CHAPTER 16

Unity, San Francisco, October 2019

On October 1, Jabal made her way to the Palace, a San Francisco luxury hotel favored by the finance and tech crowd for conferences and other large events. With its marble columns and ornate chandeliers, the hundred-year-old hotel was an interesting location for a convergence of some of the world’s most innovative companies. Jabal was one of more than a hundred startup executives and venture capitalists attending a half-day symposium about direct listings that Gurley, with help from Moritz, had organized.

Attendees received an agenda with the event’s title laid out in blue ink: “Direct Listings: A Simpler and Superior Alternative to the IPO.” Gurley had planned the event as a series of panels and question-and-answer sessions to educate the audience about his preferred way of entering the public markets. Moritz interviewed McCarthy and then Gurley followed, speaking for thirty minutes or so. A hoped-for video appearance from former Wall Street analyst Henry Blodget, a fervent critic of the entrenched IPO system, was beset by audiovisual issues.

Gurley had explicitly prevented investment bankers from attending his event. He clearly felt that they had too much control already, and he didn’t want them advocating for the traditional IPO process or otherwise undermining his message. He made two exceptions.

One, Carl Chiou, was head of West Coast equity capital markets at boutique investment bank William Blair and a former Barclays PLC convertible bond expert. Convertibles required near-perfect pricing—and when Chiou started working on IPOs that Barclays underwrote, he couldn’t understand why the process was so inefficient. He concluded that the problem was the conflicted position of the larger banks and their tendency to favor investor clients such as hedge funds over corporate clients. He soon left for Blair, where he was trying to build a franchise free of the conflicts that plagued his larger rivals.

Chiou had been putting out research reports that highlighted his analytical savvy, writing chops, and extreme “dad-ness.” Both these—in which he occasionally referred to his two sons and their favorite topics, including the American Revolution and obscure Star Wars characters—and his Twitter feed had become required reading at Benchmark and Andreessen Horowitz.

Gurley had also invited a Citigroup banker named Doug Baird to the symposium. Baird’s more than thirty years of experience included senior positions running IPOs in the 1990s at Alex. Brown & Sons. The balding Dartmouth grad had a self-deprecating sense of humor and an irreverent take on IPOs that kept him from getting hung up on historical precedent.

Importantly, neither had ever worked at Goldman Sachs or Morgan Stanley, the duopoly of investment banks that ran the most sought-after tech IPOs.

Baird and Chiou spent roughly half an hour offering a “Voice of Reason,” as their panel was titled, explaining why they thought the traditional IPO was ripe for disruption. Wearing a dress shirt and slacks, Chiou encouraged the corporate executives in the audience to take ownership of their listing. He acknowledged that they might have come up believing that bankers and investors drove IPOs. But he reminded them that they were the ones who built the companies. They should feel empowered to shape the transaction for their purpose. Chiou implored them to understand the depth of their power and to use it to take more control of the most critical moments of the stock listing, when the shares got priced and allocated. He assured them that a direct listing was a viable alternative to the traditional IPO.

“You are the stars of the show,” he told the audience. “Find people who are willing to show you transparency into how the process really works, and who are willing to work with you on a totally unconflicted basis where you are the only client.”

Baird, the consummate investment banker in his suit, began his section of the presentation with a history of how IPOs had changed over the years. He discussed how a process that began as a way to determine the valuation of a non-public company had evolved into something resembling a transfer of value from companies to investors. In the early 1990s, bankers assigned stock prices in the low double digits and expected them to rise around 10 percent the following day, Baird explained. A series of events, including Broadcast.com’s 1998 stock pop, Bear Stearns’s lowered underwriting standards, and the internet boom, changed the equation. From then on, the idea that trading up on the first day was a sign of a good company.

Baird told the story of eBay, which went public on September 21, 1998. As one of the underwriters, Baird’s firm got the list of the allocations. Securities filings showed the holdings of investors at the end of that month—nine days later. Fewer than five investors still held the stock, Baird said. Everyone else had quickly flipped it for a profit.

Baird wasn’t done. He lampooned a metric that fellow bankers liked to cite—how many (and what percentage) of one-on-one meetings between a company and an investor led to an IPO order. On tech IPOs, he said, bankers liked to tout rates of higher than 90 percent. He cited a deal Citigroup had done for a private equity firm. The hit rate was more like 60 percent, he said. The stock rose 5 percent the next day, and the private equity company did a series of follow-on sales as the stock continued to rise over the next couple of years.

