Spotify is a Swedish company that has been streaming music, podcast and video for almost a decade using its proprietary software. The company has not generated any profit since its inception but is planning to go public by the end of this year at a $13bn valuation. However, it won’t go public through the classic IPO process.
Usually, when a company goes public, it does so by raising new capital and by creating new shares. Plus, before it goes public, the company hires a lead underwriter that, backed by an IPO syndicate composed of many investment banks, has the responsibility of selling and allocating new shares to financial institutions before they are made available to the general public. For example, during the Snap IPO, the IPO syndicate led by Morgan Stanley, Goldman Sachs and JP Morgan allocated shares to financial investors at $17 a share the night before the company went public.
Spotify is not going to take this route but is planning to go public through a process called direct listing. It means that Spotify will not raise any capital nor create any new shares during its IPO but would just let people who already own stocks trade them on the open market.
This process seems easier than the classical IPOs process but does carry a few risks. First, this process won’t allow Spotify to benefit from the classical marketing surrounding an IPO which includes a roadshow to present the company to different potential investors, some media presentations etc. However, this won’t be the most important issue for Spotify as it already benefits from great public recognition.
Also, Spotify won’t be able to choose what kind of investors hold its stock. As a matter of fact, during a roadshow financial investors that are likely to hold the stock for the long term are favoured as they will give the price more stability in the long run. One other risk and perhaps the most important is that Spotify won’t have any control over the price of the IPOs that will be purely determined by supply and demand. For example, during the Facebook IPO, the price severely dropped during the first hours of trading. However, Facebook’s underwriters bought back some stock in order to keep the price above $38 a share (the initial price). Spotify won’t benefit from such help as it has decided to do without underwriters.
Understanding Spotify’s Strategy
So, one question that comes to mind is why Spotify is choosing this alternative route rather than the classical IPO route used (relatively successfully) by so many hot startups in the past. First, direct listing are cheaper than the classical process. Even if during Facebook IPO underwriters were useful in keeping the price high , they did this job for an important fee that Spotify’s board might have wanted to avoid . Also, even though an IPO might enable a company to raise money to finance new projects, it dilutes the existing shares of the company thus reducing the power of existing shareholders.
Plus , a direct listing might be a way to reward early investors and employee since they will be able to sell their share quickly as direct listings , contrary to traditional IPOs , do not include a lock-up period (a pre-determined period of time during which important shareholders are not allowed to sell their shares). Finally, the biggest reason for this faster choice might lie in a debt deal Spotify signed in 2016 with TPG, Dragoneer and some clients of Goldman Sachs. This deal included a covenant that stipulated that the interest rate on the debt will increase by 1% every six months until the company goes public.
Even if Spotify may be motivated by a particular deal that has put it under strain, its IPO might be a real game changer. First, as hot startups that don’t need new capital may be attracted to this way of going public, it will change investment bank’s business model as they won’t be able to collect their underwriting fees. Also, it might give ideas to early investors that that are looking to cash-out quickly.
As a result, a lot of people including startups, VCs, private equity funds and investment banks are looking closely at this direct listing as it might change the way they look at IPOs.
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