Stock exchange operator Nasdaq has successfully petitioned the SEC (U.S. Securities and Exchange Commission) to allow companies to raise capital through direct listings. This presents companies that have not yet debuted on the stock market with an alternative to the traditional IPO (initial public offering).
Companies looking to raise interest-free capital from the public by listing their shares can do so either through an IPO or a direct listing. The main difference between the two is that an IPO requires the services of intermediaries (called underwriters) who charge a commission for facilitating the process, whereas a direct listing sells straight to the public without an intermediary but loses out on the safety net and support provided by an underwriter.
The direct listing is the less expensive option, more likely to benefit small businesses who may not have the resources to pay underwriters. Also, many private companies hesitate to go public because of the role played by investment banks in the IPO process. Investment banks have come under criticism by prominent venture capitalists for their approach to organizing IPOs. Banks have been critiqued for underpricing the offerings to benefit their clients on the first day the new stock begins trading.
In August 2020, Reuters reported that Nasdaq had filed with the SEC to change its rules regarding direct listings. In explaining the favorable ruling issued this May, the SEC stated that the change “has the potential to broaden the scope of investors that are able to purchase securities in an initial public offering, at the initial public offering price, rather than in aftermarket trading” (see the full text for the new ruling here).
The New York Stock Exchange received approval for a similar proposal in December 2020, allowing companies to raise capital on the NYSE through direct listings. Previously, the SEC only allowed direct listings for companies that did not raise capital in the process.
How might this benefit those looking to invest in qualified small business stock (QSBS)? Small businesses that would have been unable to afford the IPO option now have added flexibility to go public through a direct listing. More small businesses may go public due to this ruling, potentially increasing the opportunities for people holding QSBS to realize gains. QSBS can come with substantial tax benefits, since the IRS allows individuals to exclude up to 100% of capital gains on this stock if the requirements are met.
QSBS Expert offers more guidance on how to understand and benefit from QSBS investments.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.