Once the bankers had finished their presentation, University of Florida professor Jay Ritter spoke to the audience about his decades of experience researching the IPO market. In Ritter’s view, banks had an incentive to sell undervalued IPOs to investors because they received some portion of that value back in the form of trading commissions. Company executives didn’t mind, Ritter theorized, because the absolute leap in their wealth numbed them to any worries about leaving some money on the table for their companies. Ritter and a coauthor, Tim Loughran, had likened the effect to prospect theory in a 2002 paper titled “Why Don’t Issuers Get Upset About Leaving Money on the Table in IPOs?”

After an interview with Stacey Cunningham, who had become the NYSE president, and a short break, McGurk gave a presentation. By then a managing partner at Coatue Management, a hedge fund that made many investments in private technology startups, McGurk walked the audience through the nuts and bolts of the direct listing process.

Sessions on the designated market maker’s role, a legal perspective, and panels with institutional investors and CEOs who had already gone through the IPO process followed. The conference broke for a cocktail hour sponsored by Latham & Watkins, after which the guests sat down for dinner and author Michael Lewis was interviewed onstage by Gurley.

Jabal tried to learn as much as she could. She left with two surprising realizations. Unity would still have to pay millions of dollars to investment banks, because direct listings were expensive. And they were also time-consuming.

Days later, Goldman Sachs hosted its annual Private Innovative Company Conference at the Wynn Las Vegas. The ninth such event, it gathered more than five hundred people from across the venture, private equity, and startup industries to connect and network with each other. Unlike Gurley’s symposium, the event gave investment banks an opportunity to speak directly to their clients, many of whom were in various stages of considering life as a public company.

Riccitiello and Jabal had flown in from California. They were in the audience on Sunday, October 4, when Goldman hosted a panel on direct listings. McCarthy and Greg Rodgers sat onstage next to Goldman’s head of equity capital markets for technology companies, Will Connolly, and Jake Siewert, head of Goldman’s communications department. Siewert introduced the panelists and turned it over to Connolly to open the discussion.

Connolly was dressed casually for a banker, in a blazer, jeans, and loafers. His youthful face showed traces of stubble. After a brief joke about not starting at the invention of the mutual fund, he gave a short history of IPOs and attempted to show that Goldman was a creative investment bank open to recent changes. “We had the unique opportunity to work with both Spotify and Slack as the lead advisor on their direct listings over the course of the last couple of years,” Connolly said. “And we’re thrilled for their success, and Barry in particular, in really being the innovative force behind this new technology, if you will. And we’re excited about the opportunity to continue to seek innovation on behalf of our clients.”

When it came time for Siewert to ask questions, he repeatedly referred to the inherent riskiness of nontraditional IPOs. His questions reflected the risk-averse nature of the investment bank and the advice it typically gave clients. He started with a question for McCarthy, whom he referred to as a trailblazer. “It was obviously risky to do it, but what gave you the confidence to know that it was the right thing to do for Spotify?”

McCarthy, wearing a dark designer t-shirt and white jeans, took a moment to thank the host while also deflecting some of the praise. “Before I answer that, let me just suck up to my host and say: no Goldman Sachs, no Spotify,” McCarthy said. The comment served as a tip of the hat to Goldman’s importance in Spotify’s success, through the bank’s help with both Spotify’s private funding rounds and its public market debut. “And how much of an innovator was I? I just took an old, tired idea that had already existed in the public markets and recrafted it and applied it to a tech IPO.”

According to McCarthy, Spotify was able to do a direct listing because it was so much bigger than Netflix was at that stage. “I realized that it was one of those ‘Dorothy, we’re not in Kansas anymore’ moments,” he ad-libbed. “And for a long time, I have watched the public market and thought that it was chronically broken. And I thought surely there must be a better way.”

McCarthy made a comment about the direct listing allowing market-based pricing, leading Siewert to follow up with a question about companies handpicking their shareholders. “You talk about having the market decide the price and deciding who gets the shares. Most of the people in this room have had the ability so far to choose their shareholders and choose their prices. What’s that transition like?”

“As a public company, you don’t have any control over who your shareholders are,” McCarthy answered. “If you think you’re going to, you need to lie down till the thought passes, then get back up.

“The best you can hope to do is go spend time with people you think are really smart and convince them that they ought to own the stock, too,” he said. “So you can encourage some people to buy it based on the way you allocate your time, but you can’t prevent others from owning the stock once it becomes public.”

Not only that, he said, but long-term shareholders like Fidelity and T. Rowe Price would have no influence on the stock price because they had theoretically put the stock on the shelf, he said. “No influence whatsoever.”

Over his Netflix career, McCarthy watched as the average size of trades became smaller and smaller even as volume increased. He learned that it was because high-frequency traders, guided by algorithms that initiated orders in fractions of a second, had become a larger part of the market. They set the stock prices, he told the audience.

