Why Did Spotify Just Raise $1 Billion In Debt Funding Under Such Horrible Terms?

[UPDATED] Debt has become an increasingly popular funding mechanism for mid to late stage startups as investors grow tired of sky high valuations and seeing their stake reduced by later equity infusions. Now, Spotify has jumped on the debt financing bandwagon, raising $1 billion under some potentially difficult terms.

In its 13th funding round, Spotify has raised another $1 billion, this time in debt funding from TPG,  Dragoneer and clients of Goldman Sachs.  That puts Spotify's pre-IPO total potential cash intake at $2.56 billion.

This time the cash comes with some potentially onerous terms. For starters, Spotify must pay 5% annual interest on the debt, adding 1% more 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, their discount increases 2.5% every extra six months. Additionally, the new investors can sell their shares just 90 days after the IPO, well before the 180 day lockup for Spotify’s other investors and employees.

WHY?

The public line for investor TPG: “This financing gives them the strategic resources to further strengthen their leadership position." But Spotify apparently still has more than $640 million in the bank, a source tells TechCrunch.  So, why accept such horrible terms?

• Spotify may believe that, with increasing competition, there will be no better time to raise more cash then now.

• It plans to IPO within a year before the more expensive terms start to kick in. Risky, given the volatility of global markets.

• It wants the cash to buy something like Rhapsody (why?), SoundCloud (maybe), Pandora (valued at $2 billion, its too expensive)

• Video. According to Peter Kafka, "for many years, Spotify’s (private) pitch to investors has been that it will grow beyond music, and into video." After all, Spotify has 70 million ad-supported users and advertisers love video.  And yes Spotify already has video, but nothing you can't see elsewhere.  Exclusive content costs money.