Why Spotify’s IPO-less IPO is a smart idea

Here’s a smart idea: If you have a startup and you want your investors to get as much as they can for their shares, consider listing your stock without an IPO.

That’s what Spotify is thinking of doing, according to Mergermarket and the Wall Street Journal.

Yeah, it’s weird. Here’s how that might work, and why it might be good for Spotify’s investors.

In a traditional IPO, the company listing the stock sells shares to a bunch of institutional investors, like hedge funds and pension funds, at an “initial offering price.”

The next day, those institutional investors sell those shares on an open exchange like the New York Stock Exchange. This is when regular folks can buy shares, but at a higher price than the IPO. That’s what generates the “pop” you always read about on IPO day. The pop also comes since the institutional investors should get a return for the risk they took in the IPO.

Let’s take a recent, real-world example: Snap sold stock in its IPO last month for $17 a share. That means Snap’s early investors, like Benchmark, got $17 for every share they sold. But the next day, when those IPO investors sold shares on the NYSE, the stock traded at $24, a 41 percent pop above the IPO price.

Every penny above $17 is a penny Snap and its early investors didn’t get. So you could argue the pop was bad for the early owners of Snap. They left 41 percent on the table.

So you could see how Spotify CEO Daniel Ek might not want to go through the IPO process. 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?

Instead, by listing directly, Spotify can skip the IPO pricing altogether and just sell shares on an open exchange.

The conceit of a direct listing is that it’s more democratic, very logical, very internet. You can see the appeal to Ek.

But there is a rationale for the IPO process, too. By hiring underwriters, a company is “pre-selling” shares to qualified buyers. That assures the company will get something for its shares while also stoking interest in the open market.

You might even argue that in the case of Snap’s IPO it might not have even gotten $17 a share if they hadn’t hired bankers to manage the sale. In effect, the bankers set a price range, then go to the big institutional investors to see where they’ll bite before narrowing in on a set price. (Some analysts have pegged $15 as a fair value price for Snap shares.)

Underwriters like Goldman Sachs are paid as much as 7 percent to 8 percent commission for their work, but companies can negotiate that down. In the case of Snap, it was about 2.5 percent to 3 percent, according to sources.

Oh, by the way, another one of Spotify’s investors? Goldman Sachs. So it’ll win either way.

Correction: An earlier version of this story incorrectly outlined how institutional investors sell shares on open exchange.

This article originally appeared on Recode.net.