Coinbase began trading publicly on the Nasdaq Exchange on Wednesday, surpassing its initial benchmark price and opening above $ 380 per share. It is the first company specializing in cryptocurrencies to hit the market, taking advantage of the growing interest in digital currencies such as Bitcoin and Ethereum. This hot IPO may soon usher in a tide of other crypto-related companies playing for investor money.
But there is a twist: Coinbase (ticker symbol: COIN) bypassed the usual method of publication on the stock exchange – a initial public offering (IPO) – in favor of direct listing. And this difference presents different risks for investors compared to the typical route of an IPO through an investment bank.
Here’s what you need to know about direct listings and why they pose unusual risks.
Direct listing vs IPO: here are the main differences
To debut on the Nasdaq Exchange, Coinbase uses a direct listing, and this process differs from the more traditional IPO route.
- In a Initial Public Offering, a company hires an investment bank to manage the process, offer advice, and ultimately sell shares to the public. In this type of process, the company raises capital for itself by selling newly issued shares to the public, and some insiders may also withdraw some of their shares. So the company gets both a new inflow of capital and an opportunity for some insiders to take money off the table.
- In a direct registration, it is the insiders or shareholders of the company – not the company itself – who sell shares through the stock exchange directly to the public. So when the stock debuts, public investors buy directly from insiders. This is what Coinbase does. It is not about raising funds for itself by selling new shares; only insiders initially sell the shares.
Direct announcements are rare. Usually, the maneuver is reserved for small businesses under the radar, but it has received more publicity in recent years as a few well-regarded companies have gone public in this fashion. Office Slack messaging app, music streamer Spotify, data mining company Palantir Technologies, and productivity app Asana have all used this method in recent years.
A company can benefit from going public with a direct listing, avoiding the high transaction costs of Wall Street, and not diluting the value of its own shares by issuing more. So if the business doesn’t need more money to run its business, then it may not make sense to pay for it.
But a direct listing also exposes investors to unusual risks that they typically wouldn’t face with the traditional route of an IPO. Here are four key risks to consider with Coinbase’s direct listing:
1. The market can be small or nonexistent
In a traditional IPO, Wall Street investment banks bring buyers together and hype up interest, both in the deal itself and in the secondary market where it can be bought by. the general public. Investors know how many shares need to be sold, and while they’re not among the privileged few to buy as part of the IPO, they can buy publicly with anyone else who wants to. .
However, in a direct listing, the number of shares to be introduced to the market depends on the insiders willingness to sell and the amount. The supply could be much lower than demand or much higher, although given the fury of investors for Coinbase, it is difficult to imagine that supply exceeds demand. New stocks will enter the market because insiders want to sell.
All of this means that there is no guaranteed market for the new stock, which makes it potentially difficult to access, at least for a while and also at a price you would want to pay.
With relatively few shares traded on the exchange, the price of Coinbase shares could fluctuate significantly, especially at the start.
In a traditional IPO, underwriters support the stock price in several ways. They market the shares to institutional investors and generate interest. They set an IPO price, creating psychological “fair value” and a trading range for the stock. Additionally, they usually support the stock through technical means, helping the stock stay above the IPO price, at least in the short term.
But because a direct listing bypasses investment banks, it does not enjoy the same benefits. And there may be relatively few stocks traded, relative to high demand, which means the stock can fluctuate significantly in its early stages. So, investors who trade in a tight market can cause the price to move sharply up and down as the market rushes to invest a position or sell one.
These technical factors could end up driving up the share price more than Coinbase’s trading performance. High levels of volatility can cause investors to sell – or buy – just when they shouldn’t.
3. Double-class stocks are not popular
Coinbase will go public with a dual class share structure, meaning it has two classes of shares. This structure gives certain insiders, often executives, additional voting control. For example, insiders can get 10 votes per share, while normal shares get one vote per share.
For Coinbase, insiders hold more than 60% control of the votes, which means they will have enough power to run the business and handle other important matters, such as how they are paid.
A two-class equity structure is not popular with outside investors because the structure means they have less say in how the business is run. Instead, the structure makes it easier for insiders to get established and run the business as they see fit.
While this issue is distinct from the risks of a direct listing, a small direct listing could attract investors less sensitive to this dual class structure than institutional investors. However, some very successful companies, such as Alphabet, have established similar structures.
4. Insiders – and only insiders – sell
In most market launches, whether traditional IPOs or direct listings, insiders sell shares to third parties. Why does this insider – who probably knows the company best – want to involve a stranger in the action? Investors always want to ask this question.
In a direct listing like Coinbase, the company itself is not collecting cash, so only insiders are looking to withdraw money. Insiders can sell for a number of reasons, such as having most of their assets linked to a single investment, creating a lot of risk for them personally. But the reasons may also be less harmless, and insiders may want to sell definitively and put the risk on outsiders.
In a traditional IPO, investors have certain protections against such insider trading. The conditions of the IPO often prevent insiders from selling other shares in the public market until a certain time after the IPO (“a lock-up”), which gives investors time. to assess the company.
However, the restrictions are generally weaker in a direct listing, and in Coinbase’s case none of its shareholders are locked up, so they could sell and release all of their shares in the market.
So all of those things together – insider selling, the ability to sell unrestricted stocks, a dual-share structure that prioritizes insiders, and – creates an unappealing perception. So there is a configuration which looks as insiders might benefit from foreign investors. But it’s a question of optics, and this trifecta doesn’t look pretty.
At the end of the line
While there are some risks associated with a direct listing may make Coinbase initially unattractive to some, it could turn out to be a great investment. But investors should consider the risks, including the IPO via this eccentric-style IPO, and what they may indicate.
That said, other recent trending direct ads including Slack and Palantir have gone without major issues, so a direct ad can work.
Of course, direct listing is only a risk, and investors should consider the many other risks associated with Coinbase, as they would with any investment. Coinbase can become a great investment as cryptocurrencies such as Bitcoin gain popularity. Either way, investors will want to understand the business, how to invest intelligently and how to diversify before launching.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past performance of investment products is not a guarantee of future price appreciation.