CHAPTER 10

Spotify, Stockholm, 2016

McCarthy was ready to change other rules too. He began to think about ways that Spotify could get better at telling its story to investors. The company already gave briefings to shareholders, but McCarthy wanted to do more. At Netflix, he’d developed a reputation for being transparent and doing more than the minimum in his communications with investors. He eschewed the traditional practice of reading a dry, prewritten statement at the beginning of earnings calls in favor of going straight into live question-and-answer sessions with analysts.

He wanted to bring a similar approach to Spotify. During talks with the convertible bond investors, McCarthy reached out to the company’s lawyers at Skadden, Arps, Slate, Meagher & Flom to ask them about the possibility, under securities laws, of reporting earnings and holding an investor day even though Spotify was still private. The SEC didn’t allow companies to speak to investors once they had begun the process of going public, but there were fewer restraints before the process began. While most private companies chose not to share detailed financial information with investors, McCarthy thought Spotify could.

“There would have been a period of time when we could have communicated with investors openly, and educated them about the company and the strategy, and exposed the management team,” McCarthy said later. “I was thinking that there were some advantages to pursuing that best practice sooner rather than later.”

And he began to wonder if he could reimagine the act of going public.

McCarthy believed that there were aspects of the process that had stopped working. Since LinkedIn’s in 2011, McCarthy had watched dozens of IPOs pop on their first day of trading. While the press liked to cheer such performances, the three-time CFO knew that underpricing deprived companies of valuable proceeds they could use to invest in the business.

Many in the industry agreed with McCarthy that the model had been broken for years. The investment banks, for example, used to buy stock from companies and accept the risk of distributing the shares. In modern practice, investment banks held the shares for a split-second before electronically passing them from the company to institutional investors. The bankers simply lowered the price if there was a risk that investors were not going to buy.

The banks did face some risk, particularly around legal liability, and could be sued by investors for material misrepresentations in the prospectus. But critics argued that the underwriting model was an anachronism.

IPOs are risky. They are stock issues from companies that haven’t faced the rigor of the public markets or are less proven than established firms. Many technology firms are trying to create entirely new industries. Most aren’t making money when they come to market.

Bankers liked to lower that risk by selling shares at a discount to encourage investors to participate. The size of the discount was a matter of debate, but 25 to 30 percent was often considered a reasonable compromise. Investors hoped to get rewarded for taking that risk by seeing their investment increase in value during the first few days of trading. Companies got to raise money by selling the shares at a lofty enough price that the proceeds supported their business.

All too often, McCarthy thought, the investment banks applied too large a discount on highly anticipated IPOs. Or they failed to accurately price the shares. The first-day performance for particularly popular deals seemed to increasingly feature a large price increase. The pop left money on the table for the company.

McCarthy surmised that the root of the problem was that the process didn’t do a good enough job of judging investor demand. It didn’t reflect any interest from individual investors, since the IPO was only sold to clients of the investment banks, which were largely institutions. And even the investors who were allowed into the process had an incentive to underbid for the shares, if they knew they’d get something in the deal.

Some may have wanted to blame the bankers for the mispricing, but McCarthy didn’t hold the same opinion. He didn’t view them as rent-seekers looking out for themselves but rather as generally honest people working within a flawed system. “I think they do their best, honestly,” he said. “I just think because the process is flawed, it doesn’t often achieve the desired outcome.”

McCarthy was predisposed to believe that the work of investment bankers was important. He was, after all, a product of East Coast financial institutions, a former investment banker by training. He also had a healthy understanding of how much control the bankers exerted over the process. One need look no further than Google’s IPO.

As he thought about whether he could design something new, he considered how the incumbents would perceive it. “I thought the greatest risk here to the transaction, or one of the risks, principal risks, would be organ rejection by the Street generally,” he said later. “They’re busy. They’ve got a lot going on. There are a lot of companies to invest in. Nobody’s got a lot of time to learn about some new, crazy idea that you’ve dreamed up that’s so far out of the mainstream nobody cares about it. They just can’t be bothered. Or there’s something about it that so antagonizes the mainstream that they just flip you off and turn their back on you. And organ rejection was one of the afflictions of Google’s failed auction.” McCarthy worried that if he didn’t include Wall Street’s most powerful players, they would turn against his deal, as some of them had done for Google, and work to undercut its success.

