#irespectmusic and #savesoho Join Forces in London, Tuesday, April 18!

IRM London

BBC 6 Music’s Matt Everitt hosts this very special event.

The Save Soho pop-up venue returns to The Union Club for a special meeting bewteen two artists, both well known for their activism in the music sector. Blake Morgan, from New York – founder of #IRespectMusic and Tim Arnold from London – founder of Save Soho.

This will be a chance to hear both artists perform as well as hear each of them discuss their passion for protecting the rights and freedoms of the creative communities in the UK and the U.S with their campaigns.

The Reservation continues the Soho tradition to support emerging artists.. For this event we are delighted to welcome singer Sara Strudwick in her debut London show.

Make your reservation now….

http://www.seetickets.com/event/save-soho-the-reservation/the-union-club/1064413

Spotify IPO Watch: Will Spotify’s “IPO” Be a Cautionary Tale for Stock-for-Royalty Deals?

The Wall Street Journal and other business news outlets are reporting that the much anticipated Spotify initial public offering may not look like what everyone was expecting and may end up not looking much like what almost everyone was thinking it would look like.

If you asked anyone in the music business over the history of Spotify, they would probably tell you that this time was different.  This time MTV wasn’t going to build a business on our backs–we had the Spotify stock.  So if the “tech guys” go into their mysterious counting house and come out with billions, then the people who built and invested in the one product that they all depend on would be treated fairly this time.  The people who really invested in the only product these companies sold–music–would be along for the ride.

Time will tell if that will turn out to be true, but it’s starting to look like there are some serious questions about what will be in the pot at the end of the rainbow, or even if the rainbow will actually end at all.

The assumption all along has been that Spotify will float what’s called a “full commitment underwriting” as opposed to a “busted underwriting” aka Deezer.  In a full commitment underwriting, an underwriter (like Spotify banker Goldman Sachs) agrees to buy all the shares of the issuing company that are available–generally less than all, maybe around 25% of the shares issued and outstanding on an “as-if-converted” basis (an important distinction in Spotify’s case that we will come back to).

What actually happens then is that the issuer doesn’t actually sell shares to the public in the traditional sense, they instead sell shares to underwriters who then sell the shares to the public.  The underwriters usually have a lead (like Goldman Sachs) who then puts together an underwriting syndicate to buy up all the shares that are available.

The proceeds, aka money, from those shares sold to the underwriters go into the issuing company’s treasury, aka bank account.  Thus the primary function of the IPO is fulfilled-raising money for the issuing company.  The company passes the market risk to the underwriters in return for locking in a share price.  So far the shares have not be available to trade, although all of the regulatory hurdles will have been met by this point, SEC clearances, etc. (a final approved Form S-1, for example).

The underwriters then sell the shares are then registered for sale to the public by licensed broker dealers with the idea that the underwriters will get at least a “2 handle” or “3 handle” on the first day of trading because there is a lot of enthusiasm for the stock with the retail stock market.  That means that the underwriters will double or triple their money (give or take) overnight, plus get some nice fees for doing the work and taking the market risk off of the issuer’s books.

The underwriters don’t want a whole bunch of shares of stock crowding into the market and interfering with the 2x or 3x (or more x) that they plan on making.  That’s why issuers have lock up agreements with certain investors (especially insiders) that prevent the sale of shares for anywhere from 90 to 180 days after an IPO.  That’s also why there are some executives (like Pandora’s Tim Westergren) who sell a predetermined number of shares on a predetermined date, which is almost always a sign of a “10b5” agreement that allows insiders to gradually cash out over a fairly long period of time (while not “trading” as in both selling and buying the company’s shares).

So what does all this mean for Spotify?  According to the Wall Street Journal, Spotify is not going the full commitment underwriting route at all–but remember, none of this is coming from the company directly, so they could still back out.  But they’re not denying the story so  far.

