The Spotify Play Page 7

“To him, it was like Spotify and streaming had already happened. Like it was a settled fact of future history,” Joe Cohen would recall.

Daniel got off the stage to scattered applause. He still hadn’t managed to sign any deals with any of the big record companies.

Two days after the conference, Apple’s first iPhone model hit stores. The device would soon spawn an app revolution and turn the Cupertino giant into one of the most valuable public companies in the world. Spotify was still in beta mode, and only available on desktop.

I Need A Dollar

Back in Stockholm, Martin Lorentzon was working out a deal that would fund the company. He got back in touch with Pär-Jörgen Pärson, saying he was ready to start negotiating. Pär-Jörgen was elated by the news but balked at Martin’s asking price. The Spotify chairman wanted around $22 million, or 150 million Swedish crowns, for 20 percent of his company.

To the Northzone partner, it was an absurdly aggressive starting bid. That price tag would value Spotify—a company that still had no deals with the labels and no commercially available product—at more than $100 million. Pär-Jörgen was torn. After all, Martin had a proven track record and seemed to be prepared to invest a large part of his personal fortune. Pär-Jörgen said he needed to discuss things with his associates at Northzone.

Other investors, like Tradedoubler’s first investor Magnus Emilson, were far more skeptical. Emilson rejected Martin’s proposal, noting that Spotify lacked music licenses and feeling the valuation was way too high. Sonali De Rycker, a partner at Atlas Ventures in London, was impressed by the beta version of Spotify, but found Martin’s valuation laughable.

“I thought he was crazy,” she would recall.

In Stockholm, it fell on Pär-Jörgen Pärson to piece together a group of investors that would be willing to share the risk. But with so few interested in betting on music technology, he didn’t even have the wholehearted support of his own firm. His partners said they had seen too many “road kills” in the sector.

The music industry was infamous for bleeding VC-funded startups dry, almost as their only form of digital strategy. Money would flow from investors straight to the labels through companies that would have done well to survive for more than a couple of years. Pär-Jörgen, who still believed Spotify could dominate the space, was growing frustrated.

He wasn’t the only suitor fretting over the deal. Fredrik Cassel at Creandum had cultivated his relationship with Daniel Ek over Skype for months. Daniel had tipped him off about a promising video-based adtech company called Videoplaza, which Fredrik would go on to make a successful investment in. But the young venture capitalist had his eyes on a bigger prize. His main objective was to get in on Spotify’s A-round of funding, alongside Creandum’s rival, Northzone.

Hangin’ Tough

For most of 2007, Daniel Ek is said to have held firm on his vision that Spotify would be a global service, free to all of its users. This is also the way would-be investors Creandum described the service in a written document dated June 2007.

The young Spotify CEO felt his pitch had a good chance of succeeding. He entered meetings with the labels with a strong product and a track record in monetizing ads online.

“That was unique. But the labels were already skeptical of anything ad-funded. They felt the money wasn’t really there,” as one source would describe it.

Daniel’s approach clashed with the conventional wisdom of the music industry. The young Swede would offer labels a share of Spotify’s revenue which would hopefully grow significantly over time. But the labels generally wanted to be paid per stream, regardless of Spotify’s ability to sell ads. In short, Daniel wanted a structure that rewarded growth and didn’t punish Spotify for users who streamed a lot of music. To the Spotify team, payouts per stream risked running up costs that would kill the business.

Toward the end of the year, Spotify’s finances were strained. On their many business trips to the US, Daniel and his top managers flew coach and held back on expenses. For years, employees would love to tell the story of how Daniel and his main negotiator, Niklas Ivarsson, were forced to share a bed in “the cheapest hotel in Manhattan.” Niklas, who had a bad cold, spent the night coughing and sniffling next to his CEO.

