4 ms·

I don't get this argument. Don't the underwriters provide an obvious service that will always have utility for some private companies: risk management?

jedberg 9y ago
My understanding is that the underwriters are gatekeepers, not risk managers. If your stock underperforms, you have to pay them back, but if your stock over performs, they keep the extra. In theory the service they provide is valuation, but in this day and age of instant information, that really isn't necessary anymore. Back in the day when it took a few days for a person to execute a trade, maybe they provided valuable insight, but now, with stock trades for retail investors taking seconds from "I want that" to "I have that", they don't really have better information anymore.
- chimeracoder 9y ago
  > My understanding is that the underwriters are gatekeepers, not risk managers. If your stock underperforms, you have to pay them back, but if your stock over performs, they keep the extra. That's typically not true. The underwriter isn't guaranteed the difference. They're basically an insurer: the company is able to know (before the IPO) exactly how much money they can expect to make on it. In exchange for this certainty, the forego the potential upside (the chance that the opening price will be much higher, in which case the company is leaving money on the table). In this case, Spotify isn't even raising any money (because this is a direct listing, not an IPO), so there's no point for underwriters, because... well, there's no uncertainty about how much money they'll be raising, since they're not raising any.
  - jedberg 9y ago
    That's what I thought too, but someone from the investment banking industry corrected me the last time I said that, and pointed out that "banks never lose money", and that the company does eventually have to repay them.
    - chimeracoder 9y ago
      Underwriters aren't gatekeepers by definition, because there's nothing preventing companies from foregoing underwriters. But almost every single company that goes public chooses to[0], because they gain significant value from the process. There are a few exceptions - Google is the most famous one. But they're rare, and even Google ran into trouble with theirs - they literally had to cut the size of the amount they raised in half about a week before the IPO, because the demand was lower than they thought, and then ended up leaving a lot money on the table. We forget about all of that today because Google is now a successful public company. But their IPO was unambiguously a disaster from the company's perspective - they would have raised much more money with a conventional process. > That's what I thought too, but someone from the investment banking industry corrected me the last time I said that, and pointed out that "banks never lose money", and that the company does eventually have to repay them. No, that's not true. If the IPO is undersubscribed, the company isn't liable for making the bank whole. If that were true, then yes, there would be literally no reason for a company to use an underwriter, because there's no requirement to.
      - jedberg 9y ago
        > because there's nothing preventing companies from foregoing underwriters. Isn't that like saying "there is nothing that prevents you from using highways"? Like sure, you don't have to use an underwriter, but, as you pointed out with the Google example, it won't go well for you if you leave them out.
        chimeracoder 9y ago
        > Like sure, you don't have to use an underwriter, but, as you pointed out with the Google example, it won't go well for you if you leave them out. Well, the original claim was that underwriters provide negative value. There's a tradeoff, but clearly they do provide positive value, on net.
- JumpCrisscross 9y ago
  > If your stock underperforms, you have to pay them back You're referring to the greenshoe [1]. Suppose a company is selling 100 shares at $100 per share. The underwriter will collect orders for 115 shares at $100 per share. This puts them in a natural short position. A greenshoe lets the underwriter buy up to 15 additional shares from the company at $100 per share. If the price goes up to $105, they exercise the greenshoe. They buy 15 shares from the company at $100 and deliver them to the buyers to whom they sold shares they didn't have. If the price goes down to $95, they buy those shares (leaving the greenshoe un-exercised) and deliver them to the buyers to whom they sold the shares at $100. [1] https://en.wikipedia.org/wiki/Greenshoe https://en.wikipedia.org/wiki/Greenshoe
chimeracoder 9y ago
> I don't get this argument. Don't the underwriters provide an obvious service that will always have utility for some private companies: risk management? Yes, and furthermore, the Spotify listing is anomaly in a lot of ways due to the idiosyncratic terms under which they raised money previously, and the fact that the major labels (who are their primary vendors) had ownership stakes in them from the very beginning. In IPOs, companies raise money, and underwriters serve as insurers to guarantee the amount that the company will raise. But Spotify isn't even raising any money today! They're just providing liquidity for existing shareholders. That's dramatically different from IPOs, so of course the underwriters are superfluous for this particular case. I don't think it makes sense to generalize anything from Spotify, but certainly not the role of underwriters.
eganist 9y ago
Well, that and aid with the capital raise. In this case, my understanding is there wasn't a capital raise so much as there was an opportunity for existing shareholders to liquidate their positions. Edit: yep. > The digital music company isn’t selling its shares on the stock market, meaning the company isn’t raising any money today. Instead, the event known as a “direct listing,” is a collection of transactions from existing shareholders (like employees and investors) selling shares directly to stock market investors. It took a while for the market makers to sort this out.
- chimeracoder 9y ago
  > In this case, my understanding is there wasn't a capital raise so much as there was an opportunity for existing shareholders to liquidate their positions. Yup, Spotify was under contractual requirements to go public, due to the terms of their last fundraising round (or else they had to pay incredibly stiff penalties). Underwriters serve a role for most IPOs, but Spotify is different because their listing wasn't about raising money - it was about fulfilling their contractual requirements to provide liquidity on public markets so that they could avoid the penalties they would otherwise face.
  - JumpCrisscross 9y ago
    > Spotify was under contractual requirements to go public, due to the terms of their last fundraising round Spotify was under obligation to do an IPO. Part of the motivation for this structure was avoiding that penalty language.
    - chimeracoder 9y ago
      > Spotify was under obligation to do an IPO. Part of the motivation for this structure was avoiding that penalty language. To be specific: they did a DLP, not an IPO. Underwriters make sense for IPOs, because the company is raising money. There's no point to an underwriter in an DLP, because the company isn't raising money. They were not under requirements to hold an IPO; they were required to provide public liquidity to their shareholders. That's why they chose a process that involved no underwriting. And that's also why their case doesn't really provide any generalize lessons, because those types of terms are incredibly rare in growth-stage venture financing.
JumpCrisscross 9y ago
> Don't the underwriters provide an obvious service that will always have utility for some private companies: risk management? IPOs have (a) companies issuing stock, (b) private investors selling stock and (c) public investors pricing an asset never before continuously priced. All this happens simultaneously. If the ball drops on one, it drops on them all. Underwriting is a good way to manage that risk. Private markets challenge that simultaneity. Instead of selling into the IPO, companies can sell some in the private markets and some after going public. Instead of having every insider sell on opening day, they can sell in private secondaries and then after the lock-up. That leaves element (c) isolated. That's difficult--Spotify still hired bankers--but it doesn't need underwriting. Another way to look at it: three services were bundled into the traditional IPO. Bankers charged richly for the bundle. Private markets give companies the option, to dis-assemble the bundle and price and time them separately.

