5 Qs WITH A DEALMAKER
Pär-Jörgen Pärson, a general partner at Swedish growth investment firm Northzone, made a really great bet 10 years ago. He led Spotify’s Series A round in 2008.
At first, Pärson was skeptical of the founders’ desire to go after the music industry. “I had already invested in a couple of music-related tech startups that both failed,” he told Term Sheet.
But co-founders Martin Lorentzon and Daniel Ek managed to convince him that they were proposing a new business model. “I had seen so many startups that were just like lambs to the slaughter — labels would get some payments from them and let them die,” Pärson said. “But the labels took [Lorentzon and Ek] seriously because they had a product that was absolutely extraordinary compared to anything in the market at the time.”
So he took a chance on that small Swedish startup, which is now a massive business planning a historic IPO on April 3. Spotify is the first large, high-profile company to pursue a direct listing of its shares. It’s an unusual move with some clear benefits — no banks, no roadshow, no crazy fees, and no lock-up period. (Read more about that here)
In a conversation with Term Sheet, Pärson discusses why Spotify chose its unusual IPO route, his biggest concern about the first day of trading, and whether other tech unicorns will follow suit.
Here’s an excerpt of our conversation. Read the full Q&A here.
TERM SHEET: Why did Spotify decide that a direct listing would be the best route to going public?
PÄRSON: It was thanks to Spotify CFO Barry McCarthy, who has already done two IPOs. He started to question what value an IPO would bring to Spotify and its investors. The team saw a number of issues with the [traditional] IPO process, which were basically based on regulations that were defined in the 1930s. They are just not up to par with what I think would be in the best interest of investors. Spotify really wanted to communicate loud and clear to everyone about how this process actually works up until the day the stock trades. But the IPO rules prevent them from doing that by making sure they communicate entirely through a middleman. The middleman may not even understand the business. So that was one complication.
The other one was that there was neither need nor desire to raise capital. Why pay hundreds of million of dollars in underwriting fees for something you don’t actually need?
So you’re saying that Spotify doesn’t need the capital right now, but do you see it eventually needing to offer new shares to raise money?
PÄRSON: I don’t think so. The Spotify business model is very cash-efficient. The company gets paid through a subscription on Day 1 of the month. They need to pay their content owners several days after the close of the month when we know what the consumption pattern has been, and that’s how they distribute the revenue share. This means they have a negative working capital requirement, which is in contrast to Netflix, for instance. Netflix needs to produce shows months or years ahead of any revenue coming in. So it’s a totally different model from that perspective.
Are you nervous about the volatility that comes with doing a direct listing?
PÄRSON: For all the tech companies that come to market with lots of anticipation and a well-know brand, there’s always a risk that the stock will shoot to the stars and have trouble to match that with their fundamentals. That is probably my biggest worry.
Where do you expect Spotify to invest the heaviest in the coming months?
PÄRSON: They have quite a few markets that they haven’t addressed. They launched in Japan a year ago, and they’re still a small player there, so there are quite a few geographical markets that are still untapped.
I also think that initially, Spotify was launched as a substitute for the recording industry. I think the recording industry represents a relatively-limited market opportunity. Where I think it’s more interesting for the long-haul is for Spotify to become more and more involved in other types of content such as spoken word and a substitute for commercial radio. That’s a $100 billion market. That would give them quite a lot of headway to grow.
Depending on how the first day of trading goes, do you expect other unicorns to follow suit?
PÄRSON: I think it’s highly unlikely that a B2B company can go down this route. It’s just unlikely that a smaller market-cap company would be able to get enough interest in the capital markets. So for huge market cap, household names with cash-efficient models that don’t need to raise external capital, I absolutely think it could be a right fit. But there are very few companies who have all of those characteristics.
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Polina Marinova produces Term Sheet, and Lucinda Shen compiles the IPO news. Send deal announcements to Polina here and IPO news to Lucinda here.