One source would recall that in late 2007, Daniel and Niklas visited Universal Music’s headquarters in New York, where their pitch failed to impress. With them was the attorney Fred Davis and his coworker Elizabeth Moody. The Spotify quartet struggled. Universal’s team thought an ad-based model would never generate enough revenue. The main stumbling block was that the label wanted a high per-stream payment of around 0.5–1.0 cents on a sliding scale, while Spotify wanted the deal to mainly be based on sharing ad revenues, according to two sources.

Eventually, Daniel had to compromise by adding a paid service. Three people at Spotify drove him to that shift in strategy: Spotify’s “dynamic duo”—Niklas Ivarsson and Petra Hansson—and the New York-based advisor Ken Parks. After scores of meetings with labels and legal consultants, they are said to have convinced Daniel that a paid version was the only way forward. The alternative would simply cost too much, in both cash and company shares, and never lead to a sustainable business.

The freemium model that would define Spotify was thus born out of a tit-for-tat dialogue with the labels, with Niklas and Petra painstakingly hammering out the details of a new template. The industry hated the free service, but was prepared to put up with it as a means to an end, with Spotify vowing to convert free users to an ad-free, premium version.

Daniel’s global ambitions remained intact, but launching in the United States was a tall order. His focus thus shifted toward signing licenses in Europe. The talks with Universal, for example, would now take place in London, where the Spotify team dealt with its head of digital, Rob Wells.

Take A Chance On Me

Toward the end of 2007, Spotify’s potential financier was struggling to get co-investors on board. Pär-Jörgen Pärson was beginning to feel like the awkward kid at the school dance. The investment company Kinnevik—at which the young Cristina Stenbeck had succeeded her late father, Jan—passed. The same went for international venture firms like Index Ventures and Balderton Capital. Finally, Pär-Jörgen managed to put together a consortium of investors consisting of the Stockholm firm Creandum and Innovationskapital, based in Gothenburg. Together, the trio would put up $15 million for a piece of Spotify.

It was a risky deal, but the investors lauded the constant improvements to Spotify’s software. In September 2007, the growing company released its seventh beta version. This time, the group photo pictured twenty coworkers.

In the photo, Andreas Ehn is seated in the front row. The key programmer, Ludvig Strigeus, is smiling from his wheelchair in the second row, two spots down from a nearly obscured Daniel Ek. In the far back are Sophia Bendz and Petra Hansson, surrounded by male engineers. Many in the Spotify team continued to believe that the commercial launch was just weeks off.

A few blocks away, at the Northzone offices, a frustrated Pär-Jörgen knew that wasn’t the case. But he was reassured by his contacts in the music business, who appeared to believe in the service. He had several phone conversations with Per Sundin at Sony BMG. The record executive was a beta tester and claimed to love the product.

“It’s only a matter of time before Spotify will have licenses,” Sundin said over the phone.

Pledges from music executives shouldn’t be taken literally, Pär-Jörgen thought. He knew they were desperate to find new revenue sources, particularly if they came with no financial risk to their own business. Besides, the labels were said to be “thick as thieves,” colluding with each other at every turn. It was hard to know when they were actually being forthright.

By the summer of 2008, it finally looked as if Northzone’s joint investment was ready to go. But then the third investor, Innovationskapital, suddenly backed out.

Hair

> Daniel Ek was at this time still flying frantically between Stockholm, London, and New York, trying to close deals with the four major labels.

In July 2008, the young Swede hit a major roadblock. He would, four years later, describe the incident on Swedish public radio, retelling how he stepped out onto the hot pavement near Rockefeller Plaza, feeling nauseous and jetlagged, with a splitting headache. A hectic week had ended in a catastrophic meeting with one of the labels, and Daniel felt it might all be over.

“I’ve just been told that my baby, Spotify, the music company I’ve worked on day and night over the past two years, won’t work out,” he said. “It’s July 2008, I’m twenty-five years old and it feels like my life is about to end.”