jedberg 9y ago

My understanding is that the underwriters are gatekeepers, not risk managers. If your stock underperforms, you have to pay them back, but if your stock over performs, they keep the extra. In theory the service they provide is valuation, but in this day and age of instant information, that really isn't necessary anymore. Back in the day when it took a few days for a person to execute a trade, maybe they provided valuable insight, but now, with stock trades for retail investors taking seconds from "I want that" to "I have that", they don't really have better information anymore.

chimeracoder 9y ago
> My understanding is that the underwriters are gatekeepers, not risk managers. If your stock underperforms, you have to pay them back, but if your stock over performs, they keep the extra. That's typically not true. The underwriter isn't guaranteed the difference. They're basically an insurer: the company is able to know (before the IPO) exactly how much money they can expect to make on it. In exchange for this certainty, the forego the potential upside (the chance that the opening price will be much higher, in which case the company is leaving money on the table). In this case, Spotify isn't even raising any money (because this is a direct listing, not an IPO), so there's no point for underwriters, because... well, there's no uncertainty about how much money they'll be raising, since they're not raising any.
- jedberg 9y ago
  That's what I thought too, but someone from the investment banking industry corrected me the last time I said that, and pointed out that "banks never lose money", and that the company does eventually have to repay them.
  - chimeracoder 9y ago
    Underwriters aren't gatekeepers by definition, because there's nothing preventing companies from foregoing underwriters. But almost every single company that goes public chooses to[0], because they gain significant value from the process. There are a few exceptions - Google is the most famous one. But they're rare, and even Google ran into trouble with theirs - they literally had to cut the size of the amount they raised in half about a week before the IPO, because the demand was lower than they thought, and then ended up leaving a lot money on the table. We forget about all of that today because Google is now a successful public company. But their IPO was unambiguously a disaster from the company's perspective - they would have raised much more money with a conventional process. > That's what I thought too, but someone from the investment banking industry corrected me the last time I said that, and pointed out that "banks never lose money", and that the company does eventually have to repay them. No, that's not true. If the IPO is undersubscribed, the company isn't liable for making the bank whole. If that were true, then yes, there would be literally no reason for a company to use an underwriter, because there's no requirement to.
    - jedberg 9y ago
      > because there's nothing preventing companies from foregoing underwriters. Isn't that like saying "there is nothing that prevents you from using highways"? Like sure, you don't have to use an underwriter, but, as you pointed out with the Google example, it won't go well for you if you leave them out.
      - chimeracoder 9y ago
        > Like sure, you don't have to use an underwriter, but, as you pointed out with the Google example, it won't go well for you if you leave them out. Well, the original claim was that underwriters provide negative value. There's a tradeoff, but clearly they do provide positive value, on net.
JumpCrisscross 9y ago
> If your stock underperforms, you have to pay them back You're referring to the greenshoe [1]. Suppose a company is selling 100 shares at $100 per share. The underwriter will collect orders for 115 shares at $100 per share. This puts them in a natural short position. A greenshoe lets the underwriter buy up to 15 additional shares from the company at $100 per share. If the price goes up to $105, they exercise the greenshoe. They buy 15 shares from the company at $100 and deliver them to the buyers to whom they sold shares they didn't have. If the price goes down to $95, they buy those shares (leaving the greenshoe un-exercised) and deliver them to the buyers to whom they sold the shares at $100. [1] https://en.wikipedia.org/wiki/Greenshoe https://en.wikipedia.org/wiki/Greenshoe

