Analysis: Signs of Intelligent Life in the Music Business

Authored by Paul Sweeting on May 26, 2008 - 5:56pm.

Required reading: "Should Societies Pursue Equity?" a white paper released last week by Will Page and David Touve. Page is the executive director of research for the Mechanical Copyright Protection Society--Performing Rights Society Alliance, the U.K.-based royalty collection agency for songwriters and music publishers. Touve is a doctoral candidate at Vanderbilt University and a former online music entrepreneur. The white paper asks the musical question: Could a licensing system for music start-ups based on giving performing rights societies equity in the company that would pay out either at the time of an acquisition or as a percentage of future revenue, in exchange for a blanket license to use the society's catalog, help resolve the current legal stalemate between rights owners and innovators.

Page and Touve start by recognizing some important realities:

Start-ups generally lack the cash reserves needed to pay standard licensing fees, as well as the human and legal resources to negotiate and administer complex licensing agreements. That typically leaves them with the unpalatable choice of signing a license they can't pay for, or hoping to get big enough by the time they're sued to deal with the problem then.
Since online music is still a nascent business, start-ups often have to adjust their business model as they go along, assuming they even have one. Thus, traditional royalty arrangements, based on a percentage of revenue and defined use cases, will be no better than a shot in the dark in most cases. Coupled that with the fact that online start-ups generally pursue growth in users over revenue in their early years and it's clear that a traditional license structure is likely to drive start-ups out of business before rights owners see any royalty revenue.
Both start-ups and rights owners have a shared interest in successful innovation that creates new markets for recorded music.

Their proposed solution is to give rights holders an equity stake in the start-up in exchange for a license. From the paper:
Rights societies could consider accepting the currency with which start-up firms generally operate - equity. Furthermore, a method for exchanging this equity for licence terms should be standardised if at all possible.

It would be ideal to adjust the percentage of equity preferred to the imagined financial prospects of individual firms. However, rights societies must accept that predicting the eventual value of start-up firms, at moments close to their birth, is neither an exercise with which societies are well versed, nor a calculation even those with experience can do with great reliability. Any standardisation of equity could be based upon the series of funding round and valuation levels.

[snip]
Given a nascent firm’s royalty obligations often exceed its ability to pay, rights societies could structure the terms for equity transaction by way of rights societies could structure the terms for equity transaction by way of convertible debt. In this way, the equity transaction might be aligned with the ongoing use of music, rather than according to opaque metrics, or as compensation for showing up to the party without a lawsuit.

The use of convertible debt would allow rights owners to swap the debt obligations for stock if the company is acquired so they share in the deal, or to gradually swap debt for equity as additional funding or increased revenues warrant.

Page and Touve go to discuss the record companies experiments in taking equity in lieu of royalty payments, as well as potential problems that could arise in appropriately allocating the capital gains.

What makes their proposal so refreshing is its fundamental recognition that music rights owners' real problem in the online music world is not legal but economic. The problem is not that their exclusive rights have been devalued by unlicensed uses of music (or not only that). It's that up to now they've lacked a mechanism for capturing a reasonable share of the value that gets created online.

On an open network like the web, exclusivity does not create value because it's effectively impossible to maintain. Rather, value is created ad hoc, through innovative, personalized, customized uses of content. Capturing that value is the province of those who provide the tools to enable those innovative uses.

The real trick for rights owners is not monetizing content through direct payments but figuring out how to capture the value that others create by using the content.

There may be a hundred reasons why Page and Touve's suggestion will not work as hoped in the real world. But ultimately, finding a way to align the economic interests of rights owners and innovators is the only avenue to building a robust online music business.

Paul Sweeting

Paul Sweeting is the Editor of Content Agenda, a business-to-business brand dedicated to the nexus of content, technology and business. This piece was originally published on Paul's blog "Media Wonk" on Content Agenda and is posted on DMW with the author's permission.