After the failed meeting, Daniel said, he called co-founder Martin Lorentzon and told him that “the man who looks like a hairdresser” had changed his mind. The label was no longer on board.

During his radio appearance, Daniel did not name the label or the man with the funny hairdo. But, looking back, it was most likely Warner Music, with its offices by Rockefeller Plaza. The “hairdresser” would have been Michael Nash, Warner’s head of strategy and business development, who was known for his frosty highlights.

During the call, Martin did his best to calm his protégé.

“Problems aren’t problems. We’ll solve this, we’ll think of something,” Martin said, in Daniel’s retelling.

At this point, Daniel was still hoping to gain global licenses for Spotify, according to one source with knowledge of the matter.

“This may have been the moment that Daniel realized that a single deal for both North America and Europe was going to be impossible,” the source said.

Ante Up

Daniel Ek was now acutely aware that Spotify’s money was running out. The company struggled to pay rent at their new offices on Humlegårdsgatan. According to one person familiar with the finances, Daniel lent the company tens of thousands of dollars so that salaries could be paid.

Pär-Jörgen Pärson had become desperate, wondering if there would ever be a funding round with the support of other outside investors. But then Daniel started making some real progress with the record companies.

A meeting at Spotify’s office, eight months ahead of the launch. From left: Ludvig Strigeus, Andreas Ehn, Andreas Mattsson, Mattias Arrelid, and Emil Fredriksson. (Rasmus Andersson)

By now, the five major record labels had become four. During the summer, two of them shook hands with Spotify for licenses that covered the Nordic countries and a few additional European markets. Suddenly, the Spotify investment was looking much less risky. Northzone vowed to cover Innovationskapital’s share of the funding, with Creandum taking the remaining third. But now, with things already delicately poised, Martin Lorentzon decided to ante up.

“We’re changing the investment to euros,” he told Pär-Jörgen over the phone in late summer.

At first, Martin’s former boss didn’t know what he meant.

“Absolutely, we can convert the round to euros,” he said.

But Martin didn’t want to change the figure, just the currency. The dollar had been falling against the euro, and Martin felt he simply needed more money.

“Martin, you must be joking.”

“No. We want it in euros. Take it or leave it,” he said.

The stubborn founder would eventually get his way. According to one person involved, Martin was able to talk up the valuation by around 20 percent.

In late August 2008, Spotify’s first external funding round was registered in Luxembourg. Northzone invested more than $12 million and became the company’s third-largest owner, after the founders. Creandum came in fourth on the cap table, followed by Martin’s former Tradedoubler buddy, Felix Hagnö.

Spotify was now valued at $86 million. Both Pär-Jörgen Pärson and Fredrik Cassel were elected to the board of directors. After prolonged and shaky negotiations, Northzone had made what would become its best-ever investment by a long stretch. Pär-Jörgen would remain a board member at Spotify for nine years.

At the Spotify office, around forty employees toasted to the news with glasses of sparkling wine. Daniel was visibly relieved, according to one account.

“That was lucky. If we hadn’t gotten funded, you guys wouldn’t have received your salaries,” he reportedly told his colleagues afterward.

In fact, the timing was immaculate. A few months later, the investment bank Lehman Brothers filed for bankruptcy, setting off the worst financial crisis in more than seventy years.

Eye of the Tiger

In 2008, Daniel Ek’s man in London, Shakil Khan, finally got the exit he had been seeking. It came when AOL bought Buy.at, of which his company, Lightstate, was now a part. Only a few people know exactly how rich the deal made him. But Shak has stated that it made him serious cash or, in his words, “wealth-type money.” Daniel reached out to his nouveau riche friend in London.

“Are you depressed yet?” Daniel said, according to Shak’s subsequent account.

“Yes, a bit,” he answered.

“Have you bought a new car?”

“I was actually just looking at one today.”

“You’ll be fed up with all that in a week,” Daniel said.

