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Create new markets: Business models, exits, and the Series-A stall
Don't become reliant on copyright or platform data, it will scupper you in the longrun
Discussing exits is somewhat of a taboo for startups while they are building momentum. Most are fully focussed on growth, and/or establishing a sustainable business, if not business model.
However, many of those same teams are also seeking investment, and the investors that they are talking to are looking for an exit to some degree in the future. This creates pressure over time and forces strategic decisions that lead to a loss of independence for the project and its team.
Within the music industries, all too often this results in a pivot towards acquisition to an incumbent, which in reality is a short-lived acqui-hire, the product itself disappears, and the team quit soon after. An inefficient venture for all concerned.
There are very, very, few examples where a team has managed to navigate this period, and those that do, have, in most cases, been forced to trade over significant equity to the existing parties with power. Curtailing their disruptive potential and usually bringing about the “Series-A stall”.
I argue that this challenge is linked to business model. In traditional tech investing theory, development post Series-A raise is all about proving “Product Market Fit” indicators and then using an injection of cash to scale out to profit.
However, there is an open question as to how suitable this VC model is for music tech. If a startup is reliant on copyrights for their business to work, then it’s looking at c.75-80% of revenue going straight to the supply chain through licensing deals. And, or, if their business is reliant on data pipelines, either from the wider industry or from digital platforms, then the risk of this basis for business being rugged is very much non-zero. Both elements provide significant downside for the scaling phase thesis, as has been proven over and over again.
Unfortunately, this often results in a trade-off for the disruptor, where, to prove Product Market Fit and adoption, to get the next stage of investment, they have to do some kind of partnership with an incumbent or build on their APIs. But in doing so they shut off future growth options, potential exits, and blunt their disruptive potential.
This is not only a question of experience and understanding for startups, but investors also.
The music tech investing space is filled with teams and individuals who have good intentions, but a fundamental lack of insight into the impacts brought by decisions made at this critical point between Seed and Series-A.
Typically, they fall into one of two camps, either coming from success in the tech investing world and looking to apply their experience and model to the music vertical, or success in the wider media business seeking to leverage their contacts for their investments. On paper, both seem like good bets, but in practice, the nuance that a startup requires to navigate this extremely challenging period is often outside of their effective advice and support.
The purpose of this piece is to describe the important elements that startups and their investors should be designing towards while navigating the Seed to Series-A and beyond period. It, like the rest of this blog, is focussed on companies that want to remain disruptive, rather than sustaining, and is aimed at startups building in the Crypto & Music space.
Business models on the internet
Building a business on the internet traditionally falls into three models, subscription, advertising, and transaction fees. Either a user pays for a service, they get it for free and their activity is monetised through third parties, or a business charges for reducing activity friction.
There is a fourth way, of course, to sell products. But the zero marginal costs of duplication for digital assets forces extensive legal layers and enforcement to keep that viable. As we’ve seen with the overall shift of media as a product to media as a utility over the past two decades.
The choice of which of these business models is most applicable often rests on the scale of customers that you will have. If few, niche, then subscription is likely best, unless the other options will destroy UX. If there’s enough data and attention being generated for effective advertising, then that is likely more scalable. And if the number of transactions going through the project is high enough to build a business off of single digit %s then transaction fees are going to be your go-to.
Blockchains commoditise internet business models
Crypto enables these business models by reducing transaction costs, making them more efficient, without reliance on a third party, and global by default.
However, this comes with additional considerations. The other side to the coin of building on blockchains is that they are commoditisation machines.
The “web2” model of seeking scale and then leveraging the moat into a monetisable position is far harder to achieve when the tech stack is composable and everything is open for competition. From a tech position this is great as it drives out inefficiencies and accelerates overall development, but those inefficiencies are traditionally where a company would centre its business model.
Far too often we see a team that is building on a blockchain stack focusing their business model around platform mechanics and expecting that this will be defensible over time. When in reality, that extractable value is a time-sensitive state that is ripe for further disruption by competitors.
This is also a challenge for individuals in the space, as seen in the recent Opensea and Blur situation. Secondary market royalties as a business model for NFT creators are an inefficiency in the wider system context, and observing Opensea over the past nine months shows what happens when the strategy is to try to fight against the inevitable, rather than work with it and continue to innovate.