Spotify now had $1.7 billion in the bank. It didn’t need money, and McCarthy was loath to issue the 12 to 15 percent more shares that he felt it would take to get Spotify trading publicly, because that additional stock would reduce his and other investors’ stake in the company. And yet it was important to McCarthy and his boss, Ek, that employees and insiders get an easier way to cash out their holdings—Spotify had been more open than many other startups to allowing employees to sell shares privately, but the process was still cumbersome. And the terms of the convertible deal made it clear that Spotify couldn’t stay private forever.

McCarthy began to think that if it was that easy to raise money in the private markets, maybe there was an opening to curate Spotify’s public debut in a way that better met the needs of the company. That would mean eschewing the traditional IPO process that had just been written into the company’s securities filings.

The week after the convertible transaction closed, on April 4, 2016, Spotify welcomed its new general counsel, Horacio Gutierrez. Sanchez had decided against taking the position, leading McCarthy to poach from Microsoft, where Gutierrez had spent more than seventeen years.

Around that time, Paul Vogel, an internet analyst at Barclays PLC, was having lunch with Facebook’s vice president of investor relations, Deborah Tuerk Crawford. Crawford had worked for McCarthy as head of investor relations for Netflix. “I’ve left Wall Street once and I’m ready to do it again,” Vogel recalls telling Crawford. In 2000, he had given up an analyst’s job at Donaldson, Lufkin & Jenrette to join an investment firm. He returned to the world of banks when he joined Barclays in 2013. “I just need to figure out what the right move is.”

“Would you like to be introduced to Barry McCarthy?” Crawford said. “I know he’s looking for someone to run investor relations at Spotify.”

Vogel noted that he’d met McCarthy once or twice when he was at Netflix but didn’t know him well. “That’d be great,” he told Crawford.

Crawford later emailed McCarthy to introduce Vogel. When the two men met, McCarthy made it clear that he was looking for a thought partner. “Barry and I had some conversations about doing an investor day and doing different types of things to really tell the story ahead of going public,” Vogel said. “Neither of us had an exact idea of what we wanted to do—it was more like, ‘What are things in the process that we would want to do differently if we could? How can we make this better? How can we make it more Spotify like?’”

Vogel, too, had noticed that the IPO process wasn’t working. “This notion of creating an artificial first-day pop in the stock is actually not really great for the company, it’s not great for shareholders who’ve been with you for a long period of time,” Vogel said later. “We both had come to that agreement pretty early on. And I think we both felt like we wanted to be able to tell the story to the widest group of investors and not just those that the banks chose or who were accredited investors allowed to listen to the information behind the walls that are set up.”

Before he could hire Vogel, McCarthy needed to start talking to exchange officials. In May, McCarthy met with Tom Farley, the president of the New York Stock Exchange, known for his boyish looks and nice suits, for what McCarthy later described as “a happy talk, meet and greet.” Stock exchanges compete vigorously to host IPOs. And their wooing of startups begins years earlier.

McCarthy officially hired Vogel as head of investor relations in June. By then, Sterky had announced his intention to leave Spotify, so Vogel quickly added oversight of financial planning and analysis to his portfolio. Vogel joined McCarthy, to whom he reported directly, as the core of a team that would rethink ways to get the company’s message out to the broadest group of investors. “It didn’t start out as broad as reinventing the IPO and going public with the direct listing,” Vogel said. “It was more, ‘What can we do differently?’”

That month, the Financial Times wrote about the fundraising environment that McCarthy had run into months before. Silicon Valley’s venture capitalists, the newspaper said, had shifted from a focus on growth at all costs to profits matter most. Investors were responding, in part, to a market for initial public offerings that had suddenly disappeared. The article was headlined “Death of the Unicorn?”

Over the course of the summer, McCarthy, Gutierrez, and Vogel set out to learn as much as they could about the IPO process and how they might adapt it to Spotify’s needs. McCarthy contracted the legal work to Wilson Sonsini, and over a series of phone calls and email exchanges, the CFO sounded out his old lawyer, Sanchez, on what was possible. One of McCarthy’s early questions: Could Spotify go public without issuing new shares?

Wilson Sonsini had helped Google design its nontraditional offering and worked with Netflix when McCarthy was there to design the compensation scheme that allowed employees to choose whether they received their bonus in stock, cash, or whatever mix of the two they wanted.

Sanchez and colleague Michael Labriola did some quick work. They found that there was a category of company that had directly listed their shares on an exchange without undergoing a traditionally underwritten IPO. Most had either been emerging from bankruptcy or were business units being spun out of a corporate parent. The process had allowed those companies to make shares available to public investors. Since they were already established companies, or business units, and presumably known to investors already, the SEC applied an easier regulatory regime and used the Securities Exchange Act of 1934 to govern the transaction.