Daniel had probably tightened his bond with Shak by learning the details of his troubled past. Like Daniel, Shak had come from humble beginnings and made money through online advertising. But the odds stacked against the Brit had been even greater.

Shak’s parents were immigrants from a small village in Pakistan who moved to the UK in the 1970s. As a teenager, Shak found himself in the working-class area of Dagenham in London, where he had to contend with local skinheads who would spit in his direction and call him a “paki.” He would fight and smoke weed. When his parents found out about the drugs, they confronted him, according to Shak, which led to a blowout.

Later in life, Shak would describe how he left home in March of 1989, the same day he turned sixteen. In his late teens, Shak stole cars and was forced to sleep rough at times. He eventually started selling drugs, which led to two years of confinement.

“I’m probably the man I am today because of these trials,” Shak would admit.

In the mid-1990s, he started buying and selling used cell phones, exploiting the price discrepancy between local phone shops in Dublin and the second-hand market in London. Shak would look through the Yellow Pages and then drive around the British capital buying used phones, polishing them up before flying to Dublin to peddle them to shop owners. Before returning to London, he’d lock himself inside one of the airport restrooms and count his billfold.

Eventually, Shak would use computer technology to escape a life of poverty and crime. He did not use a computer until 1995, when he was twenty-two years old. Yet around the turn of the millennium, he founded the company Smsboy.com, a website that let users send text messages online. Shak would go on to sell domain names and market off-brand Viagra pills online through a company called Activemed.

By the spring of 2008, Shak had turned thirty-four. The deal with AOL had made him independently wealthy, and he was looking for a new project to invest in. His friends in London warned him against it, but he decided to trust his instincts and invest half of his fortune in Spotify.

“I wasn’t backing a music product. I was backing an entrepreneur named Daniel Ek,” Shak would explain.

But Shak did not rest on his laurels. Soon, he was back on the grind, doing what he does best. He would network and schmooze with rich, powerful figures in the international tech world. Gradually, he became Daniel’s special envoy, his “eyes and ears” in the secret circles where decisions are made.

It was Shak who would eventually provide Sean Parker, the co-founder of Napster, with an early version of Spotify, long before the service was legally available in the US.

All Music for Free

ON SEPTEMBER 27, 2008, SPOTIFY threw a huge launch party at Ber
ns, a classic nightclub and concert venue originally built in the late 1800s to accommodate a rowdy variety theater crowd. The lofty salons and ornate galleries were decorated with oversized helium balloons in Spotify green, and guests were invited to play Guitar Hero. The financial crisis was raging, but Spotify had already secured its funding. Now the coworkers wanted to celebrate their launch in style. The only problem was that it hadn’t quite happened yet. A few licensing details remained unresolved.

“Daniel and Martin were nervous,” as one source would recall.

News of Spotify’s funding round had leaked before the negotiations were done. Suddenly, knowing that Spotify had the money, the labels had started demanding better terms, according to one source.

During the party, though, Daniel and Martin held straight faces in their black suits. The group photo, taken in front of the main stage in the Grand Salon, shows just over forty employees, dressed to party. The head of marketing, Sophia Bendz, wore a beige dress. The programmer Gunnar Kreitz, however, saluted his alma mater by wearing his usual KTH t-shirt.

Sophia had seen to it that the party was sponsored by a beer brand and Xanté, a French brand of pear cognac. The drinks flowed all night as the staff mingled with friends, investors, and people from the music business. Shakil Khan worked the room, shaking hands with Spotify employees, but few understood what his role was at the company.

Spotify’s negotiators, Petra Hansson and Niklas Ivarsson, had been in final talks with the labels for months. The secret blueprint that had emerged centered largely around revenue sharing, creating an incentive for growth. Around 55 percent of Spotify’s revenue would go to the record companies, who own the recordings. Another 15 percent would go to the music publishers, who administer the rights of the songwriters. In theory, around 30 percent would be left over to finance Spotify’s operations.

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