At its core, pretty much every business model that you can build for your startup in web3 will be analogous to either subscription, advertising, or transaction fees, with the key difference that what is your edge today will become commoditised tomorrow. The only way to keep ahead of the curve is to constantly innovate. And commoditise yourself, before someone else does it to you.
You need to create new markets, you need “Juice”
As stated in the intro to this piece, Product Market Fit, the holy grail of a startup is a challenging beast for music tech innovators. Proving usage in most cases means doing a deal with incumbents, on either rights or data access, which has serious ramifications with regards to building a scalable business down the road.
The temptation to attempt to leverage the scale of current major industry incumbents, acting as an agency or partner, continues to dominate the go-to-market strategy of most players in the market. However, this will always lead to a position of weakness for the innovator and sustaining power for the incumbent.
I mean sure, you can always just yolo it and not do the deals. Go unlicensed and see how far you can make it until you’re forced to the table. To be honest, that may actually be the optimal strategy rather than destroying precious runway by trying to cat-herd the hundreds of required deals and spending $500k+ on lawyers for the privilege. But, like Jimmy the Reach, from the Mighty Boosh once said, the labels always get their man, eventually.
This is pretty much the core of Vaughn’s article “To Have No Juice”. To prove that you are worthy of being funded you have to do a deal with the kingmakers, and in doing so you give up any opportunity of unseating them.
So. How can we navigate this period to build and prove Product Market Fit, but without neutering any future disruptive capability?
I think it all revolves around two things:
Not building reliance on the established and effective copyright ecosystem, and
Creating new markets that are additive, and then ultimately disruptive, to the status quo
If you can build and scale without asking for permission. If you are permissionless. Then there’s a chance that you can grow to a point where you are competing with incumbents on an axis that they don’t already control.
You can become, and remain, interesting, scary, disruptive, and most importantly, independent.
A fair criticism of this stated approach is that “but without copyright, without the music, the business isn’t music”, which I sympathise with. However, the sad fact is that the top line of our industry is ultimately tiny in comparison to other sectors. For example, Spotify recently announced that in its entire history, it has paid out (nearly) $40bn to rightsholders. We need to do better and step change the value, and I argue that this will come adjacent to the copyrights themselves.
Exits and the Series-A Stall
Hopefully, the sections above highlight why so many music tech startups end up with few options for a satisfying exit. The deals done to position for Product Market Fit, to bring in funding prior to, or at, Series-A round, usually inhibit all but absorption into an incumbent.
The knock-on effect all too often is for Series-A to be the final “up” round of funding, if the team can even get there. By this time, the impact of non-scalable business models in music tech that are built on rights and data has started to bite, and it becomes harder and harder to find willing investors. The Series-A Stall.
I’d like to be able to say in this section that there are other exit options that teams should be gunning for, but honestly, I think that this is the least obvious element of this piece.
This is because I truly believe that Crypto will provide sustainable monetisation events for proven companies in the future, but also I have to admit that the market, and regulatory environment, is still too immature and unproven to be able to confidently say so.
Outside of acquisition, the target exit in tech is usually IPO. We have the startings of something to rival that in Crypto, but, consistently, token models fail to deliver on that potential and devolve into “altcoin” equivalents, vehicles for speculative pump and dumps. In some ways, we are still paying back from the ICO days when the model was backward and a 3 man team would “go public” off the back of an adderall-derived whitepaper, and hopes and dreams.
On a more positive note, the regulatory position will no-doubt evolve as things develop, even if it ends up being in ways that we don’t expect. Which will provide clarity. And regardless, if projects are creating net new markets, as argued above, then there should be external capital to the music industry seeking to become exposed to it.
Unscalable business models, a result of the bind that reliance on copyright and data puts on music tech startups, more often than not reduce future growth and disruptive potential.
Teams seeking to fundamentally change how the industry works should set out to create net new markets, which will enable competition with incumbents on the startup’s own terms, without asking for permission.
Crypto may be the tool to facilitate better exits in the future, but there is likely a significant amount of regulatory development that needs to occur for this to be a reliable path to success.