Bill Gurley – Direct Listing vs. IPO - [Invest Like the Best, EP.144]

Episode Summary

Executive Summary: Patrick O’Shaughnessy interviews Bill Gurley about why traditional IPOs systematically underprice new issues and transfer wealth from issuers to Wall Street/buyers. Gurley argues direct listings use a fairer, algorithmic price-discovery process, reduce fees and volatility, and better serve founders, employees, and long-term investors.

Main Topics: IPO underpricing as a structural flaw (Priority: 10/5): Gurley says the current IPO process is designed to create pops and systematic underpricing. Frequency mismatch and agency problems (Priority: 9/5): Banks and buy-side firms do IPOs constantly, while founders typically do it once. Economic cost to issuers and employees (Priority: 10/5): Underpricing transfers billions from companies, founders, and workers to IPO buyers. Green shoe and lockup distortions (Priority: 8/5): These mechanisms add complexity, volatility, and incentives that favor banks. Direct listings as algorithmic price discovery (Priority: 10/5): Direct listings match supply and demand transparently, like opening stocks each day. Fairness, access, and modern distribution (Priority: 8/5): Gurley argues digital tools can replace roadshow exclusivity with broader disclosure. Regulatory and adoption path (Priority: 7/5): The next step is more reps, courage, and possibly allowing capital raises in direct listings.

Key Arguments: Traditional IPOs are broken because they target 10–20x oversubscription, guaranteeing underpricing. Founders usually do one IPO, while banks and buy-side firms do 20–40 a year, creating an agency imbalance. The process transfers wealth from issuers to first-day buyers, not just 'creates a pop.' Direct listings use price-time priority and anonymous matching, which Gurley says is how markets should work. The green shoe and lockup mainly create complexity and help banks monetize secondary offerings. Long-term investors often get tiny IPO allocations, making the process bad for real capital allocators. Direct listings improve fairness and access by giving all investors equal information and equal matching rules.

Data Points: Four-decade underpricing estimate: $171 billion - Jay Ritter’s estimate of wealth transfer from traditional IPO underpricing Recent underpricing estimate: $12 billion - Underpricing in the last 18 months, per Gurley citing Ritter Elastic one-day giveaway: $338 million - Difference between hand-allocated IPO price and next-day close Zoom one-day giveaway: $623 million - Difference between hand-allocated IPO price and next-day close Elastic founders’ missed value: $106 million - Lost value attributable to founders in Elastic’s IPO pricing Elastic investors’ missed value: $126 million - Lost value attributable to investors in Elastic’s IPO pricing Elastic employees’ missed value: $106 million - Lost value attributable to employees in Elastic’s IPO pricing Zoom founders’ missed value: $100 million - Lost value attributable to founders in Zoom’s IPO pricing Zoom investors’ missed value: $342 million - Lost value attributable to investors in Zoom’s IPO pricing Zoom employees’ missed value: $175 million - Lost value attributable to employees in Zoom’s IPO pricing Average underpricing over 10 years: 18% - Jay Ritter’s average underpricing across VC-backed IPOs over a 10-year period Lowest underpricing bank: 3.3% - Credit Suisse, when lead-left, across 35 IPOs Highest underpricing bank: 33.5% - Goldman Sachs, when lead-left, across 111 IPOs Second-highest underpricing bank: 29% - Morgan Stanley, when lead-left, across the same 10-year dataset Typical IPO fee: 7% - Fee level discussed alongside underpricing to estimate total cost of capital Implied IPO cost of capital: 40% - 33% underpricing plus 7% fee, as Gurley frames it Green shoe size: 15% - Over-allotment option sold in most IPOs Lockup period: 180 days - Typical pre-IPO shareholder lockup cited in the discussion Secondary timing discount: 25% less - Typical discount when banks run a secondary after the lockup concern Slack/Spotify direct listing opening share block: 5% and 9% - Opening blocks cited for the two direct listings Large public-fund universe: 9,000 plus mutual funds - Used to question why only 5–10 accounts matter in IPO allocation

Pivotal Quotes: "if you're at a poker table and you don't know who the patsy is, you're probably the patsy." — Patrick O'Shaughnessy: Opening framing for who benefits from the IPO process "the Silicon Valley companies that are getting the short end of the stick on this IPO process." — Bill Gurley: Gurley’s central claim about who bears the cost "the way the process is run today, a pop or an underpricing event should be so expected." — Bill Gurley: His summary of why IPO pops are structural, not accidental

Implications: The key open question is whether more issuers will take the direct-listing path; listeners should watch for regulatory changes and prominent adopters.