“Go spend time with the big guys,” McCarthy said, referring to large institutional investors like Fidelity or T. Rowe Price, and offering a couple of reasons for his recommendation. “One, they can buy a lot of stock, so you get a good return on your investment of time. Two, they’re super-smart, they have great insights, so you’ll learn a lot. Those will be more enjoyable meetings. But don’t do it because you think it will help your stock price—it won’t.”

At that, Siewert directed his next question to Rodgers, the best turned-out of the panelists, with a red pocket square sticking out of his dark blazer. Siewert asked Rodgers to discuss how the SEC was thinking about the direct listing in relation to the traditional IPO.

“Spotify came around at exactly the right time in the sort of regulatory regime,” Rodgers said. “Over on the SEC side, we got sort of lucky. The chairman of the SEC, Jay Clayton, is an ex–deal guy himself. The head of corporate finance is a guy named Bill Hinman, he’s a deal guy from the Valley. So from a very top-down perspective, we got a lot of support for trying to do something new. That’s sort of the good news.”

The SEC was focused on protecting the small investor, so once Spotify got buy-in from the top, it took roughly a year to work through the agency’s concerns, Rodgers said. The upside to all that work, Rodgers told the audience, was that one of the SEC’s top officials that very day had referred to the way that Spotify and Slack did their transactions as “the old way.” Two direct listings “is now a playbook we can follow, and as long as you know the secret sauce, you should be fine if you go that route,” he said.

Siewert returned to focus on risk. Then he asked Connolly how he would rate the two direct listings from the perspective of institutional investors. Connolly said that both listings were “hands-down successful.” For that reason, there would be more of them, he said. He called out a couple of places where he thought the investor community would adapt. One investor, he said, didn’t understand Spotify’s process but became one of the most active in Slack’s listing. “That shows the market’s learning, and the market’s capable of learning,” Connolly said, pinpointing ways in which he expected the direct listing to evolve, particularly in giving companies an option to raise capital.

Siewert pivoted to McCarthy, again speaking of risk and asking the CFO if he had any advice for the audience considering his approach.

“Looking back on your IPO ten years from now, you’ll realize that notwithstanding all of the hoopla, it’s just a financing event,” McCarthy said. “So if your business needs cash, just think opportunistically about where your lowest cost of capital is, go get it when the window opens, and then if you have the luxury of being well-capitalized, you can think more creatively about your going-public event.”

Connolly was asked about the evolving options for companies going public. “There’s no cookie-cutter approach that should be employed for every company,” Connolly said. “People are going to start saying: What am I trying to design? And it’ll be more efficient than when Spotify did it, because they broke a lot of new ground.” People, he said, “will feel greater license to modify things around their set of objectives.”

McCarthy had one warning for startup executives regarding direct listings: communicate their financial results and the overall structure of their business model directly to investors. Companies can lean on investment banks to do that in a traditional IPO, but that’s not the case in a direct listing. They must be willing to teach investors, issue guidance, and hold an investor day. “However little you know about your business, you know a lot more than they do,” he said of investors. “If you’re waiting for them to fill in the blanks, it’s going to end badly for you.”

A technology and health care portfolio manager in the audience, who had founded and sold startups earlier in his career, had grown frustrated with some of the narrative around direct listings. In his view, the context of Gurley’s pronouncements hung over the Goldman panel. The portfolio manager felt that Gurley had oversold the notion that public-investment returns should be avoided by newly public companies at any cost and wondered if the venture capitalist simply wanted the greater flexibility that direct listings offered around when he could sell his stakes in newly public startups.

After the panel ended, the portfolio manager sat next to the CFO of a company that had recently gone public. “I feel like I left so much money on the table,” the CFO said. He showed the portfolio manager a chart of his company’s stock price, which had continued to rise after its IPO.

“Are you kidding me?” the portfolio manager responded. Like other CEOs and CFOs, this executive seemed to have come to accept Gurley’s position without giving it a lot of thought. The portfolio manager explained that the rising stock price pleased the CFO’s public market investors and his employees.

Company executives liked to see their stock prices rise steadily, contributing to employee morale and attracting a stable base of investors. Spotify and Slack shares had fallen in price after their direct listings.

“Look at Spotify’s chart, look at Slack’s chart,” the portfolio manager said to the CFO. “Do you actually want your stock chart to look like that?”

“Oh my God,” the CFO said. “You’re so right.”

As the conference wrapped up for the evening, and Jabal returned to San Francisco, she was no more in favor of direct listings than when she had arrived. There was still a lot of uncertainty.

McCarthy flew back to New York on a private jet with the leaders of Tiger Global.

Siewert had attempted to put a friendly face on Goldman Sachs’s support of direct listings. But his questions about their heightened degree of risk showed an underlying skepticism that went all the way to the top of the Wall Street bank.