As a general rule, I refuse to worry about how much money bankers make. They have historically done just fine, and I presume will continue to do so. In a similar manner, I don’t worry about how much money venture capitalists earn. Not really. Sure, it’s nice to figure out deal-specific returns here and there, but frankly, I care precisely not at all about any particular VC’s take-home.
But today we have to care a little bit about both, because we need to talk about direct listings, IPOs and how to price private companies. Yes, we’re talking about Amplitude’s recent public-market debut.
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What follows is a dive into the IPO pricing issue and how startups are looking to get around the matter through alternative listing mechanisms. We’ll close with notes from an interview with Amplitude CEO Spenser Skates about the same matter. If you care about the value of private companies and how they are priced, this is for you. If you do not, please read anything else; you are going to be bored out of your socks.
The problem with IPOs
Earlier this week, we asked if direct listings would be able to solve the IPO pricing issue. Or, more simply: Could direct listings coupled to last-minute private-market fundraising help startups dodge first-day IPO pops?
An IPO pop is what happens when a company prices its initial public offering at a lower price point than where it begins to trade. A little pop is generally considered healthy. A large pop is considered an error.
In more concrete terms, if a company prices at $45 per share in an IPO and kicks off its trading life worth $46, good job. Hell, even $48 would be uncontroversial. But when a company prices at $30 and opens at $45, it doesn’t matter if its shares later come back to Earth. A sin has been committed, at least in the eyes of the company and its private-market backers.
There are two issues with IPO pops that annoy startups and their investors:
- First, they imply that the debuting company could have raised more money, or the same amount of capital, with less dilution. That makes sense.
- Second, private companies and their partial owners (VCs) do not like it when free money is handed out to others, as when bankers price an IPO too low while securing fat allocation in the deal for their own customers; watching bankers that just showed up distribute upside for little work irks founders (reasonable) and venture investors (less reasonable).
The IPO pop issue has become more acute in recent years as some big-ticket public offerings have posted insane first-day results, opening to trade or closing their first day as public companies worth far more than they were expected to be when compared to their formal public-offering price.
One way to dodge an IPO pop is to direct list. In a direct listing, a company simply begins to trade. A reference price is set, but that’s largely a made-up number that folks ignore. It doesn’t matter much. And because the company in question isn’t setting a formal price for itself, it cannot suffer from a mispriced IPO. Huzzah; we’ve solved the problem.
Except we haven’t. IPOs have some good elements to them that everyone can agree on, chief of which is that they raise primary capital. By that we mean the company looking to list its shares in a traditional manner sells stock in the transaction. That’s why it has to set a price; it has to name a number at which it sells primary equity in its IPO.
With a direct listing, you do away with the pricing matter altogether, but it can be a bit baby-with-the-bathwater if a company wants to also raise capital to fund its operations, growth or whatever else. So, unicorns have come up with a neat compromise that appears to be a fix: raise a huge, final private round of capital and then quickly direct list. Doing so decouples pricing the company and it starting to trade.
Amplitude did just that earlier this week. It raised a multipart close Series F at $32.0199 per share a few months back — and then direct listed.
However, there are issues.