chimeracoder 9y ago

> I don't get this argument. Don't the underwriters provide an obvious service that will always have utility for some private companies: risk management? Yes, and furthermore, the Spotify listing is anomaly in a lot of ways due to the idiosyncratic terms under which they raised money previously, and the fact that the major labels (who are their primary vendors) had ownership stakes in them from the very beginning. In IPOs, companies raise money, and underwriters serve as insurers to guarantee the amount that the company will raise. But Spotify isn't even raising any money today! They're just providing liquidity for existing shareholders. That's dramatically different from IPOs, so of course the underwriters are superfluous for this particular case. I don't think it makes sense to generalize anything from Spotify, but certainly not the role of underwriters.

eganist 9y ago

Well, that and aid with the capital raise. In this case, my understanding is there wasn't a capital raise so much as there was an opportunity for existing shareholders to liquidate their positions. Edit: yep. > The digital music company isn’t selling its shares on the stock market, meaning the company isn’t raising any money today. Instead, the event known as a “direct listing,” is a collection of transactions from existing shareholders (like employees and investors) selling shares directly to stock market investors. It took a while for the market makers to sort this out.

chimeracoder 9y ago
> In this case, my understanding is there wasn't a capital raise so much as there was an opportunity for existing shareholders to liquidate their positions. Yup, Spotify was under contractual requirements to go public, due to the terms of their last fundraising round (or else they had to pay incredibly stiff penalties). Underwriters serve a role for most IPOs, but Spotify is different because their listing wasn't about raising money - it was about fulfilling their contractual requirements to provide liquidity on public markets so that they could avoid the penalties they would otherwise face.
- JumpCrisscross 9y ago
  > Spotify was under contractual requirements to go public, due to the terms of their last fundraising round Spotify was under obligation to do an IPO. Part of the motivation for this structure was avoiding that penalty language.
  - chimeracoder 9y ago
    > Spotify was under obligation to do an IPO. Part of the motivation for this structure was avoiding that penalty language. To be specific: they did a DLP, not an IPO. Underwriters make sense for IPOs, because the company is raising money. There's no point to an underwriter in an DLP, because the company isn't raising money. They were not under requirements to hold an IPO; they were required to provide public liquidity to their shareholders. That's why they chose a process that involved no underwriting. And that's also why their case doesn't really provide any generalize lessons, because those types of terms are incredibly rare in growth-stage venture financing.

JumpCrisscross 9y ago

> Don't the underwriters provide an obvious service that will always have utility for some private companies: risk management? IPOs have (a) companies issuing stock, (b) private investors selling stock and (c) public investors pricing an asset never before continuously priced. All this happens simultaneously. If the ball drops on one, it drops on them all. Underwriting is a good way to manage that risk. Private markets challenge that simultaneity. Instead of selling into the IPO, companies can sell some in the private markets and some after going public. Instead of having every insider sell on opening day, they can sell in private secondaries and then after the lock-up. That leaves element (c) isolated. That's difficult--Spotify still hired bankers--but it doesn't need underwriting. Another way to look at it: three services were bundled into the traditional IPO. Bankers charged richly for the bundle. Private markets give companies the option, to dis-assemble the bundle and price and time them separately.