Morgan Stanley’s ‘Teflon banker’ talks direct listings and much more

Michael Grimes has been dubbed “Wall Street’s Silicon Valley whisperer” for landing a seemingly endless string of coveted deals for his bank, Morgan Stanley. The sprawling financial institution has served as the lead underwriter for Facebook, Spotify and Slack. Grimes, a banker for 32 years — 25 of them with Morgan Stanley — has also played a role in the IPOs of Salesforce, LinkedIn, Workday and hundreds of other companies.

Because some of these offerings have gone better than others, buzzy startups and their investors are asking Morgan Stanley and other investment banks to embrace more direct listings, a maneuver pioneered by Spotify and copied by Slack — rather than sell a percentage of shares to the public in a fundraising event, companies essentially move all their stock from the private markets to public ones in one fell swoop.

In a rare public appearance last week, Grimes told us why he supports direct listings and answered questions about other offerings in which Morgan Stanley has been involved, including as a lead underwriter for both Uber and Google. (He was less talkative about WeWork, a company that Morgan Stanley managed to distance itself from at exactly the right time.) If you care about how the process of taking private companies public may be changing, it’s worth the time. Our conversation has been edited lightly for length.

TechCrunch: Tell us about yourself. You were born in East L.A.; you studied computer programming and electrical engineering at UC Berkeley, then you became a banker, and you’ve remained one. Did you always want to be a banker?

Michael Grimes: I’ve only ever done this since i was 20. I’d joined Salomon Brothers, which later became part of Citigroup. They had a tech group where they wanted somebody in tech. I didn’t know banking or business or finance, because I had studied engineering and that made me not well-suited, to some degree, [for a bank] other than for a tech bank. Mary Meeker also started in ’87 at Solomon and [we then worked together for 20 years at Morgan Stanley until she left].

The work you’ve done with a lot of these amazing companies that you’ve helped take public has earned you a lot of nicknames — the ‘Teflon banker,’ the ‘kingpin’ banker. How do you feel when you see yourself described in those terms?

It may sound boring but may be similar to the way venture capitalist serve founders. Besides capital, they’re giving advice. We think of it as giving advice: that decision to file, do you or don’t you, how will it be received. That decision may work out for the best. There’s a lot of volatility in the market and it may not. But we want to stick with clients through thick and thin and help them navigate really volatile markets.

When a company is [at an] emerging growth [phase] but hasn’t reached a mature business model, you can have a really wide variety of fair cases for, is this going to be worth $30 billion in five years? $3 billion? $200 billion? Those could are all possible if something is growing 100 percent per year and the margins are increasing and you can do the math. [Remember that] Google has gone from $30 billion when we took it public to $800 billion or $900 billion or whatever is it [now]. So is this going to be that, or is this going to grow and peak and recede? There’s a huge amount of volatility inherent in tech investing, and that kind of comes with the territory in our business.

People seem to speak in hushed tones about you the way they earlier spoke about [earlier Silicon Valley banker] Frank Quattrone, but Frank Quattrone had a reputation for taking on deals that others wouldn’t take; you have a reputation for saying no to deals when they don’t feel right. When is a company in shape to go public?

We try to predict the receptivity of the public markets, which does change. There were times in 1999, 2007, maybe 2015 until recently, where institutional investors were taking more risk, then there are other times when they’re taking less risk: 2001, 2002, maybe now to an extent; they’re taking less risk than they were a year ago.

The institutional investors are the price setters; if they’re eager to invest in a company, then we try to predict that and get behind the companies that we think will work well there, or [else] give the company advice that this maybe isn’t the right time or maybe this won’t be well-received. We aren’t perfect at this but we kind of obsess about it.

You’ve told me that you think the more established the company, the more observable its metrics, the less volatile the offering in all likelihood. But can a company stay private too long?

It depends on what you mean by “too long.” If they run out of capital because they aren’t financeable, you could argue that’s probably a good thing that they never went public, because investor protection matters. Healthy markets depend upon investors, on balance, earning a return — not just institutions but retail investors, the ordinary investor. So if it turns out it’s a company that thrives but went public later, there’s no real harm there… I haven’t really bought into the theory of companies waiting too long to go public. That’s their choice. They have to decide based on their capital. Going back to the late ’80s or ’90s, I’ve worked with companies that have gone out with $300 million, $400 million, $500 million valuations; I’ve worked with ones that have gone out at $30 billion, $40 billion, $100 billion valuations. In all cases, it really depends on the company’s fundamentals and performance as opposed to its stage.

