Season 2, Episode 6 Spotify’s Direct Listing

In this episode of Acquired, Ben Gilbert and David Rosenthal discuss Spotify's direct listing, highlighting its innovative departure from traditional IPOs. They delve into Spotify's mission to unlock human creativity and its impact on the music industry through streaming services, which contrasts with Dropbox's creative energy focus. The hosts examine Spotify's history, from its Swedish roots and struggles with record labels to its successful growth strategies, including its partnership with Facebook for user engagement and machine learning-driven features like Discover Weekly. They also touch on the potential for Spotify to expand into podcasts, referencing the platform's inclusion in their F1 filing. Additionally, they discuss the implications of direct listings for future tech companies and the skepticism surrounding Spotify's $30 billion valuation given its low margins and reliance on music labels.

• Spotify and Dropbox have similar mission statements centered around creativity.
• Spotify's mission is to "unlock the potential of human creativity."
• Dropbox's mission is to "unleash the world's creative energy."

"Spotify's is to unlock the potential of human creativity." "Dropbox's mission is to unleash the world's creative energy."

The quotes show the mission statements of Spotify and Dropbox, emphasizing their focus on enhancing and facilitating creativity through their services.

• Spotify made history with their direct listing, which is distinct from an IPO.
• The direct listing was set to be the largest from Europe and the 7th biggest of all time, with a market cap of roughly $30 billion.
• Spotify's direct listing involved no creation of new shares, meaning no dilution and no additional funds raised.
• The direct listing allowed current shareholders to sell without a lockup period.
• The process was less expensive than an IPO, as it did not require a roadshow or hiring bankers.
• Buyers had to consider that sellers were insiders with more information.
• Spotify is a twelve-year-old company with a history of private share trading.

"Today we are covering a company making history the week it makes history, Spotify and their direct listing, which is not." "Big company, big shakeup in the industry over the last few years with the rise of streaming and a big change to the way that companies go public."

The quotes explain the significance of Spotify's direct listing, its impact on the market, and how it differs from a traditional IPO.

• The Acquired podcast has an active Slack community with over 1200 members discussing tech news, acquisitions, and IPOs.
• Community members contributed research for the Spotify episode.

"If you are new to the show, you should join us in our slack at acquired fm." "There's over 1200 people talking about acquisitions, ipos, tech news as it comes, and helping us do research for the show."

These quotes encourage listeners to join the Acquired podcast's Slack community and highlight its role in contributing to the show's research.

• Pilot is a startup-focused accounting firm in the US, offering comprehensive financial services.
• They provide accounting, tax, and CFO services, including investor reporting and financial planning.
• Pilot is trusted by startups like OpenAI, airtable, and scale.
• The company aligns with Jeff Bezos's axiom of focusing on core competencies and outsourcing other tasks.

"Pilot is the one team for all of your company's accounting, tax and bookkeeping needs." "They've been doing this now for years across thousands of startups in Silicon Valley and beyond."

The quotes describe Pilot's services and their experience with startups, positioning them as a valuable partner for growing companies.

• Spotify's direct listing was not an IPO, and they filed an F-1 instead of an S-1 due to being a foreign issuer.
• A direct listing involves no dilution and no new funds raised for the company.
• The direct listing process is potentially less expensive and does not involve the typical IPO roadshow.
• Buyers in a direct listing must be aware they are purchasing from potentially more informed insiders.
• Spotify's direct listing allowed for immediate liquidity for shareholders without a lockup period.

"The biggest difference is the company doesn't take any dilution." "With a DPO, a company doesn't take any dilution and they don't raise any money."

These quotes clarify the mechanics of a direct listing, emphasizing the lack of dilution and fundraising compared to an IPO.

• Ben & Jerry's conducted a DPO in 1984, raising capital from local supporters in Vermont.
• They later followed up with an IPO, raising additional funds by issuing new shares.

"Ben Cohen and Jerry Greenfield needed funds for their ice cream business." "Their Vermont loyal fan base ended up funding Ben and Jerry's ice cream in a DPO for its first way to raise capital."

The quotes recount the history of Ben & Jerry's DPO, illustrating an early example of a company using direct public offerings to raise capital.

