Techrunch reported yesterday that Spotify has raised a whopping $1B debt deal. This is on top of the $1.1B in equity that the company has raised to date. As I read about this deal I noted some terms that raise concerns and serve as an important lesson for the rest of us as we think about how to capitalize our companies:
TPG and Dragoneer get to convert the debt to equity at a 20% discount of whatever share price Spotify sets for an eventual IPO. And if it doesn’t IPO within the next year, that discount goes up 2.5% every extra six months.
Spotify also has to pay 5% annual interest on the debt, and 1% more every six months up to a total of 10%. And finally, TPG and Dragoneer can sell their shares just 90 days after the IPO, before the 180-day lockup period ends for Spotify’s employees and other investors.
So, here are my concerns with this deal:
It’s clear when you read this that the company has to go public in the next two years. This is the clear mandate from the new investors. And the company will be heavily penalized for not hitting that timeframe.
Tomorrow will be the end of Q1, a quarter where no technology IPOs took place. Who knows what the IPO market will look like in two years? The company is potentially out of alignment with it’s new investors. The company wants to go public whenever it makes the most strategic sense. The new investors want to go public inside two years, no questions asked.
In addition to the lack of alignment between the company and it’s new investors I have to assume that there is lack of alignment between those investors and the old (equity) investors – all 38 of them! Yep, 38 investors that have collectively put in over $1.1B in capital are now no longer in the driver’s seat when it comes to exit strategy. How does that happen?
Debt holders have very different objectives than equity holders. As a lender I want to preserve capital above all else. I want to reduce risk. As an equity investor, I am willing to take on lots of risk in order to maximize returns.
So, Spotify management now has $1.1B of equity with a return maximization objective and $1B of debt with a risk reduction objective. That should make for some fun board meetings. Especially if the IPO market continues to be tough. And especially if the company experiences any downturn in operating performance.
As my good friend and FreshBooks CEO, Mike McDerment says: “you need two things to succeed in business and life: alignment and shared values”. From the outside looking in, Spotify has neither of these in this deal.