very similar to an IPO price range mechanism - defeating the idea of a market pricing mechanism
Further questions of whether there will be an opportunity to increase the size of an offering, or to increase the price outside the range, and whether the secondary direct listing can proceed if the primary direct listing fails, will likely be considered
These issues aside, it would seem that the decks have been cleared for Direct Listings to take-off…
…This is where things get interesting
Council of Institutional Investors (CII), an association of employee benefit plans and funds, state and local entities investing public assets and large foundations and endowments filed a petition for review of the SEC approving order allowing for the capital raises in DLs. This has effectively put an indefinite hold on NYSE doing any direct listings with capital raises, till the issue is resolved by SEC.
If you are curious you can check out CII’s associate members list here - it includes more than 60 of the largest U.S. and non-U.S. asset managers with combined assets in excess of $35 trillion and on-U.S. asset owners with more than $4 trillion in assets.
So what’s the problem that the fine folks at CII have with Direct Listings?
It’s to do with section 11 liability and the issue of traceability.
You see, Section 11 of the Securities Act of 1933 imposes strict liability for material misstatements or omissions in registration statements. However, to bring a claim against the issuer a plaintiff must “trace” the shares he or she purchased to the challenged registration statement.
Let’s consider an example - Company A files for a conventional IPO and raises capital from the public. A year down the line we find out the numbers reported in the prospectus were fudged and material agreements with customers were falsified. Both of these would impose liability under section 11. However, for a shareholder to successfully sue Company A, they would need to prove that they got their shares through the IPO, in reliance on the information provided in the prospectus. In other words, the shares have to be “traced” to the registration statement.
If the shareholder cannot trace the shares - then hard luck - there is no case.
Here is a summary of CII’s concern by Freshfields Bruckhaus Deringer
CII objects to the rule out of concern that companies may attempt to limit their liability to investors for damages caused by false statements of fact or material omissions of fact within registration statements associated with direct listings. This concern arises in part because of the potential inability of investors who buy in a direct listing to “trace” their shares to those offered in the registration statement.
Now some of the optics around the issue also doesn’t help. I found it hilarious that CII’s petition refers to an article by Latham & Watkins - the law firm that acted as counsel to Spotify and Slack in their direct listings - which have below statements.
In this article, we discuss another important advantage of the direct listing: the potential to deter private plaintiffs from bringing claims under Section 11 of the Securities Act of 1933
The primary reason a direct listing could deter litigation is by restricting the class of persons who have standing to sue under Section 11. To establish standing under Section 11, a plaintiff must “trace” the shares it purchased to the challenged registration statement.
In the case of a traditional IPO, tracing is easily established by anyone who purchased stock before non-IPO shares enter the market. But tracing is difficult (if not impossible) to establish in “mixed market” situations—such as after the expiration of an IPO lockup period or secondary offerings—where registered and unregistered shares are commingled in the market. (Direct Listing to be regarded as “mixed market” situation)
Second, the direct listing could limit the damages a plaintiff may claim. Section 11 provides for damages calculated (in most cases) as the difference between “the amount paid for the security (not exceeding the price at which the security was offered to the public),” and the value of the security at the time suit was brought
There is no “offering price” in a direct listing . Plaintiffs could argue that there is no cap on damages—which we think would be clearly inconsistent with Congress’s intent in capping Section 11 damages. On the other hand, defendants could potentially argue that the absence of an “offering price” means no damages are claimable from the company
In other words, the article says Direct Listings are attractive because
They could deter litigation under section 11 as it’s very difficult/impossible to trace shares in a DL
Defendants could potentially argue zero damages are claimable as DL’s have no offering price (generally damages = offering price - price when the claim was bought)
CII makes another interesting point in their petition. It points out to a recent ruling in a District Court in the US - Pirani v Slack Technologies
In September 2019, Plaintiff Fiyyaz Pirani, an investor who acquired Slack common stock on the first day of its public listing and subsequently, brought a securities class action against Slack and several of its directors, asserting claims under Sections 11, 12(a)(2), and 15 of the Securities Act. That action alleged that the registration statement and prospectus for the listing contained misstatements and omissions regarding Slack’s service outages, agreements in the case of such outages, competition from Microsoft Teams, scalability and purported key benefits, and growth and growth strategy.