You mention companies that aren’t financeable. It brings to mind WeWork. Obviously its S-1 was disaster, but it also really needed the money from an offering. Could things have gone another way for the company? Was there a way for it to go public?

We weren’t involved in that filing so I’m probably not the right guy to opine on that situation.

Do you think JPMorgan deserves all the heat it’s gotten for that situation?

I don’t really have the inside scoop on what decision was made on the filing and receptivity. That’s something when we’re looking [at taking a company public], we really focus on really closely, but I don’t really know.

What about Uber? Morgan Stanley was the lead underwriter. You don’t think Uber went public too late? It seems like it was enjoying a lot of momentum last year, so much so that it was reportedly told by bankers that it could be valued at $120 billion in an IPO — which is nearly triple where it’s valued right now. Did you think it would go out at that number?

If you look at how companies are valued, at any given point of time right now, public companies with growth prospects and margins that are not yet at their mature margin, I think you’ll find on average price targets by either analysts who work at banks or buy-side investors that can be 100%, 200%, and 300% different from low to high. That’s a typical spread. You can have somebody believe a company will be worth $30 per share, $60 or $80 three years out. That’s a huge amount of variability.

So that variability isn’t based on different timelines?

It’s based on penetration. Let’s say, what, 100 million people or so [worldwide] have have been monthly active users of Uber, somewhere in that range. So what percentage of the population is that? Less than 1% or something. Is that 1% going to be  2%, 3%, 6%, 10%, 20%? Half a percent, because people stop using it and turn instead to some flying [taxi]?

So if you take all those variables and possible outcomes, you get huge variability in outcome. So it’s easy to say that everything should trade the same every day, but [look at what happened with Google]. You have some people saying maybe that is an an outcome that can happen here for companies, or maybe it won’t. Maybe they’ll [hit a] saturation [point] or face new competitors.

It’s really easy to be a pundit and say, ‘it should be higher’ or ‘it should be lower,’ but investors are making decisions about that every day.

Is it your job to be as optimistic as possible about the pricing? How are you coming up with the number, given all these variables?

We think our job is to be realistically optimistic. If tech stops changing everything and software stops eating the world, there probably would be less of an optimistic bias. But fundamentally — it sounds obvious but sometimes people forget — you can only lose 100 percent of your money, and you can make multiples of your money. I don’t think VCs are as risk-averse as they say, by the way. Some 80% or 90% of investments end up under water, and 5% or 10% produce 10 or 20 or 30x and so that’s the portfolio approach. It’s not as pronounced with institutional investors investing at IPOs, but it’s the same concept: you can only lose 100 percent of your money.

Let’s say you put five equal quantums of investment out to work in five different companies and one of them grows tenfold. Do I even need to tell you what happened with the other four to know you made money? Worst case, you’ve more than doubled your money, and therefore you’re probably going to lean into that again. So generally speaking, there’s an upward bias, but our job is to be realistic and to try to get that right. We view it as a sacred obligation. There’s variability and volatility within that. We try to give really good advice on receptivity. And when the process works as intended, we have predicted it as well as you can within a range of high variability.

Michael Grimes

This summer on CNBC, Bill Gurley told viewers that banks, including the top banks, have mispriced IPOs to the tune of $170 billion over the last three years, meaning that’s the amount of money that companies left on the table. Do you think we need direct listings and can you explain why they could potentially be better?

Sure. We think Bill has done a great service by focusing a spotlight on the product, which we innovated with Spotify and then later with Slack. We do love the product, we’re bullish on it.

You’re asking how they work?

Yes, as it relates to price discovery. So in a direct offering, you’re talking to people who own the stock and people who might want to buy the stock to figure out where they meet, which doesn’t sound that different than what goes on with a traditional IPO.