But when Sanchez pulled in a colleague named Jeffrey Saper, a longtime securities attorney who did a lot of work with investment banks, disagreement broke out within Wilson Sonsini. Saper, who had spent time with the SEC and believed in traditional IPOs, was largely against the idea from the beginning. “Nobody does it this way,” one person recalled Saper saying. “This is not the way to take it.”

Wilson Sonsini, like many corporate lawyers, was used to guiding clients through existing laws and precedent, not coming up with new creations that then needed to be stress-tested with securities regulators. Saper fit the mold. The Wilson Sonsini partners didn’t think that what Spotify had in mind could work, in part because McCarthy wanted to stay away from having to file a registration statement.

It was in some respects an unsettling time at Wilson Sonsini, one of Silicon Valley’s oldest law firms, now facing some internal conflicts. A number of partners had grown frustrated with Larry Sonsini and other senior lawyers at the firm who seemed to them to be focused on profit over growth. They felt that they were at times left without the resources, in terms of both manpower and time, to pay proper attention to the business they’d already won or that they hoped to win.

That certainly seemed true in Spotify’s case. McCarthy wanted Sanchez to act in the same role as he had done at Netflix, but Wilson didn’t have enough people on the East Coast to meet Spotify’s demands. The problem was made worse by the fact that McCarthy had squeezed Wilson Sonsini to do the work for a smaller than normal fee.

Sanchez and Labriola conceded that if the transaction involved simply having shareholders list their stock on an exchange, and didn’t involve Spotify issuing new shares, the SEC might allow the company to list under the provisions of the Securities Exchange Act of 1934.

By September, McCarthy and Sanchez knew that it was probably technically possible to get Spotify’s shares trading publicly without raising capital. “We embarked down a path of imaging that the transaction would be governed by the 34 Act,” McCarthy said later. But should they pursue a transaction to get Spotify’s shares trading without raising capital? McCarthy had his regular check-in with Ek coming up and decided that he would finally broach the idea with his boss.

Spotify was designing a gleaming new Stockholm headquarters. It had run out of room in Jarla House; McCarthy now worked out of a different space. On the eighth floor of Jakobsbergsgatan 31, about half a mile south of Jarla House and around the corner from the Nobis Hotel, McCarthy and his team watched over the company’s finances. On Tuesday, September 20, McCarthy walked north to Jarla House to meet with Ek. It was a walk he often took, bundled up against rain, sleet, and snow. More than once he grumbled about the dark skies and bitter cold of his adopted home.

McCarthy knew a direct listing would be a nonstarter if he couldn’t get his CEO on board. The framing was critical. Sticking it to Wall Street wouldn’t have much emotional relevance for Ek, though it did to Lorentzon. But doing something different to better solve Spotify’s particular situation might appeal more to Ek’s sensibilities. “I had thought long and hard about how I wanted to introduce the idea to him,” McCarthy said later.

Arriving at Jarla House, McCarthy made his way to Ek’s office. When the two men sat down for their regular catch-up, McCarthy made his pitch. “I have this crazy idea to do something that’s never been done before,” he recalls saying. Ek leaned in. McCarthy had his attention. McCarthy went on to describe the idea in detail. He said he expected to hear back from Sanchez sometime soon, at which point he’d have a better idea of whether it was doable. Ek liked what he heard. “He wasn’t at all dissuaded by the risk of being first,” McCarthy said. “Being innovative, being different for a purpose, has great appeal for him.”

Meanwhile, Vogel was trying to schedule an investor day, but Spotify was in the midst of another round of negotiations with the music companies, and the talks were dragging out. McCarthy described the basis of the terms that were under discussion. “The bulk of the chunk of money is percent of revenue, independent of plays, and then the money gets divided up based on percent of plays. There are also some guarantees—think of it as schmuck insurance—that protect them on the downside,” he said later. “So you’re kind of dancing between those two raindrops.”

Spotify didn’t want to host an investor day until the negotiations were complete. It would give investors another opening to pick at Spotify’s business model.

With Ek on board, McCarthy began to think about the role of the bankers in his transaction. He wanted to be thoughtful about how the banks might help him. “Let’s think fundamentally about the nature of the advice that their value added,” he said later. “What exactly did they do for companies when they took them public? They provide advice, and they provide underwriting. Well, the underwriting risk exists for what, a fraction of a second? There’s no real risk, right? The deal is pre-sold. The bank buys it. They want it for a second. They sell it to Fidelity, T. Rowe, everybody else. So all the value-added really is in the advice. And we’re going to be public like every other company was going to be public. We were going to present ourselves to the investment committee, just like every other company who’s in the process of going public. And so I wanted their advice.”

