Why record labels are not like venture-capital firms for artists

Today, I want to focus on debunking one popular myth that pervades the music industry — namely, that record labels play the same role for artists as venture-capital investors play for tech founders.

You can’t talk about tech startups without talking about how they’re funded. Hence, if we’re thinking of the concept of artists as entrepreneurs, we need to investigate the options artists have to get capital to grow their businesses.

One historically significant source of upfront cash for artists is the record-label advance. Even though artists can increasingly get recording advances from other sources such as independent distributors, labels remain the primary players in the music-industry ecosystem who are willing to shell out hefty amounts of upfront cash on a regular basis to jumpstart or scale artists’ development processes.

Hence, music-industry writers and professionals often compare record labels to venture-capital firms in their relationships with entrepreneurs. To be fair, there are some similarities between the two organizations that are worth highlighting:

• Both labels and VC firms are known for taking high risks on artists or founders that are relatively unproven or in the “pre-product” stages. In both worlds, it tends to be true that the higher the risk, the higher the return.
• Because these investments are riskier, both labels and VC firms take a portfolio approach to diversifying risk. In other words, they spread out their investments across many different kinds of companies to lessen their overall risk and avoid putting all of their eggs into one super high-risk basket.
• In general, labels and VC investors are throwing cash at high-potential companies at an unprecedented volume, making their portfolios wider than ever. According to the IFPI, the major labels have nearly 8,000 artists signed to their collective rosters, and continue to sign around 700 new acts a year. According to Crunchbase, investment activity in 2019 was relatively less concentrated at the top compared to the music industry. The top 15 VC firms by deal volume last year signed just over 500 checks to startups, with the total amount of deals across the startup world nearing 32,800.

With all this said, there’s a similar, twofold trend in both recorded music and venture capital that suggests their roles in startups’ lives are evolving.

• One, firms are increasingly choosing to give capital later in a startup’s development cycle, as opposed to early on in “pre-product” stages. We see this in the label world, where at least the majors are predominantly signing artists who have already established an audience and social presence on their own dime, to further reduce risk. Similarly, by some measures, over 80% of startups raising Series A funding rounds from investors are already making money off of their customers, versus just 15% of companies in the same position back in 2010. This puts even more pressure on the entrepreneurs in both industries to take on the burden of risk as they’re starting out.
• Two, more and more entrepreneurs in both music and tech are deliberately forgoing traditional investment or capital resources early on, in favor of building up their companies on their own terms. For instance, many artists opt to release their music and build their fanbase independently for a few years first, ultimately to have more leverage in record-deal negotiations. In the tech world, organizations like Zebras Unite are uniting startup founders who don’t align to traditional tech culture — i.e. “quantity over quality, consumption over creation, quick exits over sustainable growth, and shareholder profit over shared prosperity” — and actively building alternative models for their businesses. In this climate, traditional investment firms arguably don’t have a choice but to get involved later and later in entrepreneurs’ development stages.

In short, record labels and VC firms are largely in high-risk, portfolio-based businesses with entrepreneurs who have already proven themselves in some way. But that’s where the similarities end.

Difference 1: Record labels are not even investors anyway

The first difference that might immediately invalidate the concept of “labels as VC firms for artists” in the first place is that a record label advance is not an investment.

A typical label advance is just what it sounds like — a cash advance on future royalties. In “exchange,” the label takes majority ownership over a set number of the artist’s future singles or albums. After paying off the advance, the artist typically gets only around a 15% to 30% cut of future sales.

It’s worth noting that major labels are increasingly signing exclusive, limited-term licensing deals with artists instead of taking away majority copyright ownership in perpetuity. But in this limited term, they still take the majority of artists’ recording sales, and the advance stays an advance, not an investment.

In addition, there usually isn’t the same kind of limited-partner structure with record deals that one sees in the tech startup world — i.e. record labels are usually working with their own money, instead of drawing advances from an outside partner’s fund.

Difference 2: Label deals often impede rather than encourage entrepreneurship, especially on a repeat basis

The second set of differences between a record deal and a VC investment lies in the impact of both kinds of deals on founders’ abilities to act entrepreneurial in the fullest sense.

My intuition is that the most unfavorable label deals often make artists feel less entrepreneurial, not more, in terms of their ability to maintain creative control and release music with minimal bureaucracy.

It is also arguably much easier to be a serial entrepreneur who keeps getting VC investment time after time even after multiple failed startup attempts, than it is to be an artist who keeps seeing success and business opportunities after their first recording deal flops. This speaks in part to the fact that the “products” in question for music are often the artists themselves. In contrast, in the case of tech, it is relatively easier to separate the branding of a given startup or software product from that of its original founders.

Difference 3: (Most) labels don’t have an interest in artists’ entire companies

Last but least, in giving cash to artists, record labels get a financial interest in only one specific revenue stream in the artist’s entire business.

With the exception of 360 deals, labels are participating only in their artists’ recording sales, not in their income from touring or brand sponsorship. This is arguably not the best way to “invest” in an artist’s career as a whole — primarily because both recording and touring income streams tend to be seasonal or cyclical. An artist might release only one or two records (thinking albums or EPs here) in a year, the consumption around which will have a natural spike around its release date followed by an expected decline over time, with the exception of sync deals down the line that help further with promotion. Then the artist might go on tour for anywhere from a few weeks to several months, which is also seasonal and generates income for a limited amount of time, with little to no passive income on the backend.

In contrast, when a VC firm invests in a startup, they are typically taking part in a startup’s entire business, not just in a single revenue stream.

If an investor wanted to take part in the upside around an artist’s career as a whole, and if they wanted to understand the dynamics of how music promotion works on a systemic rather than fragmented and siloed level, they would ideally invest in all of an artist’s revenue streams at once — inclusive of recording, publishing, touring and brand deals. I’ve heard of some artists getting direct investments from angel investors into their full businesses in this way in exchange for equity rather than IP ownership, but this kind of structure remains relatively rare.

Also, I feel like this kind of holistic investment relationship is predicated on artists even being able to have a clear, centralized view of all of their finances in the first place, let alone communicate that view, which can be difficult without having a business-savvy manager and/or accountant on their team. This could change with the onset of new financial services that are being built specifically for online creators, influencers and artists, including Karat, Stir and HIFI.

It’s worth noting that a lot of major labels, artist-management firms and talent agencies now have venture-capital arms that focus solely on investing in outside tech companies rather than in artists. Examples include Warner Music Group’s Boost seed fund, ie:music’s ie:ventures and the venture arm of Red Light Management (which has invested in the likes of Mixhalo and Satisfi Labs).

This raises a hypothetical question: Is it possible for these now-diversified labels and management firms to take a similar, holistic investment approach to their artists, not just to tech companies? What kinds of investment approaches might be possible beyond the historically exploitative 360 deal?

In the next entry, I’ll dive into a more fleshed-out taxonomy of early-stage capital sources for artists aside from just record deals, why there are so few of these sources in relation to the opportunities that abound in the startup world and how we can potentially close these gaps in the future, for the good of the music industry as a whole.