It’s actually different in a technical way. In a traditional IPO, there’s a range, let’s say $8 to $10. And the orders we’re taking every day for two weeks, let’s say, while the prospectus is filed, we’re taking orders from institutions [regarding] how many shares they want to buy within that range. That means generally within that range, they’re buying. It’s not binding but generally speaking, they’re going to follow through. If it’s outside of that range, we have to go back and ask them again. So if there’s a whole lot of demand and the number of shares being sold is fixed so that supply is fixed… the company’s goal is for oversubscription because they want an upward bias. They don’t want to trade up too much [and leave] money on the table and they don’t want to trade down at all — even a little bit — and they don’t want to trade flat because that could be [perceived] to be down; they want to trade up modestly. An exception was the Google IPO, which was designed to trade flat and traded up modestly, 14% or something like that.

The range might be moved once, maybe twice — because there’s not a lot of time because there’s a regulatory review to turn it around — so [let’s say] it’s moved from $8 to 10 to $10 to $12 and there’s still much more demand than supply; it’s a judgment call as to, is that going to price at $14? $15? $12? Some investors might think it should trade at $25 while others think it should trade at $12. So there could be real variability there, and when trading opens, only the shares that were sold the night before in the IPO, some subset of them are trading and that’s it, everything else is locked up —  the whole cap table. So for six months, it’s those same shares trading over and over, other than maybe [a small sampling] or investors of former employees who weren’t locked up.

Okay, so let’s switch now to a direct listing.

So with a direct listing, the company is not issuing any shares. There is no underwriting where the banks buy the shares and sell them immediately to institutional and retail investors. But there is market making and the way the trading opens is similar but the size is totally flexible. There’s no lock-up. The whole cap table can essentially sell shares, versus the average IPO right now where I think it’s 16 percent of the cap table is sold in an IPO, and that’s down by half, by the way, from 15 years ago.

So everyone can sell on day one, but are there handshake deals to ensure that not everyone dumps the shares on day one?

No, there’s no hidden agreement. They can sell as many shares as they want, but it’s going to depend on the price. The way a direct listing opens trading is a critical function because there’s no order book. No one has been taking orders for two weeks. The company has met with investors and done investor education. We’ve helped them write a prospectus, etcetera, but there are no orders, there’s no price range, and off we go. With Slack and Spotify, we were the bank responsible for the trading. What that means is on our trading floor in Times Square, our head trader, John Paci, and his team are in touch with anyone on the cap table who might want to sell and institutional investors who might want to buy, and what’s happening are two auctions at the same time.

So in the traditional IPO, we were taking orders for size within a range that might move a little bit, [but] this is now any price. So take the buyers. [We’re trying to find out] who will pay $8 who will pay $12. Will anyone pay $16? So you’re taking that demand and sorting it by price. At the same time, you’re taking that supply, asking, ‘VC No. 1, is there a price at which you would sell shares?’ If this person says, ‘Yes, but at $20’ and we don’t have any demand at that price, then we figure out: who would sell at $18? Maybe VC No. 2 says they would sell 5 percent of their shares at $18. So we have some buyers, but it’s not enough to open trading with enough liquidity, which is key to all this. If you had one VC and one buyer, the buyer would go away. They’d say, ‘you didn’t tell me I was going to be trading with myself.’ So we have to figure out where a simultaneous demand auction for the highest price, and a supply reverse auction for the lowest price clears and meets. If you can move a billion dollars worth of stock at $14 and get demand for a billion worth of stock, then that’s the price.

That’s then sent to the exchange where the exchange can take and add any other market maker or bank that has another seller or a buyer — so they add in, call it, another 30 percent from other brokers — and that produces the opening transaction.

That’s what Bill Gurley would call algorithmic-based…

StrictlyVCSo you think direct listings are more efficient than traditional IPOs.

I think the pricing mechanism is. Google’s auction IPO was also an efficient pricing concept, but the concept of an auction is inherently efficient, absolutely.

Speaking of Morgan Stanley, I was on CNBC this summer talking about direct listings with University of Florida Professor Jay Ritter, a renowned IPO expert, and he said the reason Google’s auction didn’t work was because the banks involved sabotaged the effort by telling institutional investors to bid low. Is that true and, more fundamentally, are you going to thwart these? These don’t work without the banks’ support.

