Reddit is casting aside community spirit in search of financial maturity

At the end of Henry IV, Part 2, the wayward Prince Hal ascends the throne and publicly rejects his drinking pal Falstaff. “Presume not that I am the thing I was,” the new king tells his erstwhile friend. Hal learned a lot from carousing with Falstaff, but his assumption of state power means he has to cast off his wild ways and misfit friends.

This literary motif repeats itself in modern life. A person or company prospers on the wave of rebellion and disorder, but when the time comes for a public display of responsibility, that past must be jettisoned in some form or another.

The Reddit IPO is just such a moment. Reddit has long been a bustling platform for online discourse. While it hasn’t exactly prospered — never turning a profit in nearly two decades — it has turned into a uniquely vibrant (and sometimes toxic) mix of discussion hub, social network, and news aggregator. 

You would expect Reddit’s upcoming $500mn-plus IPO to have a touch of populist flair. Indeed, Reddit’s features a “directed share program” (DSP), channelling stock allocations towards selected users and moderators. The DSP is designed to give those who’ve been the lifeblood of Reddit a stake in its public success and to recognise those who have done the most to propel platform growth. Under the DSP, some 75,000 Redditors have been invited to buy reserved shares.

But what’s notable isn’t the presence of the DSP, but rather its pedestrian size. Reddit’s IPO ostensibly celebrates its community, and yet the amount given to its community in the deal is fairly … average. 

As Reddit’s registration statement says (our emphasis):

As a community platform, Reddit is committed to providing users and moderators with an opportunity to participate in this offering. At our request, and reflecting our desire to set aside a significant number of shares for certain of our users and moderators, the underwriters have reserved up to 1,760,000 shares of our Class A common stock, or 8% of the shares offered in this offering, for sale at the initial public offering price through a directed share program to:

• eligible Reddit users and moderators; 

• certain members of our board of directors; and

• friends and family members of certain of our employees and directors

While Reddit’s prospectus emphasises the desire to reserve a significant share for users and moderators, the DSP allocation falls within the conventional range of 2-10 per cent. Airbnb’s 2020 IPO earmarked 7 per cent for qualifying hosts, while Uber’s 2019 flotation dedicated 3 per cent for eligible drivers. Overall, the power Redditors will receive just under $60mn of stock or less than 1 per cent of the company. That’s not quite the same as Falstaff’s banishment, but not much better.

It’s nice to imagine that Reddit could have broken the mould and offered a meaningful chunk of company shares to its Redditors. After all, the company relies especially on the “unpaid labour” of its users and prides itself on the authenticity of its communities. “Our users have a deep sense of ownership over the communities they create on Reddit,” Reddit co-founder and CEO Steve Huffman writes in the prospectus. “This sense of ownership often extends to all of Reddit.”

Reddit also hosts the subreddit WallStreetBets, champion of the individual investor and catalyst behind the meme stock frenzy that propelled stocks such as Gamestop and AMC Entertainment skywards and crushed hedge funds which shorted those names. Indeed, Huffman pays tribute to r/wallstreetbets in the prospectus (emphasis added): 

Time and again, Reddit communities have provided exactly that context and been a tremendous force for good: they have created and catalyzed global movements, including campaigning for net neutrality in 2015, starting the March for Science in 2017, or standing up for retail investors, as r/wallstreetbets did in 2021….. 

Reddit’s conservatism around the DSP suggests that the IPO is more focused on maximising value for owners than creating value for the community.

Directed share programs, sometimes known as “friends and family” plans, have a chequered history. During the TMT bubble in the late 1990s, windfall profits were earned through directed allocations of underpriced IPOs. In the (in)famous 1999 IPO of Internet Capital Group, for example, the f&f accounted for 30 per cent of the deal; the shares rocketed for a while before crashing and burning. Meanwhile, investment banks in the dotcom era directed IPO stock to the personal accounts of other clients they were soliciting, and whatever the rationale, it was bad optics at best.

In 2003, a NYSE/NASD IPO advisory committee, convened at the behest of Securities and Exchange Commission, warned that “when misused or overused, an issuer’s friends and family program (directed share program) may compromise the IPO process”. The committee argued for “reasonable parameters” for the fair use of the DSP, suggesting a maximum of five per cent. 

Admittedly, today’s modern-day DSPs have a much different hue. Nowadays directed share programs target members, customers, developers and affiliates, associates or partners of one sort or another. The idea isn’t to pay a bung to some favoured parties, but rather to enfranchise them in the company’s success. And digital technology allows for much larger DSPs than previously imaginable; some 70,000 Deliveroo customers bought into the online food delivery company’s IPO in London via the PrimaryBid platform. 

Moreover, the link between DSPs and IPO underpricing has been broken. Investors in the 2021 “Community Share Offers” for Soho House and Deliveroo suffered losses from the outset. The DSP means you have preferential allocation, but it’s not free money anymore.

But all this highlights that while DSPs have shed the old stigmas, allocating too much stock incurs risks. If the shares trade off in the after-market, it’s natural for regulators or even the plaintiffs’ bar to blame an unconventionally large DSP. And recipients may not appreciate the gesture. “I feel like a wally,” one Deliveroo customer-cum-investor told CNBC when the IPO tanked.

As for Reddit, it faces a unique dilemma. As even the company recognises in its SEC filing, the meme stock frenzy has massively amplified its public recognition and visibility. But just as revolutions sometimes eat their own, Reddit management senses that the febrile engagement generated by its communities is a double-edged sword. The prospectus even has a risk factor saying its “stock could experience extreme volatility” due to “strong and atypical retail investors interest” from the likes of WallStreetBets.

Thus while Reddit made its name from hosting meme stocks forums, it doesn’t want to become a meme stock itself. It subscribes to the mantra that institutions are the price-setters and retail investors are the price-takers. The Reddit IPO price will be decided by the order book from the big fund managers, not crowd-generated by popular participation. This runs counter to the carnivalesque ethos of WallStreetBets in which conventional understandings of financial valuation are upended and traditional hierarchies are inverted.

At one level, the sizing of Reddit’s DSP is sensible and prudent. A much larger-than-normal DSP could expose Reddit to legal, regulatory and reputational risks if the share price falls. Moreover, it could result in a large rump of unruly shareholders who may not have the expertise to evaluate the investment. 

Yet Reddit’s actions represent a quiet repudiation of the subversively iconoclastic spirit that has made Reddit so iconic. Just like Prince Hal, Reddit wants its stock to have no part of the craziness it has hitherto benefited from.