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The Swedish music streaming company is using a dangerous mechanism to go public, called a direct offering, that could see its price swing wildly over the first few weeks and potentially end in disaster. If things go south consumers could see a rise in prices.

Direct offering

Typically when a company goes public with an initial public offering (IPO), they first offer shares to a bank, who then offers those shares to their clients at an agreed upon price. This means that the bank is now invested in the success of the IPO. It also means the price of a share is more firm because the company has already been traded at least a little.

This method offers stability and raises large sums of cash for the company immediately while keeping its value relatively stable.

Spotify has instead opted for a direct offering, where they list certain number of shares and the New York Stock Exchange (NYSE) lists a "reference price" to start bidding. By going around the typical process, Spotify will save millions of dollars in bank fees, even after paying $36 million to Goldman Sachs, Morgan Stanley, and Allen & Co. for advice. The banks won't underwrite the stock, but instead play a limited role in its roll-out. The company claims they did this because they don't need cash on hand and they wanted their listing to be more fair.

The typical IPO favors large investors because it gives banks the first crack at it, but a direct offering allows all sizes of investors a chance at purchasing the stock right away.

This free-market approach is also what causes the price volatility. Even if Spotify has valued themselves correctly, the rush to get in early can cause a massive spike in price, leading to a massive drop in price. Spotify has been valued at as high as $23.6 billion according to the Wall Street Journal, but if they get it wrong they could wipe billions off their value.

The worst case

If that happens and Spotify is nowhere near as valuable as they thought, the CEO could be under a lot of pressure from the new board to substantially raise profits. This could take many forms, such as paying artists less, having more ads in the free version, or even raising prices. Spotify has already struggled with artists in the past and consumers expect a near unlimited library, so it seems their only option might be to raise prices.

They could do this a number of ways. One option might be to get rid of their discount regimes. Currently, Hulu subscribers, students, and Capital One card members gain certain benefits on Spotify that could be on the chopping block.

They might instead move to a partial subscription model where you pay a lower price for a certain number of ad-free songs or playlists. This might bring in more customers who currently don't want to pay full price for a limited music selection. Their last option is to just raise the full subscription price, because outside of certain genre-specific streaming apps, Spotify has little competition and consumers have little choice.

Spotify goes public tomorrow, Tuesday, April 3rd to an increasingly volatile tech market.