• Spotify was founded in Sweden by Daniel Ek and Martin Lorentzon.
• Daniel Ek was a tech prodigy, starting companies from a young age.
• Ek's ventures included a web development company, a virtual world game, and an ad company.
• He also led a BitTorrent client company, which was acquired by BitTorrent Inc.

"Spotify is a Swedish company or founded in Sweden, not Switzerland, as the New York Stock Exchange learned this week." "It was started in Sweden by two co-founders, Daniel Ek and Martin Lorentzon."

These quotes provide background on Spotify's origins and the founders' entrepreneurial journey leading up to the creation of Spotify.

• Transferring MP3 files had downsides, including costs and time spent on organizing.
• The act of meticulously organizing iTunes libraries consumed significant amounts of time.
• There was a belief that digital music collections would be a lifelong possession, similar to physical records or CDs.

"I want my life back. I want all those hours back. I meticulously cared about this for a while."

The quote from Ben Gilbert expresses regret over the extensive time invested in organizing a digital music library, which in hindsight felt wasted.

"I thought I was going to have that with me for life."

Ben Gilbert reflects on the expectation that his digital music collection would be a permanent asset, akin to physical music collections of previous generations.

• The user experience with iTunes and piracy was flawed due to file management issues and unreliable content.
• Daniel Ek envisioned a better way to consume music, leading to the creation of Spotify.
• Spotify's name originated from a misheard suggestion during a brainstorming session.

"The user experience for music is not just that the industry is broken, but the user experience is broken."

David Rosenthal highlights the dual problem of a broken music industry and a poor user experience that Spotify aimed to fix.

"So he has the vision that there's a better way, there's actually a better way to consume music that is better than pirating, better than iTunes, and that is what becomes Spotify."

David Rosenthal summarizes Daniel Ek's insight that led to the creation of Spotify, which aimed to provide a superior music consumption experience over piracy and iTunes.

• Spotify faced challenges in licensing music for streaming, especially in the U.S.
• The company's launch strategy included invitation-based free accounts and the option to bypass the wait with a paid subscription.
• Spotify's growth was fueled by its European launch and subsequent expansion to the UK.

"They launch in Sweden with free accounts available by invitation to everyone. So they use the invitation growth hacking method for free accounts. But if you want to pay to subscribe, anybody can come in and pay to subscribe."

David Rosenthal describes Spotify's initial launch strategy in Sweden, which utilized an invitation system for free accounts and an open subscription model for paid accounts.

• Sean Parker, co-founder of Napster, saw Spotify as a continuation of his vision for digital music.
• Parker's email to Daniel Ek outlined the potential of integrating Spotify with Facebook for viral growth.
• Spotify's integration with Facebook's OpenGraph and ticker feature drove its user base growth.

"My goal for the second generation Napster was to implement social and sharing features."

David Rosenthal quotes Sean Parker's email, indicating Parker's long-standing goal to integrate social aspects into digital music, which he saw realized in Spotify.

"You guys are likely going to be the first major success story with Facebook Connect."

David Rosenthal cites Sean Parker's prediction of Spotify's success through integration with Facebook Connect, highlighting the strategic partnership's potential.

• Spotify's partnership with Facebook at the F8 conference led to a significant increase in sign-ups and user base.
• The integration with Facebook allowed users to see and play what their friends were listening to directly from the social platform.
• Spotify continued to innovate with features like Discover Weekly and Daily Mix, driving further engagement.

"Basically overnight, literally in 24 hours, they get a million sign ups from this because it's all over everyone's newsfeed."

David Rosenthal points out the immediate impact of Spotify's integration with Facebook, which resulted in a massive influx of new users.

"They just start raising a ton of money to keep pumping it into marketing and product development too."

David Rosenthal notes Spotify's aggressive fundraising to fuel its growth and continuous product development, indicating the company's ambitious expansion strategy.

• Spotify transformed playlists into a prominent feature, distinguishing itself from iTunes' single-song purchase model.
• Playlists contributed to user engagement, aligning with the revenue model based on streaming numbers.
• Labels and artists benefit from increased streaming through Spotify's playlist-centric approach.