Image by by M.C. Jay

Published in DMW Daily, May 27, 2008

Previous story: Web Widget Maker RockYou Raises $1 Million
Next story: Analysis: 5 Great Marketing Blog Lists ... And What You Can Learn From Each One

Email this page

add to:

del.icio.us |

digg | Yahoo! MyWeb | Slashdot

Comments

The societies should just do their job: offer licenses!

Submitted by Gerd Leonhard (not verified) on May 27, 2008 - 10:07pm.

While I like and appreciate Will's and David's work I think this idea is rather far-fetched: isn't the job of the rights societies to PROVIDE LICENSES to anyone that wants to use the music and pay, and shouldn't they just do that and come up with licensing schemes that make it possible to do so? Why should they receive equity for doing their job? Does the landlord receive equity for renting to the startup? As far as I can see, a revenue-sharing and / or user / traffic based licensing scheme would work just fine if the societies applied some sort of realistic way of a start-up's situation, and if they were indeed authorized by their members (publishers, composers, labels etc) to actually make a deal! I have said this before and it's a fit here too: the liability for being licensed does not really fall to the startups - it falls to the Rights Holders and their Organizations to provide them with a realistic, workable option - and by and large they just haven't bothered until now. To ask for equity instead just looks like another scheme that the major labels (and some indies or their organizations) have been employing for the past few years: if you want our music give us a piece of your company. Imagine if this had been realized when RADIO was licensed: every station would have had to give equity to the rights holders - that would have worked just fine if you have 100.000% to give rather than 100% ;). Imho, they should stop makig excuses why they can't propose meaningful and realistic licenses and just get on with it. Read more in my new book (free PDF) www.music20book.com

Regarding Gerd Leonhard's comment

Submitted by Jay Baage on May 28, 2008 - 5:05am.

I'm with Gerd on this one. The license issues are far too complicated and the economics don't work in favor of new digital music enterprises. The music biz really needs to fix this issue pronto if they want to move this industry forward and encourage innovation. For a relevant example, check out this article: Analysis: Habbo, Music and the Record Labels | Digital Media Wire http://www.dmwmedia.com/news/2007/11/06/analysis-habbo-music-and-the-rec... Jay Baage, VP, Content Digital Media Wire

Time For A New Day

Submitted by David Sherbow (not verified) on May 31, 2008 - 6:43am.

Why is it that everybody who pontificates about the digital music space thinks its always about major labels and what we need to do for them and what organizations startups need to pay? There is so much more to the digital music space than what the 100 pound gorillas who used to be 800 pounds have to say. I am an entrepreneur in the new music discovery space with an extensive real music business background who is about to soft launch a new music discovery website. If I do what I want to do with my totally unique business model, the gorillas will not only lose more weight but will barely be able to sustain themselves. There are more sites than you can count that have tried to include major label music in their business models and which have failed. It's time to look for those new startups that have no desire to include major labels in anything they do except take their money as investors.

What is equity but another version of cash

Submitted by David Touve (not verified) on June 1, 2008 - 12:48pm.

Whilst I agree with both Gerd and Jay regarding the difficulty of these kinds of license issues, I disagree in the opinion that somehow equity is something other than cash. Loosely stated, Equity is a claim upon the profits of an organization. Licenses, in general, are a claim against the direct cash flows. So on certain ways, given the uncertainty of revenues and business models for young firms, we can't really design licenses. Structured appropriately, equity could provide a means to align the interest of both parties in the production of "profitable" online businesses - or at least the production of businesses whose cash flow and profit horizon are such that a larger fish wishes to pay now for the right to own those future flows. The problem, imho, is presently equity deals are wielded like a toll booth - a startup has to offer up equity in order to get through the gate for a license deal. From there, a further deal exists that places a claim on cash flows by way of a clear license (you owe use $x for each stream, or $x per subscriber. Regardless. I know this issue is tough, and appreciate your thoughts. We figured it was better to help in getting this issue into open forums, and beyond the backrooms. We know equity deals are being done... and there is reason to believe these deals may be more aggressive than necessary. So the point was to offer up a less aggressive context.

Thanks for sharing. It has

Submitted by mp3 (not verified) on July 31, 2008 - 6:31am.

Thanks for sharing. It has appeared for me very useful