He would have to come up with answers sometime soon.

A week later, Paul Kwan headed to the San Jose airport for an overnight flight to Stockholm. The head of Morgan Stanley’s West Coast tech practice and the former head of internet and software banking, Kwan had worked with many of the world’s largest internet companies. He had known McCarthy for years. The two men worked closely together when McCarthy was at Netflix and used Morgan Stanley’s services. Kwan was on his way to see him.

Kwan thought that this meeting would be like dozens of others he would do that year—it would give him a chance to touch base with the client and find out if there was anything he could do to help. Often there wasn’t, but bankers were used to calling on clients for years before a big transaction would deliver millions of dollars in fees. Kwan understood that the clock had started ticking on Spotify’s public offering, and he wanted to make sure he would be in line to lead it.

The morning of his arrival was cold, and he bundled up for the trip to McCarthy’s office. Their meeting was scheduled for 11:30.

Kwan was ushered in, and the two men sat down in a conference room. “I’ve been thinking about nontraditional ways of going public,” McCarthy said. The CFO explained that he needed to give insiders a way to buy and sell shares easily, and that he didn’t need any of the money an IPO could provide. He posed a question of whether there was utility in using the traditional IPO process to solve Spotify’s unique set of objectives. “We’re thinking about doing a direct listing.”

Kwan hid his surprise. An expression of skepticism could hurt his chances of getting hired for the transaction. Earning the mandate of being one of Spotify’s lead banks, even in a direct listing, would likely deliver tens of millions of dollars in fees. “That’s interesting,” he told McCarthy. “I understand why you are asking the question. They are the same issues we have been trying to solve for years.”

Kwan recognized, in what McCarthy was describing, some of the elements of a corporate spinoff. In 2007, he recalled, EMC, the world’s biggest manufacturer of data storage hardware, had directly listed a division that made software for corporations to use that storage more efficiently. It was a successful transaction—EMC received an $11 billion windfall, and the division, named VMWare, became one of the world’s largest software firms by value.

McCarthy was planning for only existing shareholders to sell stock. Spotify wouldn’t sell anything, but he figured that the company would be in charge of settling on a price for the shares others were selling. “Help me answer these three questions,” McCarthy said. “How will I figure out the offering price when I’m not selling anything? How will public investors behave—will they buy it or ignore it? Do we lose any PR or marketing benefits of a traditional offering?”

The two men discussed those questions for some time before it was time for Kwan to go.

“Go do some work on it,” McCarthy said.

Kwan walked out of the meeting thinking that he might have an interesting transaction on his hands. And that the deal might solve some of the issues with the traditional IPO.

On October 18, McCarthy traveled to Morgan Stanley’s Menlo Park office to meet with Kwan and others on his team. Since Kwan had visited McCarthy, he’d had his fellow bankers work on answers to the CFO’s questions. Morgan Stanley had concluded that McCarthy wanted to do something different, and that they wanted to be part of whatever that was. They looked for ways to get to yes.

In late October, McCarthy moved back to the United States. He settled professionally at Spotify’s Sixth Avenue headquarters in Manhattan, in a seven-story Beaux-Arts building located in the heart of the Flatiron district that was home to many of the city’s tech startups.

In December, as the streets of New York began to fill with the sounds of holiday shoppers and the bells of the Salvation Army Santas, McCarthy prepared to show his cards to Farley and his colleagues at the New York Stock Exchange. He was beginning to assemble a cast of characters who could help him pull off a new type of direct listing, and he needed to find an exchange willing to entertain his idea.

When Farley heard that McCarthy wanted a meeting, he had brainstormed with his colleague John Tuttle about what Spotify might want to discuss. On December 16, a chilly and clear day in New York, Farley boarded the subway for the trip north from the NYSE’s marble-columned building on Wall Street to Spotify’s offices. The meeting was small, just McCarthy, Vogel, and Farley, but critical in terms of bringing another important player on board.

McCarthy had kept Farley in the dark. He’d grown accustomed to having his idea met with skepticism but found that most people eventually came around. He preferred to explain his reasoning in person. When Farley arrived and the three men gathered in a meeting room, McCarthy broke the news.

“I have an idea,” McCarthy said. “You’re sworn to secrecy.”

Farley was intrigued. He agreed to be discreet.

“I want to take Spotify public,” McCarthy said, “but I don’t want to raise stock, and I just want to list it.”