Spotify evidently is skipping the underwriting step altogether.  MTS readers will recall in our “Spotify IPO Watch” series that I was skeptical about Spotify’s ability to put together an underwriting syndicate, and the decision to skip an underwriter is being passed off as a way to save some millions in fees.  That’s whistling past the graveyard–those fees are high, but are more than justified if the IPO raises a bunch of money which is usually the point.

According to the Wall Street Journal:

The Swedish company, last valued at $8.5 billion, is seriously considering not holding a public sale of shares. Instead it is exploring simply listing its shares on an exchange in what is known as a direct listing, according to people familiar with the matter. It wouldn’t raise money—the hallmark of an IPO—or use underwriters to sell the stock.

The approach has advantages for Spotify and its existing investors. It could enable the firm to save tens of millions of dollars in underwriting fees, prevent its existing holders from having their stakes diluted, and enable executives to publicly tout the company ahead of its listing, unlike a strictly regulated IPO, the people said….

In direct listings, early investors would be subject to less stringent lockups governing the sale of insiders’ shares and the company could avoid the first-day trading pop that characterizes many IPOs shepherded by underwriters. They are good for some investors but also indicate a company potentially left money on the table. Having a public stock would also give Spotify’s investors and employees the opportunity to cash in their shares.

There are risks to this approach, whose consideration by Spotify was earlier reported by Mergermarket. With market forces determining the share price from the outset, the company’s public debut could be more volatile and unpredictable. Also missing would be the large blocks of stock underwriters typically allocate to investors they believe will hold the shares for the long term and promote trading stability.

Spotify last year issued a $1 billion convertible bond to parties including TPG and Dragoneer Investment Group. The interest rate of 5% increases 1 percentage point every six months until the company goes public, giving it a potential incentive to pursue a listing sooner rather than later. If it lists directly, Spotify would likely need to renegotiate terms of the facility, one of the people said.

Spotify had agreed that the investors could convert the debt into equity at a 20% discount to the share price if an IPO takes place one year hence. If it takes place later, the discount increases. Since this wouldn’t be a typical public offering, it may not trigger a conversion. So Spotify may need to negotiate with the investors a price at which they would receive equity.

I find it hard to believe that sophisticated investors like Texas Pacific Group and Dragoneer will be bamboozled by Spotify taking a loophole on their IPO.  The rest of the shareholders–hard to say.

One thing is almost certain–that “need to negotiate” the WSJ refers to is almost certainly going to result in more stock or cash or relief from lockups or some preferential goodie going to the bond holders who very likely have a first position security interest on all the assets of the company as collateral for their $1 billion plus loan.  (Assuming, of course, that a direct registration doesn’t constitute an event of default under the loan that could allow the bondholders to take over the company.)

It is also almost certainly going to result in other “investors”–the stock for royalties folk–not getting those same benefits.

Stay tuned–Spotify may give us the best argument yet for not taking equity-in-lieu of cash in companies that should be paying royalties like everyone else.

 

 

 

 

Following the Money: Solutions for Google’s Problems with Defrauded Advertisers

Americans are freedom loving people, and nothing says freedom like getting away with it…

From Long, Long Time written by Guy Forsyth

Google’s UK Policy Manager Theo Bertram advised in 2012–“Follow the Money to Fight Online Piracy“.  Google’s copyright lawyer Katherine Oyama endorsed this approach on behalf of Google before the U.S. Congress in 2011 (“We would publicly support legislation like what I described, the follow the money approach…”).

Several UK banks and other advertisers are now doing just that according to the London Times (“Banks pull Google ads in row over hate videos“):

Three of Britain’s biggest banks have pulled advertising from Google after their marketing appeared alongside extremist YouTube videos.

HSBC, Lloyds and Royal Bank of Scotland acted over fears that chunks of their advertising budgets have in­advertently ended up in the pockets of banned hate preachers and anti-semites. The lenders join a growing list of big advertisers who have withdrawn marketing from the search engine and its YouTube video platform. These include McDonald’s, L’Oréal, Audi and the BBC.