"What was great about Spotify is they really made playlists the first class citizens, and this was part of what they got the labels back on board with, is, whereas iTunes is a singles focus... With Spotify, the focus is on playlists."

The quote explains Spotify's strategic focus on playlists as a core element of their platform, differentiating it from iTunes and aligning artist and label incentives with user engagement through continuous streaming.

• Spotify reached 40 million paying subscribers by the end of 2016.
• Subscription plans vary, including family and student discounts, affecting overall revenue calculations.
• Despite conservative estimates, Spotify's subscription revenue signifies a substantial business scale.

"End of 2016, 40 million paying subscribers... even if you multiply it by five, be really conservative, that's $200 million or euros in subscription revenue per month. That's a lot of revenue."

The quote provides an overview of Spotify's financial success in terms of subscriber count and monthly revenue, highlighting the company's significant scale by the end of 2016.

• Spotify's gross margins were low, with premium services at 16% and ad-supported services at a negative 12%.
• The business model's low margins contrast with other tech giants.
• The positive cash flow dynamic is a result of subscribers paying upfront and labels being paid after month-end.

"During that year in 2016, their gross margins on the premium stuff is 16%. The ad supported stuff, they actually lose 12%... their consolidated is 14%, which jumped up the next year due to sort of a deal negotiation."

The quote discusses Spotify's financial margins, highlighting the challenges of low profitability within their business model despite revenue growth.

• Spotify chose a direct listing over an IPO, avoiding unnecessary dilution and banking fees.
• The company experienced a robust secondary trading market and hired Barry McCarthy as CFO to lead the direct listing.
• Spotify's shares traded above the reference price, indicating positive market reception.

"They set a reference point for trading of $132 a share, which equates to a market cap of about 23 and a half billion... It opens. The first trade happens at $165 a share and around a 30, which is totally way higher."

This quote details Spotify's direct listing process, the initial reference point for trading, and the actual higher opening trade value, reflecting investor confidence and market demand.

• Co-founders Daniel Ek and Martin Lorentzon retained significant ownership stakes.
• Despite raising substantial capital, the co-founders' ownership did not dilute excessively due to high valuations and revenue growth.

"Daniel Ek still owned 25.7% of shares and Martin owned 13.2%. So that's almost 40% among the two co-founders."

The quote provides insight into the ownership distribution of Spotify, emphasizing the substantial stakes held by the co-founders even after multiple funding rounds.

• Spotify presents itself as a savior of the music industry, attributing the streaming model to the industry's resurgence.
• The company emphasizes its leadership in market share, data-driven personalization, and lean operations.
• Skeptics highlight Spotify's dependence on music labels and lack of differentiation in the catalog.

"What Spotify says is, look like the music labels love us because we saved the industry... And there's all these ways for both artists and labels for everyone to do better, because the way that we enable people to listen to music actually creates growth for music."

The quote captures Spotify's self-portrayal as a transformative force in the music industry, suggesting mutual benefits for the platform, artists, and labels through its business model.

• Skeptics question Spotify's long-term sustainability due to the power of music labels and the variable cost structure.
• There are concerns about Spotify's ability to maintain differentiation from competitors like Apple Music.
• The threat of platform owners like Amazon entering the market with a different business model poses additional challenges.

"Skeptics would say that, congratulations, you have algorithmically generated playlists. I don't think that's differentiating enough to make people switch or make artists want to launch with any sort of exclusivity."

The quote reflects skepticism about Spotify's competitive edge and the potential for other platforms to usurp its market position, despite its current success and user engagement strategies.

• Amazon offers a powerful default option on Alexa for music streaming.
• The company provides a free tier with a limited catalog, appealing to casual music listeners.
• Amazon's free tier is disruptive as it allows direct play without shuffle mode restrictions and is available on any device.

"the default on Alexa, that's very powerful... And then there's the free tier for Amazon, which is, you have complete control. It's a limited catalog, but it's most of the stuff that you care about if you're a casual music listener, and then it's just completely free with prime and you can play directly, you're not limited to shuffle mode, you can play on any devices. It's a big disruptive force."