For a second, Farley didn’t know what to say. “The banks won’t be too happy with that,” he finally said.

“Why would I need a bank? I’m not going to use a bank,” McCarthy said. “Why does that matter if the banks are happy or they’re not happy?”

Farley tried to process this. It wasn’t what he’d expected.

“There is some precedent for this, because when companies emerge from bankruptcy, often they just list the stock,” Farley told him. “Similarly, when foreign companies list in the U.S. as a dual listing, they just list the stock, and the opening auction mechanism on the stock exchange is what sets the opening price.”

“I’m aware of that,” McCarthy said. “There’s actually been a lot, and I don’t understand why companies don’t look at this particular avenue.”

“I’m trying to understand why you’re interested in this,” Farley said.

“Well, a lot of reasons. I think I can have a more fulsome dialogue with my investors if it’s not governed by a typical IPO quiet period,” McCarthy said. He meant one governed by the Securities Act of 1933. “We don’t need the cash, so why go raise a whole bunch of cash. The typical IPO process doesn’t make a ton of sense to me.”

By the end of the meeting, Farley told the Spotify executives that the exchange would like to be involved.

“I love it, I’m in,” Farley said. “I want to help. Let me go back, work with the team. Figure out what rules would need to change, if any.”

Farley may not have realized it, but he’d already won the competition against NASDAQ. For most of its forty-five years in business, NASDAQ had been the exchange of choice for America’s fast-growing internet companies; Apple, Microsoft, and Amazon.com chose the venue for their listings. But by 2016, McCarthy and other tech executives had soured on it because of its system error during Facebook’s IPO.

The instant he was off the elevator and out on the street, Farley called his boss, Jeff Sprecher, CEO of the Intercontinental Exchange, which owned the NYSE. As Farley walked down Sixth Avenue, he told Sprecher about the conversation he’d just had with the Spotify executives.

“I’ve got to tell you about the meeting I just had,” Farley said. “I think there’s a better way to do an IPO, and Spotify might take the leap.”

As the two men talked, Sprecher offered some advice, grounded in his years of experience. “I think they’re going to use the banks.”

“What do you mean?” Farley asked.

“You know, the banks help you in other ways, and Barry’s a smart guy,” Sprecher said. “You’re not going to want to alienate the top guys. They’re going to bring you deals and maybe later on you raise some debt, or you do a convert. You’re going to want the research.”

He went on. “I like this, but I think the banks will be involved.”

McCarthy also began sharing his idea with board members. Pärson, one of the company’s first backers, said that directors discussed it for a couple of months. “It was almost presented initially as a crazy idea.” Pärson explored the idea with Farley at NYSE as well. “The thing with Tom was that he loved that idea,” Pärson said, “whereas, the NASDAQ people were initially very, very skeptical.”

One month after the Farley meeting, McCarthy began to seek out people whose opinion he respected. He reached out to TCV’s Jay Hoag and to Andy Rachleff, who had named McCarthy to the board of his digital investment advice company years earlier. He also sought out Mary Meeker, now a venture capitalist, who reminded McCarthy of the importance of having the banks involved. Another person McCarthy contacted was Herb Allen, the patriarch of boutique investment bank Allen & Co. and the host of a star-studded summer conference that McCarthy liked to attend. McCarthy also sought out Ken Broad, a hedge fund investor at Jackson Square Partners who’d been managing a small/mid cap growth fund when McCarthy was Netflix’s CFO.

On February 10, 2017, at 1:00 p.m., McCarthy walked into a small conference room named Barracuda on the seventh floor of Spotify’s New York offices for a call with Broad. The offices were utilitarian, with concrete floors and white bench-like desks identical to those in the Birger Jarlsgatan 61 offices. The conference room was in the back corner of one floor, adjacent to the desks of McCarthy and Vogel, which faced each other.

McCarthy dialed into the call with Broad, and the two men chatted for a while.

“Hey, what do you think about this as an idea?” McCarthy said, and proceeded to outline his vision for a direct listing.

Broad was open to it. Back in the late 1990s he’d become a student of the IPO process, interested in understanding whether it was worthwhile for small investors to spend time evaluating companies going public through an IPO if there was no guarantee of a large allocation. He shared some of what he’d learned with McCarthy.

One topic the two men talked about was how to think about the traditional IPO and its inherent problems. Broad suggested that McCarthy look into the degree of underpricing in the market, and referred him to a University of Florida professor named Jay Ritter. Call Ritter, Broad said, “if you’re trying to frame why this might be better in terms of the degree of underpricing. This guy’s the godfather of IPO stats.”