Slack moved to dismiss the plaintiff’s claim stating
On January 21, 2020, Defendants moved to dismiss the ACAC, arguing, among other things, that (1) Plaintiff did not have standing because he could not allege facts showing that he bought registered shares; (2) Plaintiff could not recover damages under Section 11 because Slack’s direct listing did not involve a public offering price; (3) Plaintiff could not plead standing under Section 12(a)(2) because Defendants were not statutory sellers; and (4) Plaintiff failed to plead that any statement was false or misleading
Interestingly, the District Court ruled that section 11 would still be applicable to Direct Listings
However, the court also referred the case to a higher court of appeals - recognizing the significance and novelty of the issue.
As per CII’s petition, the higher court in question is more likely to stick to the narrower definition
In this respect, it is notable that many of the concerns expressed by the District Court are similar to other situations where courts have uniformly declined to dispense with the existing standing requirements of the Securities Act, including secondary offerings
So finally, what is CII asking the SEC to do?
Fix the traceability problem by implementing necessary technological changes OR
Disallow direct listings with capital raises which could extinguish investor rights
And we wait and watch - till the SEC decides.
Nevertheless here’s the summary as things stand, again I will rely on Freshfields Bruckhaus Deringer
The new NYSE rules bring the traditional IPO and direct listing processes much closer together as both now permit capital raising and investor liquidity.
However, some key differences remain such as no lock up period imposed on existing shareholders, better pricing transparency and an ability to provide guidance as part of a direct listing.
While these benefits are compelling, the traditional IPO continues to offer the ability for underwriters to engage extensively in marketing activities with and on behalf of the company and an ability to curate a more stable shareholder base. Also, in a traditional IPO, companies may price outside of the range set forth in their prospectus.
In a direct listing, if the limit order for the full number of shares the company expects to sell cannot be sold at the price at the lower end of the price range, the direct listing fails, and the shares do not begin trading.
The changes to the DL rules seem to position it as a hybrid IPO getting rid of some of the more frustrating aspects of traditional IPOs like lock-ups but also losing out on some good features around pricing flexibility.
In any case, having more options seems to be a good outcome for issuers.
F45 SPAC update - Deal terminated
F45 Training and Crescent Acquisition Corp mutually agreed to terminate their previously announced business combination agreement.
While we remain optimistic about the current performance and long-term growth prospects of F45, the prolonged uncertainty around the pandemic has challenged our ability to successfully complete the business combination,”
Robert Beyer, Executive Chairman, and Todd Purdy, CEO, said jointly.
“Despite our best efforts to finalize this transaction, we ultimately concluded that approaching the public markets at this time was not the right option for F45,”
said F45 CEO Adam Gilchrist
This was surprising news. I for one thought that the anecdotal evidence was that the fitness sector was making a strong recovery from COVID-19. The deal had valued F45 at an EV of US$845m.
As it turns out, Australia will still have to wait for its first SPAC deal.
Steve Smith - You beauty
Steve ‘Smudge’ Smith is an exceptional cricketer. Ashes hero, World Cup winner and Captain. Admittedly, his batting technique is hardly easy-on-the-eye but he is super effective.
I believe there is a strong case for him to move on from cricket and focus on his real talent - angel investing :) (assuming he is not advised by someone)
Here’s his track record
Koala Mattress: Smith invested $100k for a 10% stake in 2015. As per the AFR, in Dec 2020, Koala raised $3 million at a share price of $137.34, valuing Smith's stake at $13.7 million and Koala at $160m.
Latest funding rounds value the business at $500m.
Snappr: Smith paid $100k for a 4% stake in Snappr as part of a $500,000 angel round in July 2016, when it had barely sold a photoshoot. The business thus being valued at $2.5m
AFR estimates a 600% gain on the investment for Smith based on the latest valuation estimate for the business of $60m
AFR estimates that Smith has made more money off these investments than his whole career earnings playing cricket.
Smudge is now backing Cashrewards - an online shopping rewards platform. This time he has gone in with $200k. The company is expected to go public in October as well - so you can join in on the ride if you choose to.
And that’s a wrap for this post.
Next one is going to be a post on a framework for investing in companies.