Hypothetically, the one shirt Spotify employees and investors will have left after down round(s), debt conversion(s) and dilution(s).
Bruce Houghton at Hypebot has a great article on Spotify’s tough financial situation, in particular the soaring interest rates and the ratcheting stock discounts attached to the convertible debt it took from private equity firms TPG and Dragoneer. As Hypebot reports:
“Spotify pays 5% annual interest on the debt, adding 1% every six months for a total of up to 10%. Investors can convert their debt to equity at a 20% discount of Spotify’s IPO share price; and if there is no IPO within a year, the discount at which they can eventually buy stock increases 2.5% every extra six months. Additionally, these investors can sell their shares just 90 days after the IPO, well before the 180 day lockup for Spotify’s other investors and employees.”
Houghton astutely points out that this gives the major labels some serious negotiating leverage as Spotify needs long term licensing deals from the majors in order to get to an IPO, and hence get out from under the metastasizing debt.
I’d just like to add something else: this looks like one of those nasty funding vehicles that are often the grist of HBO’s Silicon Valley Series.
What seems to be happening here is that Dragoneer and TPG have a radically different set of financial incentives than the current stockholders. I haven’t seen the terms of the debt, but it appears that the longer it takes for Spotify to IPO the better it is for Dragoneer and TPG. Why? They have ratcheting interest rates and ratcheting discounts on the stock and the longer it takes to IPO the more money they get, and the more of the company they can buy with that convertible debt at a steeper discount. If the IPO is late and the price is low, it’s entirely possible that the convertible debt allows Dragoneer and TPG to swallow most or even all the company. This is especially likely if the IPO is spread over multiple offerings. And why might the post-IPO Spotify stock price collapse? Well, a lack of buyers will hurt a stock price. And why might there be a lack of buyers? Perhaps the market is wary of the dilution implied by the convertible debt held by Dragoneer and TPG? See how that works? This is a negative reinforcing loop.