investing

How the Spotify IPO Broke the Rules

Look for other big companies to sell shares directly when they go public.

When Spotify announced an initial public offering in the spring, headlines focused less on the decision to go public than how the music-streaming giant chose to do it. Rather than hiring underwriters to bring the stock to market, Spotify listed its shares directly on the New York Stock Exchange. Other well-known companies mulling a public offering, such as Uber and Pinterest, may follow Spotify's example, says University of Florida finance professor Jay Ritter.

Typically, when a company wants to raise money by going public, it hires an underwriter–usually an investment bank–to drum up interest among investors. The underwriter sells shares to investors (usually large institutions rather than individual investors) at an offering price determined by the bank and the company.

By listing shares directly on an exchange, Spotify saved money in two ways, Ritter says. The firm avoided the fee paid to underwriters and sold shares directly at market price, rather than at an artificially low offering price set by the investment bank and issuing company.

Despite its unorthodox IPO, Spotify's shares didn't do anything out of the ordinary. The difference between the stock's first-day high of $169 and low of $148 was 14%, putting it in line with Twitter (14%) and Chinese e-commerce giant Alibaba (11%).

Recent successful IPOs by Spotify and data storage company Dropbox could encourage other private companies to go public in the next few months. If you're considering buying a stock following its IPO, examine the company's annual sales, which you can find in its S-1 filing with the Securities and Exchange Commission. In the three years following an IPO, companies with substantial sales significantly outperform those with little or no sales, says Ritter. Companies with less than $10 million in sales had an average three-year loss of 9.5%.

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