Here’s why Spotify is bypassing the normal IPO process — and why more companies don’t do it

By listing shares for sale on an exchange, a company cuts out the middle man. That means foregoing the usual process of enlisting underwriters who market the stock to institutional investors.

In other words, the company is flying solo and hoping there’s already enough pent-up investor interest. And it’s saving itself from having to pay hefty fees in the process.

So how does Spotify arrive at a trading price on its first day of trading? After all, a normal IPO arrives in the market with a price that’s been established through the maneuverings of underwriters.

In the end, it’ll be the type of auction that takes place when a stock is first available for trading — except without that initial pricing backstop. That likely means at least one day of highly volatile movements as investors discover a price. It’s relatively uncharted territory, and as Bloomberg’s Matt Levine pointed out in a recent column, it “will be a whole new kind of fun.”

Why is Spotify planning to do one, and what does it mean for existing investors?

As mentioned above, doing a direct listing can save millions of dollars in underwriting fees. However, that alone is no reason to do one. Most companies would experience major issues building demand without a banking contingency marketing its shares behind the scenes. Spotify’s willingness to bypass underwriters shows how big of a wager the company is making on its existing investment profile.

And it makes sense when you look at where Spotify stands right now. The company said last week that it had reached 70 million subscribers, while it received a private market valuation of as much as $19 billion last year. With those statistics in mind, it’s perhaps a little easier to understand that the company would bet on itself.

In the end, Spotify doesn’t need public investors to achieve a huge market valuation. All it needs is more share liquidity — something that an exchange offers that the company can’t get anywhere else.

“When we think about why companies go public, they do it for liquidity, to raise their profile, for capital,” John Tuttle, head of global listings at NYSE, told Business Insider. “But for those companies that are well-capitalized, all they really need is liquidity.”

Tuttle also noted that direct listings are “not for every company.”

So what does this all mean for existing investors? Most importantly, they won’t have their holdings diluted by underwriters or large institutions.

Recode’s Edmund Lee perfectly summarized Spotify CEO Daniel Ek’s reasoning in a recent article: “Why give all that money to brokers and big funds instead of to people who own Spotify, like his investors, his employees and Ek himself?”

Why doesn’t every company do one?

The answer to this question can be mostly figured out through the rationale offered above, and it’s pretty simple: only the most highly-valued and publicly-visible companies are equipped to pull off a direct listing.

Spotify is in a unique situation, having achieved a so-called “unicorn” valuation multiple times over, while also being tied to the music-listening habits of millions of people across the globe. It’s well-positioned to thrive on the open market without the investment banking infrastructure that normally props up a newly-public company.

What are the risks?

At the time of listing, the deal hasn’t been shopped around to large institutions that have historically been known to buy big chunks of shares and hold on to them for far longer than the average day trader.

This leaves the stock more exposed to volatility, which can be a double-edged sword, and might ultimately dissuade those institutions from entering the shares as a stabilizing force. Also contributing to price swings will be the price discovery outlined above — which will occur when Spotify shares hit the market without underwriter help.

Another risk — albeit one that doesn’t matter to Spotify directly — is that a successful direct listing could inspire copycats to try and circumvent the IPO process. As stated throughout, Spotify is uniquely positioned to thrive through a direct offering, and other companies might not be so fortunate.

Frank Chaparro contributed reporting.