Securities Law Blog

According to The Wall Street Journal, the online music streaming service Spotify is planning to go public without using an underwriter or issuing any new shares through a so-called “direct listing.” A direct listing effectively separates the stock exchange listing from the “public offering” part of a traditional underwritten initial public offering (IPO) in which capital is raised. For companies with no current need for added capital, a direct listing provides a platform of benefits associated with being a publicly reporting and traded company including a higher enterprise valuation, greater and more prompt access to public equity markets, a boost in credibility within the industry and a stock that can be used as currency for acquisitions. However, not all companies can organically compensate for the lack of an underwriter and the rigorous IPO marketing process in pursuing a direct listing.

Spotify and many similar subscription-driven digital publishers have two unique business advantages that make a direct listing potentially as attractive as a traditional IPO in creating a liquid, exchange-listed stock – a large customer base of potential investors and knowledge of direct response digital marketing techniques.

In a direct listing, a company files with the SEC a Form 10 registration statement under the Securities Exchange Act of 1934, which describes the company’s business, management and capital stock, and includes audited financial statements. A Form 10 automatically becomes effective 60 days after the filing, even if all SEC comments have not been cleared. The Form 10 registration process in a direct listing does not involve the sale of any new shares to the public and, compared to a Form S-1 registration statement under the Securities Act of 1933 used in a traditional IPO that registers the shares being offered to the public, is merely the means by which the company becomes a publicly reporting company that is required to file periodic reports required under the Exchange Act.

The company then applies for an exchange listing. For larger companies like Spotify, this would involve satisfying the initial listing requirements of a tier of the Nasdaq Stock Market or the New York Stock Exchange. Larger companies would typically meet all the minimum financial criteria for listing on an exchange and, with advance planning, all of the corporate governance requirements such as having an independent board and audit committee. The one exception to immediately meeting exchange listing requirements is often not having a stockholder base of 300 stockholders owning at least 100 shares each (known as “round lot holders”). However, companies that have funded their growth while remaining private for a decade or longer may have a significant number of angel investors and early venture investors, as well as founders and employees to meet the stockholder base requirement.

While direct listings are an alternative to the traditional IPO for nearly all companies, direct marketing firms – subscription-driven digital publishers, direct response advertisers and direct mail catalogers, for instance – have a unique advantage. The strategy of capturing the benefits of going public through a direct listing follows the same basic tenets of a successful direct marketing program:

•  the universe of potential investors and shareholders must be profiled to determine likely buyers;
•  a solicitation program to reach this target audience – either by social media, email marketing or other online advertising, must be deployed;
• a disclosure document with detailed financials similar to a business plan or prospectus must be prepared;
• procedures for tracking response rates and fulfilling order requests must be created; and
• a limited but ongoing investor-relations program will be required, as will a process for managing the trading aftermarket.

Direct marketing is an important aspect of Spotify’s business – it regularly works with music labels on targeted direct marketing campaigns promoting upcoming tours and albums to members of its customer database based on their listening habits. Direct marketing firms like Spotify have developed natural affinity groups that can be advantageously turned into buyers and long-term holders of their shares. If shares are held by customers, it is likely to result in increased product sales and customer retention; for those held by employees, increased productivity and loyalty; and by vendors, better customer service. These firms have developed sophisticated databases of prospective investors’ names, addresses, phone numbers, emails and other demographic data to kick-off and sustain trading stability (all without the benefit of an underwriter’s roadshow).

A successful direct listing follows much of the same methodology of a direct marketing program, representing a unique and logical opportunity for Spotify and direct marketing firms.