Music Finance 2.0
The famous economist Joseph Schumpeter once coined the term “Creative Destruction” to describe the process whereby we constantly destroy old business models by innovating and creating new ones. With the decline of the traditional record label deal, we have now seen the rise of new ways of financing and profiting from the music business. Indeed, destruction breeds opportunity.
The rise of new technologies like Napster starting in 1999 coincided with the peak and eventual decline of the record business. A combination of factors led to this decline including file sharing, the end of the replacement cycle, competing entertainment and physical retail difficulties. With so many challenges, global revenue in the record business was cut in half from $38 billion in 1999 to $16.5 billion (as established by the book-keeping body of the recorded music business, the International Federation of the Phonographic Industry).
There are three main areas being funded by both institutional and private investors that represent these future opportunities in the music business. They include:
- Crowdfunding (funding the creation of music or technologies)
- Investing in new technologies for music consumption(funding new ways of consuming content)
- Securitization of music publishing royalties (monetizing existing catologues)
Together new business models are emerging that point the way forward to a brighter.
CROWDFUNDING – New Ways of Creating Music
The revitalization of the music industry can begin with the artists, and the companies emerging that empower them. The crowdfunding model has a lot of potential to revitalize the music business. Companies like Kickstarter, Pledgemusic and Indiegogo are empowering artists to fund their own career without the need of a record label to back them.
Kickstarter, which may be the most famous of the crowdfunding sites, reported to have raised 480 million dollars for projects in 2013 from over 3 million backers. Artists have used this to their advantage. One of the most famous campaigns was Amanda Palmer’s Kickstarter campaign where she raised 1.2 million dollars for the release of her solo album Theatre is Evil. This allowed her to fund the recording and marketing of the album without needing to sign over her intellectual property to a record label and allowed her to maintain all the profits for herself.
In the US in particular, the recent passing of the JOBS act through the U.S. Congress allows for non-accredited investors to invest equity in crowdfunding projects. For musicians and entrepreneurs, the JOBS Act will have long-term implications. In particular, JOBS makes equity crowdfunding legal and allows for financing in the industry to unravel in new and exciting ways. Of all the changes, the most interesting change of all will be the ability to convert fans into shareholders in an artist’s career.
According to a 2013 study commissioned by the World Bank, by 2025 the global crowdfunding market could reach between $90 billion and $96 billion — roughly 1.8 times the size of the global venture capital industry. Musicians are destined to have more opportunities and freedom than they ever did in the past.
INVESTING IN NEW TECHNOLOGIES - New Ways of Consuming Music
New technologies that transform the way we consume music are another rising destination for private equity financing. Rising ventures in this area, including the likes of Spotify, Rdio, and Pandora, are transforming our music consumption by providing unlimited access to songs without charging directly for the cost of buying music. Instead, these services monetize by both charging subscription fees and bringing in advertising revenue.
What is becoming clear from these ventures is that that people will still pay for music if they have unlimited access and convenience. The success of these new ventures are evident. For example, Spotify, with 10 million paying subscribers, has already received 537.8 million dollars in funding from major Venture Capital firms like technology crossover ventures, AFsquare, Fidelity Ventures and Goldman Sachs, according to Crunchbase. VC’s will see a return on their investment as the business is already showing healthy signs of revenue and can start planning for an initial public offering.
SECURITIZATION OF MUSIC – Monetizing Existing Catalogues
The potential for securitization of music royalties to help finance an artist was first introduced with the Bowie Bonds. In 1997, David Pullman managed to raise $55 million dollars based on the securitization of future royalties from 25 David Bowie albums. The bonds paid an interest of 7.9% and had an average life of ten years. Unfortunately, the value of the bonds began to decline as online music and file sharing grew in popularity, decreasing album sales. This resulted in a downgrade in credit rating to almost junk status by Moody’s in 2004.
More recently, investors have revamped this model – and found more success in the area of securitization – by focusing exclusively on publishing royalties. Investors, such as Round Hill Music, a New York based publishing company, have found that publishing royalties are the most stable area and predictable area of cash flow in the music business. Although record sales have declined precipitously, publishing royalties have remained strong as a result of synchronization licensing and performing rights royalties.
Round Hill Music raised over 50 million dollars for a private equity fund to purchase publishing assets. This fund has many positive characteristics including the stable revenues from the publishing business as well as immediate cash flow to investors. Unlike venture capital, which takes a long time to reach profitability, this type of private equity transaction shows annuity-like cash flows with a reduced J-curve effect. Additionally, music royalty returns are largely uncorrelated to overall public and private equity markets.
In The Future of Music, authors David Kusek and Gerd Leonhard predict that the publishing business will develop into the biggest source of revenue for musicians when intellectual property rights become less restrictive. They write, “Once the mechanisms of performance royalty collection are adapted to address the new modes of song usage, performance royalty collection and publishing will take the lead as the primary source of revenue for musicians.” One can already see traces of this when we look at the flourishing ringtone business, music for video games, and synchronization income that stems from digital media products.”
In a recent landmark study, Edison Research found that, “America is in a golden age of audio consumption and that Americans spend roughly a fourth of their waking day listening to some sort of audio.” Despite the decline of the record industry, we are currently living through one of the most interesting times in the history of music where opportunities are rife to capitalize on our cultures intense passion for music. With innovative new ways of financing – including securitization of music, funding new technologies, and crowdsourcing – an influx of private equity and venture capital dollars are helping to usher us into this new age.
By Ryan Stotland