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  • Northzone News
  • 15 March 2018
  • 6 min read
  • Words: PJ Parson

Spotify - The Impossible Success Story

Spotify’s success story is both brilliant and hard-won. As the company prepares for its listing, I look back at the decade of close work with Daniel and Martin, from the early days in 2007, and leading the first financing round in 2008. Success is often hard fought, and the journey with Spotify has been a privilege and a roller coaster.

“..and could we just change the price to Euro?” Martin Lorentzon asked almost in passing in our telephone call as we were about to conclude the final negotiations of the A-round.
“Sure”, I said. “Could you send over the new share count?”
“No, I want the price and round size to be in Euros, not Dollar. You know, the Dollar has lost so much value over the past few months and I think it would be a too low valuation”.
“Martin, you’ve got to be kidding me, right?”
“So you are asking me to invest 20% more money at a 20% higher valuation than we’ve been discussing over the past 6 months?

Something special 

I have known the Spotify co-founders Martin Lorentzon and Daniel Ek since the last dotcom boom. Martin worked in one of my earlier internet investments that ultimately failed, only to found his first big success, Tradedoubler, in our offices during off-hours with his co-founder Felix Hagnö. Daniel, meanwhile, and still in high school, moonlighted as part time CTO at Scandinavian auction site Tradera, a company I once served on its Board of Directors.

When Daniel and Martin presented their demo of Spotify in early 2007, I was totally blown away.  But, I had already lost several millions in failed prior music technology investments and the ongoing lawsuit against Niklas Zennström for his file sharing app Kazaa and the threats to imprison the entire Pirate Bay founder team clearly gave reason to pause. The music industry was a virtual minefield.

But there was something entirely different going on at the tiny offices at Riddargatan than anything we as venture capitalists had seen before in Sweden. The best talent was attracted to Spotify like bees to honey and the buzz wasn’t constrained to the environs of Stockholm – no there were brilliant minds in London, New York, LA and San Francisco that knew about this crazy cool app and had secured a much coveted private beta invite. One of them was former Facebook President Sean Parker.

Getting the investors on board

The most important obstacle for Daniel and the content team was to secure licensing rights to stream a complete catalogue. The four major labels were experiencing plummeting sales due to rampant piracy and could not see how providing a free service would do anything other than send them even deeper into the red. But they clearly saw the excellence in the product and technological skills and kept the dialogue going demanding exorbitant upfront payments to provide the rights.

It took more than two years to land the necessary content deals with sustainable commercial terms. Well, sustainable only if you are dead certain to raise massive amounts of capital without having a single dime of revenue for the foreseeable future. Luckily, Martin Lorentzon’s exit from Tradedoubler meant he had been able to finance the first two years and gave substance to his motto “I put all my eggs in one basket – and then I guard it zealously”. I had by then negotiated for 18 months and put together three different syndicates that all fell apart. Considering the fact that all VC’s in Europe and North America had by then declined to invest it was more than ballsy by Martin and Daniel to drive such a hard bargain. Finding a local VC syndication solution was my final straw to get this deal I wanted badly to be done. Creandum and Innovationskapital stepped into the negotiations and at the eve of signing the terms sheet, I get the call from Innovationskapital that they are out. The deal leader couldn’t get support from the rest of his team. My partners at Northzone began to think I was overly obsessed with this overpriced, overconfident startup addressing a market which was described by Hunter S. Thompson as follows; “The Music Industry is a cruel and shallow money trench where thieves and pimps run free and good men die like dogs. And then there’s the negative side.”

Picking up Innovationskapital’s piece in the syndicate was the only thing to do to get over the finishing line. This move made Northzone the largest shareholder after Daniel and Martin and we have never needed to regret it since, despite the final twist of the pricing as described in the opening.

Daniel didn’t waste any time and recruited top talent right left and centre. Ken Parks, a New Yorker and EMI executive joined to head up the content team and Gustav Söderström, fresh from exiting his Kenetworks, took control over the product. The mobile product started to take shape and the first ideas of a revenue model was crystallizing. Sean Parker got involved in the product development discussion and the star struck Spotify engineers inhaled every piece of advice from the Napster legend. At a board meeting in the gloomy company apartment on 17th Street, doubling as the NYC office, we were discussing how many users would convert to premium accounts. Our assumptions where until then based on Skype, converting roughly 4% to paid. Sean was more than animated when he said that it was totally stupid to not aim for 100% conversion to premium. “It is entirely a product problem to solve!” Indeed, he was right.

Funding for growth

Two years into our investment, the company was raising its third round of financing, now at the milestone valuation of $ 1 billion which very few European companies had managed to reach at the time. Spotify was obviously the darling of the European tech industry. Then things changed.

Facebook was going public and their chaotic IPO send shockwaves through the tech ecosystem. The crucial funding process got shakier by the day as Facebook’s share price sank lower and lower. With no cash in the company accounts, Martin and Daniel asked us to step in alongside themselves and prove to prospective new investors that we believed in the company. We knew that the funds would only last a couple of months unless the big round would happen – so were we throwing good money into a black hole? It didn’t help our comfort level either that user growth showed signs of slowing down. But conversion to paid was kicking in and the revenues started to grow, albeit from a low level. What ultimately convinced Goldman Sachs and Accel to take the plunge is unknown to me, but it certainly represented a huge milestone as it also provided funding for the critical US launch.

“We need to change our business model, otherwise we are doomed” Daniel told me matter of factly over a coffee in the cantina of the new office on Birger Jarlsgatan. “Nobody will be using desktops in a few years and our growth of new free users is stalling since we can’t offer a free product in the mobile”. “I need your support to force the labels to rewrite all the agreements to enable us to be mobile first”

“So what happens if they don’t want to cooperate just like many times before?” I asked. “Well, then we’re dead. Therefore I need to raise $ 250 million” Daniel said calmly.

Very few things can rock the level headed temper of this self-taught computer wiz-kid from a working-class neighborhood south of Stockholm who became the most accomplished CEO I have ever worked with, despite him being 20 years my junior. Daniel is and has always been the secret weapon of Spotify. His strategic mind and ability to move freely from discussing the highest level of abstraction to the lowest level of detail and make the connection between them fully understood by his organisation is extraordinary. He is an eager learner and makes sure he gets access to the smartest people wherever they are. He never rests on his laurels and motivates and empowers his team to aim higher. He is a believer of failing fast and moving on. The only thing that could truly throw Daniel off balance is if his favorite soccer team Arsenal loses.

The rest is history

Fast forward to March 2018, nine months after my, Sean Parker’s and Klaus Hommels’  resignations from the Board of Directors and staffing up with the right people for the next phase, the company has just filed its F-1 to go public on the NYSE. They have outperformed even my most optimistic expectations, being live in 59 countries (still 140 countries to go!), and having changed the course of a struggling industry now back to growth. The bet on mobile first was perfectly timed and growth accelerated to more than 70 million paying customers. The consumer experience is superior to any other service, proven by NPS scores that are above and beyond the pack. I am extremely grateful to have played a small part in the impossible story of a Stockholm startup that continues to impress 12 years after its founding which was on April 1st 2006 and very soon as a public large cap tech stock with the very appropriate ticker SPOT.

And the rest, as they say, is history.