In the early years of the digital music industry, entrepreneurs were passionate about music but had no understanding of how the music business actually worked.1 The entrepreneurs were, nevertheless, easily able to raise funds from venture capitalists due to the dot-com bubble.2 However, after the dot-com bubble burst, it became very difficult to attract venture capitalists due to their lack of faith in the profitability of the digital music industry.3 A few years later, there has been a resurgence of venture capital in that industry, and it is still rising now.4 Unfortunately, venture capital interest in funding music-related startups is relatively still low.5
On the other hand, it was estimated that about one out of every hundred dollars invested in music came from venture capitalists, which showed there was room for growth regarding venture capital activity.6 Indeed, startups that offer novel services, such as streaming and downloading websites like Spotify and Pandora, have already distinguished themselves by further developing the relationship between the digital music industry and venture capital. For example, Warner Music Group currently receives twenty-five percent of its recorded music digital revenue from subscription services and on-demand video services, as well as webcasters such as Pandora.7 However, there are some signs that support why this will fail to continue in the long run.
Spotify is the paradigm of new digital music startups that have caught the attention of many venture capitalists. Towards the end of 2013, Spotify raised $250 million in a new funding round from venture capitalists with a valuation set at $4 billion.8 Spotify was founded in Sweden in 2006 and operated only in Europe until July 2011 when it expanded internationally by debuting in the United States.9 Essentially, Spotify hosts a website that allows its 24 million monthly active users to stream a tremendous amount of music ad-supported for free or ad-free if users pay a low monthly fee.10 The big problem with this whole streaming concept is that it requires licenses from the artists, which are highly expensive.
At first glance, it may seem like a good idea for venture capitalists to invest in Spotify. Its corporate filings show that the company more than doubled its revenue in 2012 from $252 million to 577 million, while only increasing its net losses from $60 million to $77 million.11 However, due to the royalty deals it makes with record labels, Spotify must pay seventy percent of its revenue back to these rights holders.12 Spotify is a low-margin business and needs more cash to fund its operations.13 Also, it must continue to expand globally if it wants to succeed.14 Last year, Spotify was running in 17 countries, and this year, it is in 32 countries.15 But despite such expansion, Spotify’s losses are growing almost proportionally as well.16
The combined needs to pay off licensing fees and expand globally are preventing Spotify from becoming a profitable company.17 The biggest question for future investors is, what does Spotify plan on using the $250 million it earned through venture capital for? It seems to most critics that Spotify is likely to report a loss as it spends those funds to expand, and its historical pattern seems to support that prediction.18 It will take over a year to determine whether Spotify’s business plan is actually effective or simply unsustainable. Therefore, making a new investment in Spotify, as the venture capitalists did, hardly seems worth waiting for.
It is important to remember that Spotify is just one of the many companies that exhibit the problems most other digital music companies continue to struggle through. Pandora, a similar music streaming website with over 70 million users, has also struggled to make profits due to the high cost of royalty fees.19 Thanks to these new streaming websites, the digital music industry has caught the attention of venture capitalists again. Perhaps more investors will turn towards the music industry in the future. Unfortunately, it seems that these empty bets made by venture capitalists in digital music companies that require expensive licenses are unsustainable and will most likely not work unless something is changed.
Peter Alhadeff & Aaron Gottlieb, Jason Mendelson on Venture Capital, Music Bus. J. (May 2012), www.thembj.org/2012/05/venture-capital-and-jason-mendelson-2/ (last visited Feb. 7, 2014). ↩
Kiefer Wells, Venture Capitalists: Paying for the Muse, Music Bus. J. (Mar. 29, 2011), http://mbj.berkleemusicblogs.com/2011/03/29/venture-capitalists-paying-for-the-muse/. ↩
Glenn Peoples, Business Matters: Where Venture Capital Money is Flowing in Music, Billboard biz (Aug. 10, 2012, 8:40 PM), http://www.billboard.com/biz/articles/news/1084191/business-matters-where-venture-capital-money-is-flowing-in-music. ↩
Jill Krasny, Spotify’s $4 Billion Valuation is Tone Deaf, Inc. (Nov. 22, 2013), http://www.inc.com/jill-krasny/spotify-aluation-tone-deaf.html. ↩
John Cionci, Hello America. Spotify Here., Spotify (July 14, 2011, 11:11 AM) http://news.spotify.com/us/2011/07/14/hello-america-spotify-here/; Evelyn M. Rusli & Michael J. de la Merced, Spotify’s Financing is Said to Lift Value to $4 Billion, DealBook (May 17, 2012, 12:35 PM), http://dealbook.nytimes.com/2012/05/17/spotify-is-raising-millions-in-a-deal-that-would-value-it-at-4-billion/?_php=true&_type=blogs&_r=0. ↩
Sarah McBride, Music Service Spotify Raises $250 Million, Reuters (Nov. 21, 2013, 4:46 PM), http://www.reuters.com/article/2013/11/21/us-spotify-venture-fundraise-idUSBRE9AK1F720131121. ↩
Nathan Olivarez-Giles, Spotify’s Losses Grow Despite Revenue Doubling 2012, The Verge (July 31, 2013, 3:54 PM) http://www.theverge.com/2013/7/31/4575506/spotify-doubled-revenue-in-2012-but-losses-grow. ↩
McBride, supra note 10 ↩
Krasny, supra note 8. ↩
Tom Cheredar, Spotify’s Valuation Soars Over $4BN After Raising a Fresh $250M, Venture Village (Nov. 22, 2013), http://venturevillage.eu/spotify-valuation-funding. ↩
Rusli & de la Merced, supra note 9. ↩
McBride, supra note 10. ↩
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