Should Unicorns Take A Page from the Small Cap Playbook?

It’s that time of year when analysts, investors and pundits sit back and evaluate how well the markets performed in 2019 and ponder what obstacles stand in the way of growth and prosperity in 2020. We take the temperature and determine if the capital markets glass is half-full, half-empty or somewhere in between. We evaluate whether market conditions are right for more of today’s iconic and exclusive billion-dollar startups to go public or if startups should raise another round of private capital because “now isn’t the right time.” 

2019 in Review

As we look back, 2019 has generally proven to be a strong year for IPOs.  And, with new listings raising $42.5 billion by early September, 23% more than this time last year, it’s impossible to deny that stakeholders seeking access to capital markets are scrutinizing their options. The questions on many of their minds are as blunt as they are bold: “Are Silicon Valley entrepreneurs and the founders, executives and early investors of companies in other business sectors being disadvantaged through the deliberate underpricing by investment banks?” “Has a more systemic pattern of overvaluation impacted the prospects among today’s unicorns?” In either case, the speculation can be problematic for considering an IPO.

Following a series of high-profile IPO busts this year, there were several good performances, and a select few companies that didn’t make it to the starting line. All the while, many venture capitalists, investors, and entrepreneurs are emphatically insisting that the traditional IPO process isn’t the only salient path to access the public markets. The decades-old process of having Wall Street investment banks underwrite public offerings, and in doing so, setting the stock price, has been deemed by some as fundamentally flawed. Long overdue is an alternative approach to gaining access to capital from the public markets—one that will appease companies and investors alike. This year, companies have deviated from the established roadmap—choosing alternate routes to the public markets. Both Slack and Spotify successfully entered the public markets via a direct listing, and the chatter continues that other unicorns (Airbnb, Postmates and DoorDash) may soon follow suit.

Unicorns Follow the Small Cap Direct-To-Market Approach

I agree that multiple paths of entry to public markets serve companies well. 2019 seems to be the year the unicorns have taken note and have chosen this route via the national exchanges. However, purporting the direct listing as a “new” path, or a “new product” created by a national exchange, pioneered by Spotify and Slack and now under consideration by others, is not entirely accurate.

Unbeknownst to many, the direct listing isn’t a novel concept– this process has paved the road to the public markets for countless small cap companies for nearly a decade. Dozens of companies–from community banks, gold mines and robotics developers–have avoided the high cost and time pressures of the traditional IPO by entering the public markets more gradually, with OTC Markets’ direct-to-market listing, more colloquially known as the “Slow-PO.”

This transition from existing, privately held shares to public status provides a deliberately paced ramp up for management to determine how many shares to allocate for public trading.

Making previously restricted shares available for trading may garner less attention, but it essentially provides a practical and efficient entry point to build investor confidence and liquidity organically.

OTC Markets has been doing “direct listings” for many years. Community Banks including Bank of Idaho Holding Co. and Merchants & Marine Bancorp, as well as the recognized Grayscale Bitcoin Trust have avoided the high cost and time pressures of the traditional IPO by entering the public markets more gradually, having chosen this direct-to-market route as a path to achieving sustainable long-term growth.

For these types of companies, an exchange listing neither scales nor is well-suited to meet their needs. Such national exchanges just don’t make sense and would not serve them well. These companies are eager to avoid the complexities, distraction, expense, and uncertainty of an IPO and have found a viable path in this direct-to-market option.

Direct-to-Market; A Viable Path

Company CEOs and investors alike are taking pause to evaluate their options for growth and determine whether a traditional IPO is the most effective way to serve their investor base. The direct listing route can be attributed to a few broader macro-economic factors:

  • Unprecedented access to private capital.  Venture capitalists have invested $96.7 billion through the first three quarters of 2019, which puts this year on pace to be the second highest in terms of venture capital investment behind last year’s record totals. Companies considering a direct listing don’t need to use a public offering to raise capital. They can do that before the IPO from private investors.
  • IPO costs are significant. The underwriting, legal and accounting fees to go public are significant. According to a PwC survey, 83% of CFOs estimated spending more than $1M on one-time costs associated with their IPO. In contrast, a direct listing is much less costly.
  • Discerning public investors. WeWork was emblematic of the fact that the devil is in the detail, –exposing the potential for dysfunction that can be found in the financials. Investors are looking for revenue and profit and ignoring the glitzy marketing. I’m seeing a renewed focus on the fundamentals — rewarded by the investment community.
  • Timing the market. While companies need to be ready to comply with public market scrutiny and reporting requirements, direct listings are less about market timing and more about providing value to the shareholders. With the volatility and geopolitical uncertainties, timing the market has never been more difficult. I think there’s more market discipline coming into play, and I think that’s healthy for markets.

Shining a light on the direct-to-market process is good for startups, good for investors and good for the markets overall. There shouldn’t be a singular, one-size-fits-all path to access the public markets, nor a single market to facilitate that process. The path taken should be thoughtfully evaluated so that it scales to the trajectory and growth goals of the company. While the direct listing approach isn’t the silver bullet that will guarantee success for all newly public companies, it serves a different purpose. It’s an alternative for companies to consider — a way to allow companies of all sectors and sizes, with strong fundamentals, to access a path for long-term growth.

While 2019 saw big highs and notable lows, it was an impactful year for companies making a debut into the public markets. From an investor perspective, public markets are still the best option to bring private companies into public transparency and command a discipline of markets.

From our viewpoint, as a public market operator for over 600 ‘small’ U.S. public companies (those having a market cap less than $250M) across 45 states that trade on OTC Markets, we are poised to welcome innovative, investor-focused growth companies no matter which path they choose.  As we look to the coming year, the industry is bracing for yet another wave of dynamic IPOs on the horizon — from oil behemoth Saudi Aramco to home-sharing company Airbnb… Perhaps they will take a leaf out of our playbook?

Jason Paltrowitz is Director of OTC Markets Group International and Executive Vice President of Corporate Services at OTC Markets Group, the operator of financial markets for over 10,000 U.S. and global securities. Connect via LinkedIn.