Conflict of Interest in Investment Banking
February 12, 2025
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The costs of issuing an initial public offer can be prohibitive. There are many companies across the world that want to access finances from the general public but cannot do so because they find the costs prohibitive. Hence, in order to bypass the floatation costs, these companies decide to go public without taking the help of an investment banker. This is done using a process called direct public offerings (DPOs). These direct public offerings are a threat to the investment banking business. This is because if enough companies start seeing the merit in direct public offerings, then many of them would not engage an investment banker. In this article, we will understand what a direct public offering is and how it impacts the investment banking business.
A direct public offering is an issue of shares to the general public. It can be thought of as being similar to an initial public offering, but it has three major differences.
Hence, direct public offerings are faster, cheaper, and have fewer regulations as compared to initial public offerings.
Direct listing facilities are only provided by certain stock exchanges. Hence, if a company wants to do a direct listing, they would have to select a specified stock exchange. Then they would have to register for a direct listing. After that is done, the company generally ties up with a network of brokers, which can provide them with the required last-mile connectivity.
Once such a tie-up is completed, the company published advertisements soliciting offers from the public. The public is supposed to fill in the application and pay the amount directly to the brokers. The commission for the services of the broker will be paid by the company. However, such commissions are much lower than the fees which have to be paid to investment bankers.
Based on the applications received, the company will issue shares directly via the brokers. The underwriting and issue management services of investment bankers are completely circumvented in these issues. The issuing company does not go through a price discovery process. Instead, they directly offer shares at a fixed price. The minimum and maximum quantities per investor are also decided by the issuing company.
Direct public offerings provide smaller companies a chance to tap the stock exchanges to raise more money. If they tap the stock exchange, then they are not completely at the mercy of banks and venture capital firms. Generally, regulations and high floatation costs were the deterrents for these firms. With initial public offerings, both these deterrents can be eliminated.
Direct public offerings are unlikely to go mainstream in the near future. They are only used by small companies who do not have the cash flow required to engage an investment banker. It is likely to remain that way for some time. This is because direct public offerings have a lot of disadvantages. Some of them have been listed below:
The bottom line is that direct public offerings are an offbeat mechanism that is used by some companies to raise funds. It has a lot of disadvantages as compared to an IPO. Hence, it is unlikely to make the IPO obsolete, at least in the near future.
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