How might these sites have gotten a share of revenue from ads served against their videos?  There’s only one way I know of that could happen, and it starts with having a Google Adsense account approved by Google.

Adsense Approval

In order to get an approved Adsense account, the party must apply for it, give out their payment information (see Step 2 “How Will I Be Paid”) and Google approves the account for monetization purposes.  The applicant gets paid because Google approved them for payment.

A YouTube channel partner gets paid for advertising on their YouTube videos through an existing Adsense account, so this is a second layer of approval to associate the YouTube partner channel with the YouTube partner’s Adsense account:

YouTube Channel Partner How to

So if we follow the money as Google has suggested many, many times, it is clear that it is not possible to have a monetized YouTube channel without at least two layers of approval by Google.  Google also knows who to pay, which bank account to pay, and presumably the taxpayer name and tax ID number for the account.  And of course I would assume that Google would be sending an IRS Form 1099 to the channel partner or otherwise complying with taxing authorities.

Following the money in this case would be very simple, particularly if Google is cooperating.

The money isn’t the only issue, however.  YouTube partner accounts depicting Nazi symbolism transmitted in Germany, Austria, Switzerland or any other country with prohibitions on the dissemination of Nazi symbolism may present a different problem.  Those accounts (and presumably Google itself) will be subject to the Strafgesetzbuch section 86a criminal law in Germany and analog criminal statutes in Austria and Switzerland which ban Nazi symbols like this:

Neo-Nazis Using YouTube for Propaganda

And also like this:

kolovrat 1

In fact, if you do YouTube searches for bands on the ADL’s “Bigots Who Rock” list, you’ll find other examples.

It is also worth noting that YouTube monetizes search (YouTube is the second largest search engine online) even if the videos themselves are not monetized, and that YouTube almost certainly keeps all the money such as the ad for Osmo that monetizes a search for extremist videos.

youtube aladnani osmo ad

The problem that YouTube is experiencing now that has resulted in hundreds of major advertisers pulling out is not that different that the problems that Google had with music and movie piracy as described in the Megavideo indictment (pp. 8, 34):

kdc adsense

Google had given Megaupload (or an associate of Megaupload) an Adsense account  Although it appears from the indictment that at least one Adsense account was terminated, Megaupload had been operating for a while before the account was terminated.  It does not appear that Google notified advertisers, recovered improper payments to Megaupload or refunded even Google’s own share of revenue to advertisers.

This is important to remember–following the money inevitably leads back to Google itself for advertisers to demand at least the share of advertisers’ money that Google kept for its own account not to mention the sums paid to the YouTube or Adsense partner.  In fact, there’s an argument to be made that the YouTube or Adsense partner, however distasteful, may have done nothing wrong as between that partner and Google.  It is Google that made the promise to the advertiser of where their ads would appear, not the channel partner.

The solution for this is probably best summarized by Professor Ben Edelman’s bill of rights for advertisers.  The solution is ultimately going to turn on both enforcement of Google’s terms of use as well as its monetization policy.  It should be obvious now that Google’s current practices on YouTube simply will not wash–the plan should be to stop the videos from being uploaded if they violate the terms of use, not relying on advertisers or the police to catch them after the fact.

This will take time to give effect of course.  The good news is that Google has a host of forensic information that will be of good use to the police in some cases, but inevitably will make refunding advertising payments to Google’s clients ever so much easier.

All they have to do is follow the money.

 

Fighting for a Straight Count: Does Streaming Accounting Cost More than the Royalties?

When you drill down on exactly what goes into tracking and accounting for songs and recordings on streaming services one thing becomes apparent:  No matter how much you automate, those systems are expensive and the royalties are minuscule.  This is in large part because of the revenue share method of royalty payments that creates a vastly more complex accounting world than a simple per-use penny rate would require.  It’s time to make that change to simplify the reporting.

