A New Music Model? Perhaps. But not for VCs.
Brad Stone has a nice article in today’s NYT about Polyphonic, a new model for funding music artists and bands. The venture is exciting, largely because of the people involved. Terry McBride, in my opinion, is probably the most innovative businessperson in the music business and has a track record to demonstrate it. In the article, Brad Stone quotes me as casting doubt on the appropriateness of this model for venture investors. To demonstrate why, we need to make a bunch of assumptions, but I will make those assumptions as reasonable as possible:
The Polyphonic model, according to the article, will take $20M and invest $300K chunks into bands. Let’s assume that is structured as an advance against a 50/50 split on all revenue the band produces (publishing, touring, merch, recorded music sales and other licensing.) After fees to operate the business (let’s say $2M over three years), on average, Polyphonic would make 20 investments (i.e., fund 20 bands) a year over three years, or 60 bands. This assumes Polyphonic does not provide any follow-on funding to the bands. That is, on $300K, the bands must pay themselves, pay for marketing activities, tour support, record an album, seek distribution, and generally fund their infrastructure. (While possible, this is thin.)
How much revenue can a band produce? Let’s break that down. Out of the 105,575 new releases in 2008, just 1,515 sold more than 1000 units. Polyphonic likely expects these 60 acts to perform as a portfolio. Some will bomb, some will do well, and a few will do really well. (VCs manage investments this way too.) Putting some numbers around that, let’s assume 10% sell meaningless amounts, 50% do okay (under 20,000 units), 35% sell well (45,000 units) and 5% do exceptionally well (more than 100K units). Let’s say one is a huge breakout and sells 1M units. And let’s assume a 1x multiple on the sales revenue for merch, publishing, touring and other income (ie, doubling).
As the chart below shows (at $7 royalty a record ($10 ASP – 30% retail margin) and assuming the band can double its recorded music revenues through touring, publishing, merch, etc.), the total to an entity like Polyphonic would be just under $27M on a $20M investment, or about a 35% cash on cash return. Might beat the S&P over three years, but probably not.
You can see where the sensitivities are: if the major breakout hit sells 2M units, the the take is more like $46M. If you assume no breakout hits, but all 60 acts sell 45,000 units, the return is about $28M. If you assume every band can triple its revenues beyond its recorded music sales, the you can produce about $46M on $20M, which is pretty decent.
The other challenge with this model is that the funder owns nothing more than a cash flow interest in the band. The article discusses that the artist still own their masters and all rights. I applaud that construct as I think that is the right new model with the right incentives. However, it means the multiple applied to a company like Polyphonic, which is building no long-term equity value, is less than that paid on a company building longer-term equity value. In other words, it is hard to sell a company like Polyphonic for a big multiple.
VC economics, however, look very different. If a VC took $20M into 10 deals at $2M each (let’s say each investment buys 25% of the company) and just one companies is sold for $200M, assuming all other deals fail (unlikely), the VC has produced $50M on $20M. If two companies are sold for $200M, the VC has produced $100M on $20M. (This analysis is greatly simplified just to illustrate the point.)
Let me be clear: I really like what Polyphonic is doing and am hugely supportive of their model and direction. I want alternative models like this to exist, I want artists to prosper, and I want artists to be in control of their own destiny, surrounded by smart people who understand how to market in the new digital world. I just don’t think these models can produce a venture return. There are plenty of other sources of capital for these models, and I am excited to see them get funded and take off. Hats off to Terry McBride and the team at Polyphonic.
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Ask and I receive! Thanks – helpful – I think I knew the reasoning but seeing the numbers adds an interesting layer
There are a bunch of other reasons why this won’t likely be funded by traditional VCs. Most importantly, who do you sell it to? The majors are not buyers for anything with healthy multiples. But even if you think you could sell it to LiveNation or a somewhat healthy media/entertainment company, this company doesn’t really “own” anything. Really hard to build value this way. Plenty of other sources of (non-equity) capital for this.
Seems like debt (supported by cash flow) would be an obvious choice
You got it. Also feels a little like restaurant financing to me. (I don’t mean this in a pejorative way!)
there’s an obvious disruption piece that does not seem to have been considered and that’s forward thinking Brand integration into the model from the beginning (partner vs sponsor)
you’ll start to see that evidenced in 2010 IMHO in a big way as dealing with conventional labels for rights and fleeting single’s based artists is unwinding: not overnight; but its peaked
Thanks for commenting, Danny. I agree that brand patronage of artists is a key revenue stream and I include it in my analysis above in the “non-recording revenue” calculation, which I estimate can be 2x – 3x larger than the recorded music piece.
yeah, but most of the branding deals are done with the majors – after all, the majors all have sister companies in the movie/tv industry, where a lot of that kind of revenue lives…
Two primary things I’d like to point out. First, I think touring revenue has the potential to do far better than 2-3X recorded revenue. This is especially true in the mid-range 35-50K unit type bands. I don’t have the exact numbers, but I’m picturing the LCD Soundsystem, Broken Social Scene level acts doing live numbers far exceed those assumptions.
Secondly….and granted that you had to simplify…..I would guess Polyphonic doesn’t intend to chop the money into 300K slices and sign 60 bands. I would have to imagine they will be starting their acts off with 300K, providing them with much of the infrastructure you mention, and adding to the budget as success dictates.
