Spotify: Rewriting the Lyrics on IPOs

More well-heeled startups could target direct listing going forward
March 28, 2018 Updated: March 28, 2018

In 2008, Spotify revolutionized the music industry by introducing music streaming to the masses and forever changing the industry business model.

Ten years later, in 2018, the Stockholm, Sweden-based company is providing a new blueprint for how technology companies can go public, by eschewing the traditional IPO.

Spotify Technology SA’s shares will begin trading on the New York Stock Exchange on April 3 without a formal IPO (initial public offering) process to raise money. This method, called a “direct listing,” isn’t unheard of, but Spotify is by far the biggest and most well-known company to use it to go public.

“It’s not about the pomp and circumstance,” Spotify’s co-founder and CEO Daniel Ek said at an investor presentation on March 15. “I think the traditional model of taking a company public isn’t a good fit for us.”

And Spotify is serious about being nontraditional. Instead of going on roadshows to market its stock to institutional investors behind closed doors, Spotify’s IPO Investor Day was held at the trendy Spring Studios in the Tribeca neighborhood of Downtown Manhattan and live-streamed on its website.

Spotify is in a highly competitive industry with well-heeled late-comers such as Apple and Amazon, as well as incumbent Pandora, whose shares sank more than 2 percent on the day of Spotify’s investor presentation.

Not Selling New Shares

Spotify’s avoidance of a traditional IPO has generated a lot of buzz. When boiled down, the biggest difference between a direct listing and a traditional IPO is that a direct listing does not raise money for the company through selling new shares.

Like they would in an IPO, co-founders Ek and Martin Lorentzon and existing shareholders such as Goldman Sachs and Tiger Global will be able to sell their shares on the exchange.

In practice, the process of a direct listing is far simpler than for an IPO.

In a traditional IPO, the company raises fresh capital by selling new shares. It must pay high fees to underwriters, lawyers, and investment bankers. Executives and their advisers go on roadshows to gauge interest and receive commitments from institutional shareholders. The underwriting banks also determine a starting price for the IPO and promise to backstop the stock price if necessary.

A direct listing skips all of that. While Spotify has retained Morgan Stanley and Goldman Sachs as advisers, it won’t raise new capital. The direct listing simply provides a means to let its early shareholders and founders sell their shares to the public without the dilution associated with new share issuance.

This process is cheaper than an IPO, lets the public buy into the company, and allows existing shareholders to cash out if they wish. The downside is that without feedback and backing from banks and institutional investors, its publicly traded shares can experience greater volatility, and existing shareholders may not receive the full value of their stock.

Could More Tech Firms Pursue Direct Listing?

Every late-stage startup is eyeing Spotify’s direct listing.

It could become a more common way for technology startups to list their shares publicly. Direct listing is a perfect fit for Spotify—a late-stage startup that doesn’t need to raise more capital, with a household name that doesn’t need marketing.

More startups are finding themselves flush with cash as venture capital financing continues to grow. A total of $213.6 billion in venture funding occurred in 2017, an increase of nearly 24 percent compared to 2016, estimated Crunchbase, a venture capital tracking service.

In a video on its website, Spotify cited not needing the additional cash as the biggest reason for its direct listing, as it has no debt and around 1.5 billion euros ($1.8 billion) in cash.

For startups with enough cash and name recognition, such as Spotify, a direct listing is a simple and inexpensive way for existing shareholders to cash out.

More importantly, Spotify’s direct listing could also present a unique opportunity for ordinary investors.

In a traditional IPO, investment bankers generally try to price the shares conservatively, hoping for the typical “IPO pop” on the first few days of trading. This mostly benefits the bankers’ institutional clients—hedge funds, mutual funds, and big brokerage houses—who buy big blocks of stock at the IPO price. Most ordinary investors are left to purchase shares on the secondary market, usually after the stock has already popped.

The direct listing avoids that, and, in theory, places all investors on equal footing. While the price range at which Spotify’s shares will trade is a mystery absent an IPO process, at least it’s equally a mystery to all market participants.