A recent post by a founder of a digital distributor gives you a sense of the complexity involved:

It’s easy to figure out how much an artist made. But if you want to figure out how much each collaborator is owed from each stream… now you’re looking at millions of rows in hundreds of royalty reports from dozens of sources — every month.

Payments are paid in fractions of cents.

Did I say fractions? I meant 20 decimal places.

Did I say cents? I meant 30 different currencies.

Did I say 30 different currencies? I meant a 350-row exchange rate lookup table. “Customer currency: Swedish Krona, royalty currency: Ukrainian Hryvnia” is a thing (and so on, and so on).

Did I say a 350-row exchange rate lookup table? I meant a different table every month — from every streaming provider.

This gives you a look under the hood of the number of transactions that are inherent in a royalty system that pays every time an end user listens to a track.  It also informs why artists and especially songwriters are royally cheesed about the sharp decrease in the size of their royalty payments.

The hidden transaction costs of the configuration shift from album bundles to singles with  the coming of iTunes was challenging but was at least manageable.  The shift from singles to individual streams is cost multiplier of significant proportion above the shift from albums to digital singles.  I would submit that not only is the cost not manageable, but when distributors promote themselves based on their ability to handle twenty decimal places to the right, it probably never will be.

When a firm’s costs exceed revenue, the firm must either take on debt, sell equity or shut down the insolvent business or business unit–or delay paying royalties, more about that later.  Royalty accounting is, of course, a core business function of distributors, but it is also a core function of the parties receiving those royalties out to twenty decimal places to the right–record companies and music publishers.  There are even more accounting costs incurred by the labels and publishers in calculating the artist or writer shares and their own share of revenue, which will cause the decimal places to increase–to the right.

What this means is that in order to stay in business, be able to meet contractual obligations and pay their artists or writers, royalty systems must be able to handle a new level of complexity they were never before required to process.  Sound expensive?

Add to this complexity that many digital music services use the compulsory mechanical license that requires monthly statements and a true-up annual accounting signed by a CPA and no audit right–instead of quarterly or semi-annual accounting with an audit right.  Even if a publisher is accounted to monthly and pays writers quarterly or semi-annually, the publisher still bears the cost of processing the monthly accounting.  The frequency of ingesting these monthly payments may compound the transaction costs at the publisher and songwriter level.

One technique employed in the Pandora on-demand song license (paragraph 6(a)) is to defer both payment of mechanicals and royalty statements until the revenue payable is $50.  While this may seem reasonable on its face, it’s not–for largely the same reasons that the Copyright Office rejected this approach (37 CFR Sec. 210.16(g)(6)).  Pandora’s license is clearly a variation on the law, which limits the deferral to $5 (not Pandora’s $50) and requires that Pandora pay any deferred royalties on the Annual Statement of Account.

That means that the service cannot write itself an indefinite interest free loan with the songwriters money and not tell the songwriter it is doing so.  And, of course, you can’t audit statements you don’t receive.

Holding these sums is one way to finance the cost of running these accounting systems that deliver ever-smaller fractions of a penny paid to songwriters and artists.  That should sound familiar–new money used to pay old obligations.  Does the name Madoff come to mind?

It’s also important to note that in a revenue share world where money is allocated based on a core calculation of uses of your catalog divided by all songs used on the service in a month, that fraction will produce an ever smaller share of revenue if the rate of change in your catalog titles is less than the rate of change in the number of all songs on the service. (This will likely be true even if the service revenue increases, because your share of it will decline on a relative basis.)

So what is twenty decimal places today, could be even more decimal places in a year or two.

Where the industry went wrong was in the beginning when services got us to buy into the idea that getting something was better than piracy and that we owed the services a chance to find an audience.  When the revenue shared was low and higher margin goods were the focus, that was one thing.

The current state of plays is another thing altogether and revenue share deals for per listen payments require a level of complexity we can’t continue to support.

And yes, that means you, Facebook negotiators.