No, that’s not true. I know multiple banks told Google, ‘we’re not going to do this.’ And we had the opposite approach. We did the same thing we’re doing with direct listings [which is to embrace] innovation, and we didn’t just do it, we spent six to nine months with dozens of programmers building the system to be able to handle all the bids and penny increments and all the things that Larry and Sergey and George Reyes, the [then] CFO wanted. So we built all that out and institutions made their own decisions. I can’t imagine at the top institutional investors saying I’m going to bid low because some bank told me. It doesn’t make any sense.

Now, I think institutions were worried about a winner’s curse because we wrote it into the prospectus. It says this will be priced based to the highest bidder, fixed number of shares in an auction, one times subscribed — that’s called the clearing price, and it literally says in there, ‘therefore you should not expect to sell your shares for a profit.’ Because by definition, if you take the highest — I think we were selling $2 billion worth of stock — if you take the highest $2 billion worth of stock and you price it there, you could be concerned over, well, who’s going to take it higher? It wasn’t designed to go higher; it was designed to trade flat. So I think some institutions mistakenly, probably, were worried that that could happen and they could lose out and some of them did bid, some of them didn’t. More than we expected did not. In the end, the stock traded up 14 percent, so it wasn’t quite flat, then it went up almost every day for a year as each institution said, ‘Wait, why didn’t we do that [auction]’? It went from $85 to $283 a year later.

Playing devil’s advocate, I still have to wonder why you are promoting these things. Direct listings sound like a lot of work.

It’s probably comparable to [a traditional IPO].

You’re also two-for-two with Spotify and Slack and right now, when companies think about direct listings, they’re going to call you because, why re-invent the wheel? But eventually, that’s going to change if they take off. Meanwhile, your fees are already less because in a traditional IPO, you’re getting a percentage of the proceeds raised versus a flat advisory fee with a direct listing. So why should we believe you want these to succeed?

Because we’re client-driven. It’s not a slogan, it’s not a bumper sticker. We love being service providers to the prime movers. So what’s right for the client is right for us.

There are fewer banks involved and there are fewer fees, but it’s not fewer fees for the banks doing the work. So you’ve got a couple of banks, they’re getting paid essentially the same as in an IPO. The company is saving money because there might not be 13 banks doing this, but two or three. But we’re focused on delivering for the customer. We’re not trying to account and measure how many banks and how much in fees; that’s not going to drive our decision making on advice.

I do wonder why VCs are suddenly so motivated to bang the drum about these. I wonder if they aren’t trying to pressure banks into getting rid of lock-up periods. Would you ever just get rid of the lock-up period for traditional IPOs?

We’ve done a lot of innovation around lockups. With Google there were serious lock-up innovations [with some employees’ lock-ups ending in] 45 days, if I’m remembering correctly, and others 90 days and some longer. We want to do whatever works for companies and investors. I think there can be . . . I don’t think VC pressure comes from trying to get rid of lock-ups. Direct listings inherently don’t have lock-ups. I think the motivations are algorithmic pricing and allocation — both of those — and more liquidity certainly is a motivation.

If we go back to deals getting smaller while assets under management of investors are getting larger…  and remember, software is eating the world and tech is changing the world, and this is where a scarcity of supply has [fueled] demand so in the last couple of years, trade-ups have gone up more, not as much as in ’07 or ’99, but probably third to those two periods of time in the 32 years that I’ve been doing this, so I think there’s some motivation there [relating to] efficiency. I think that was the motivation of [Spotify CFO] Barry McCarthy; he really deserves credit as the issuer who championed this and innovated this.

Are these really more widely applicable than believed? For example, health care companies need the capital when they go out and something like a third of the listings over the last five years have been healthcare companies. Could they really do direct listings?

I think so. I’m not an expert in that area. But we do think it’s broadly applicable. Raising capital is currently not permitted by the company in a direct listing, so that today would not be doable; so they’d have to have capital that was raised beforehand through a private placement, etcetera, so if they’re cash-strapped, maybe not. But if they have ample capital, then yeah, I think it would be applicable.

But not a lot of companies have a ton of capital when they go out. Slack had a bunch of money from SoftBank, for example, but that money looks to be drying up a bit. If there’s less capital chasing pre-IPO companies, does this model still make sense?

There are a lot of assets looking for pre-public technology companies — a lot — and only so many companies. So I don’t think the private markets are going to be starved for capital. There is going to be more capital than companies seeking capital [for the foreseeable future].