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U.S. companies that are going public through a direct listing can now raise capital in the process, following the recent approval by the Securities and Exchange Commission of a proposal by the New York Stock Exchange.

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The change 鈥渉as the potential to transform the equity markets,鈥� NYSE vice chairman and CMO John Tuttle wrote on LinkedIn.

Until now, the ability to raise capital was a key difference between a traditional initial public offering and a direct listing, but the rule change means there鈥檚 now another option for companies that don鈥檛 want to go through the hassle of an IPO, but that still want to raise money in the process of going public.听

How direct listings and IPOs differ

A traditional IPO involves the sale of newly-issued securities to underwriters and their clientele, while a direct listing is something like a secondary sale of existing shares.听

• IPO: In a traditional IPO, a block of shares is sold to institutional investors at a set price. The IPO approach gave companies a way to both go public and raise capital in the process.听
• Direct listing: In contrast, a company doing a direct listing starts trading without a block of shares being sold, and therefore without new capital being raised. A direct listing gave founders, vested employee shareholders, and prior investors a path to liquidity. The approach has become increasingly popular in recent years because it gives companies that want to trade their stock on a public exchange a way to get there without the extra money and hassle of a traditional IPO.听

There are reasons why a company might want to go the direct listing route rather than a traditional IPO, including to save money on bank fees and avoid lockup periods. But it wasn鈥檛 ideal for a company that needed to raise capital, and nowadays that鈥檚 most companies. (You can read more about the difference between an IPO and a direct listing here).

How the rule change works

With the change, a direct listing combined with a capital raise can present a company with something of a happy medium: go public and raise money, but save money on underwriters.

鈥淲e are adding the option for newly issued shares, either alongside existing shares or standalone, to be priced in an opening auction,鈥� Tuttle wrote. 鈥淭he value of these newly issued shares represents the capital raised by the company. All of the newly issued shares sold by the company itself must be sold in the opening auction, at one price and at one time. Selling shareholders may also sell in the opening auction if there is demand for additional shares at the opening auction price and may also sell at any time after the opening auction is completed.鈥�

, a general partner at Benchmark known for investing in Uber, Zillow, and Grubhub and a frequent critic of IPOs, tweeted that the NYSE鈥檚 announcement was 鈥渞eally big.鈥�

IPOs have been under a lot of scrutiny for being expensive and not always priced correctly. Many companies that have gone public this year have seen their stock trade far above the set IPO price, meaning that the shares were not priced as high as they could have been, and money was left on the table.

鈥淲e could get to a modern approach where Silicon Valley companies, founders, employees, and investors don鈥檛 have a 40 percent costs of capital to enter the public markets,鈥� Gurley .听

Direct listings have attracted more attention in recent years as high-profile companies like Spotify and Slack have chosen to go public that way. Two high-profile startups, and , are also expected to go public through a direct listing rather than an IPO.听

The SEC鈥檚 approval of the NYSE鈥檚 proposal also comes as some companies choose to go public via special purpose acquisition companies, or blank-check companies, another alternative to the traditional IPO.听

Illustration: Dom Guzman