The equity question is a legitimate concern, though I would have to think people as savvy as McBride and Co. have addressed it in some form.
Hi Don, thanks for your comments. Your points are spot on. Irving Azoff says his bands get only 9% of revenue from recorded music, so at certain levels, non-music sales revenue can be very significant. I think, on average 2x – 3x is a reasonable assumption given that the Polyphonic model is stated to focus initially on bands below the size of Broken Social Scene.
I think the bigger takeaway from my analysis is that the biggest sensitivities are around the hit acts…those are the ones that move the needle. That means this model looks pretty darn similar to a typical label model where a few acts are responsible for carrying the entire portfolio. That’s not that much different than the VC model, BTW.
Nice article; I have three thoughts to share…
You say: “That is, on $300K, the bands must pay themselves, pay for marketing activities, tour support, record an album, seek distribution, and generally fund their infrastructure. (While possible, this is thin.)”
But, if the bands are receiving 50% of the revenue in addition to the $300 k, there is no reason why you need to make this assumption.
Also — you are only assuming a 3-year deal with your math; the revenues beyond year three could be substantial and make the economics much better.
Two final thoughts: you are using a 4x multiple for “other revenue” on your lowest 10% bracket and a 2x on the other brackets…also, if you add up the two revenue stream totals you have ($18,536,000 and $37,114,000), divide in half and subtract $2 million for expenses, you get $25,825,000, not $23,799,000.
Thanks for commenting. The reason bands must pay themselves out of the $300K, is that the model assumes the $300K is an advance against which 50/50 rev sharing is recouped, hence the assumption is correct that bands must survive on this amount unless and until they have sold enough units to start seeing revenue from sales. The reason for the deltas you mention in the math is because you are forgetting that the $300K advances must be paid back before revenue sharing kicks in. Thanks for catching the x4 vs x2 error, I fixed it (but it does not change the results of the analysis).
Its a very good piece indeed but I also have some confusion over the model. Just wanted to confirm the total gross revenue from all streams is 37 million before recoupment and splits? Ill assume so unless your adding 37million and 18 milion as totals instead of aggregating accross the page. On that basis I applied some analysis below on a 37 million gross revenue model as opposed to a 54 million gross revenue
Correct me if I am wrong, but it looks like you took the 2 million off the top model for operational fees and invested 300k in to 60 groups, so 18 million would on the face it be recouped before profits are even split (as you indicatd in previous comments)? More accurately we know the first two levels of bands (or first two line items) dont produce any profit, if the recoupment comes out first so all returns go back to Polyphonic (assuming gross rev. of 42k and 6.3 mill on the first two line items (first two tiers of bands.
Then the last 3 tiers of bands do recoup 50 percent of proft after return of the 300k advance. So taking a line item (the third one), wouldnt there be 21 bands that returned returned profit after recoupment, ie 21 x 300k equals (6.3 million return to polyphonic) plus 50/50 profit split on the rest of the revenues.
In the model above youve stated 50/50 recoup is 6.765,000 but with recoupment wouldnt polyphonic take home 6.3 first plus half the profit of whats left (ie out of 13.7 they would take (6.3 as recoupment) plus half of profits/or half of whats remaining (about 3.7million) This would amount to a total of approx 11 million for polyphonic on a 50/50 recoupment for line item 3. Ie shouldnt the total recoupment for polyphonic on line item 3 be much more and so on in the next two lines where the bands are returning bigger numbers
This math would occur in the next two lines where bands make more than the advance which is recouped first. I am not sure if I am missing something fundemental here, apologies if so as I know its a summary model.
If ive misinterpeted and total revenues are originally around 55 million and not 37 million this looks even more favorable. Perhaps ive not analysed correctly
Hi Matthew. Based on your comments, I have rebuilt the chart to show each step of the calculation. I was taking some shortcuts to make the chart smaller, so I have fixed that and hopefully this makes things more clear.
From David Pack here, to David “Pakman”, cheers, and thank you for a very timely and extremely well thought out blog post on Polyphonic, new indie music business models and your VC perspective.
For over 30 years I have been a recording artist, producer, and am now managing a great new indie alternative rock band.
I also ran my own start-up media co. from 2000-2004.
My first call to help the group I manage was to Terry McBride as I agree with you that he is perhaps today’s most innovative music biz mind, and his Polyphonic venture with with his partners: Radiohead’s manager Brian Message and Adam Driscoll,UK’s MAMA media chief, certainly proves it.
In fact, I am in the process of submitting my band to Polyphonic for consideration and found your blog on this topic to be a great resource.
One thing I’d like to add isn’t about money, it’s about the fact that Polyphonic’s new model helps support “artists” who otherwise get no support, especially here in America.
The risk vs. reward may not be the greatest multiple of x3 or x 10 but it offers something money can’t buy, and that is “hope”. Can you imagine how hopeless it feels out there for so many artists? Artists are so incredibly undervalued in our country, yet they are the culture shapers and influencers, and many times the first ones to affect change in global pop culture.
My hope is that people with incredibly bright minds like yours, in the VC world, will come alongside us in the music world to help us create and execute the new model. We need a global co-operative for the arts in general in this way, don’t you think?
Thanks for a truly illuminating blog, and great thinking.
I’m really encouraged by this.
David Pack
Orange County, Calif.