The quote emphasizes Amazon's strategic positioning with Alexa and its potential to disrupt the music streaming market by offering a user-friendly and accessible free tier.

• Amazon's history of attempts in the music industry suggests a lack of understanding.
• Past endeavors like Amazon MP3 have not been successful.

"I don't think Amazon gets music. We've seen them try with Amazon MP3. They've taken multiple stabs at music. I think it's an animal that you have to have the right dna to create."

The quote reflects skepticism about Amazon's ability to dominate the music industry due to previous unsuccessful attempts and a perceived lack of innate understanding of the industry.

• Spotify's Total Addressable Market (TAM) may be limited, raising questions about future growth.
• Amazon's free tier could attract users who are unwilling to pay for Spotify's services.
• The growth of the free tier market could impact Spotify's potential user base.

"How big is Spotify's Tam, really, of people who are going to pay $10 a month in the world for music?... How many more people will do it, especially when there's an alternative out there of, like, I could get something that's like 60% as good for free."

This quote questions the size of Spotify's paying customer base, considering the availability of free alternatives like Amazon's music tier that could satisfy a significant portion of the market's needs.

• Spotify could have chosen to go public through an IPO.
• The company's cash generation from operations reduces the need for capital from an IPO.
• Secondary offerings as an alternative to an IPO could be considered to raise cash without immediate dilution.

"Here's a crazy thing that could happen... they could just do that as their ipo. And as I was thinking through this, David... They basically get to raise cash later and take less dilution."

The quote discusses the possibility of Spotify using secondary offerings as a strategic financial move to raise capital with less immediate dilution compared to a traditional IPO.

• The music industry's reliance on shows and merchandising for revenue makes exclusive deals less appealing for artists.
• Video content exclusivity is more accepted due to different industry dynamics.
• The question of whether Spotify will need additional capital depends on their business model and potential shifts towards content creation.

"Does it make sense in music to have exclusive content in the way it does with video? Unclear."

This quote highlights the debate over the effectiveness of exclusive content in music compared to video, considering the different ways artists generate revenue and the potential need for Spotify to raise capital for content creation.

• Spotify's direct listing is seen as an innovative alternative to traditional IPOs.
• The direct listing process is considered employee-friendly and avoids the typical six-month lockup period.
• Tencent's equity stake in Spotify and the strategic partnership with Tencent Music Entertainment are highlighted.

"It's super. The thing they touted, which I don't think is the main driver, but it's super employee friendly because they don't have this six month lockup period."

The quote explains one of the benefits of Spotify's direct listing approach, which is the absence of a lockup period that is typically required in traditional IPOs, making it advantageous for employees.

• The discussion covers whether direct listings will become more common.
• Key factors for a successful direct listing include brand recognition, not needing immediate cash, and market stability.
• The role of institutional investors in private companies is changing the landscape of public offerings.

"The big one for me that I think is the, I'm going to use your phrase, the thing that's been bandied about in the press a lot recently has been, are we going to see more direct listings?"

This quote introduces the theme of whether direct listings will gain popularity, reflecting on the factors that made Spotify's direct listing a topic of interest in the press and investment community.

• The discussion questions whether Spotify's valuation is justified based on fundamentals.
• Comparisons are made with other tech companies and their valuations.
• The potential for Spotify to expand its business or improve margins is considered in the context of its current valuation.

"It's kind of hard for me to believe that Spotify is worth $30 billion... Is Spotify really a $30 billion company?"

The quote expresses doubt about Spotify's valuation, prompting a discussion on the company's growth prospects and the logic behind the market's valuation.

• Spotify's reported user growth is strong, but there are questions about the sustainability of this trend.
• The company's expansion into new markets and the potential for additional services are discussed.
• The impact of Spotify's user base on its valuation and the relevance of anecdotal evidence versus reported data are considered.

"So, yeah, to your point, will they two x? Probably. Will they three x? Seems like they could get there. Will they ten x?"

This quote reflects on Spotify's potential for user growth and market expansion, weighing the likelihood of significant increases in its user base against the challenges of scaling to a much larger size.