Music and Equity Crowdfunding

Over the last fifteen years, since the advent of the worldwide web, there has been a revolution in the world of finance. More money is being raised online today than ever before from crowds of like-minded investors, consumers, and communities of fans, especially in the creative arts. The phenomenon is global and has all the hallmarks of a higher growth early stage industry, with newer sites making the difference in the last couple of years. Kickstarter and Indiegogo, for instance, have taken over much business from ArtistShare, the first ever music fan funded site started more than ten years ago.

The Power of Crowdfunding

Global growth has been explosive. According to the first ever Crowdfunding Industry Report — a free abridged version is available at www.crowdsourcing.org — the market will reach $3 billion early in 2013, up from half a billion in 2009. This is a new trade in the making, and top analysts and investors are bullish about its future. Fred Wilson, a well-known venture capitalist and blogger, has said that just in the United States, a one per cent shift in long-term investments could produce a $300 billion market. If he is right, and one-twentieth of all crowdfunding monies were spent on music, the business would outdo overnight the glory days of old.

Crowdfunding platforms are broad-based and do much more than trade rewards against pledges, as musicians are accustomed to think. There are more than 450 sites worldwide, and they trade in equity and lending, as well as rewards and donations. U.S. legislation is expected to open up the doors soon for online equity deals when the JOBS Act, short for Jumpstart Our Business Startups, is given the go ahead by the Securities and Exchange Commission (SEC). As JOBS becomes the law of the land, financing in the industry is likely to unravel in new ways. For musicians and music entrepreneurs, JOBS will have long-term implications and here we speculate on what those might be.

The Juncture

In an exceptional show of bipartisanship by the Senate and the House of Representatives, the JOBS Act became law early in 2012. Implementation was slated by January 2013, but there has been a delay in the application of the law, especially its equity crowdfunding provisions.  The SEC has to consider how to deal with both fraudulent fund-raisers and the passions of a new breed of possibly large and untrained unprofessional investors online. To minimize damage, maximum investments are being proposed per individual and crowdfunding project; in addition, investors will be limited to putting down a predetermined percentage of their income or net worth, to control potential losses (the top equity investment that will be accepted from a pool of online investors is $1 million, and the caps on invested income online, or net worth, are the greater of $2,000 or 5% for incomes, or net worth, less than $100,000; for incomes, or net worth, over $100,000, the figure is 10%).

As these online investors will not be, as defined by the SEC, ‘accredited’ in any way, it propels the regulatory body into uncharted territory and makes it doubly cautious before it gives the thumbs up to Congress. A new SEC administration was installed two weeks ago, and incoming Chair Mary Joe White has made it clear that the JOBS Act is one of her priorities. The SEC crowdfunding safety guidelines are now anticipated by next year, and the U.S. should then take its place alongside a number of other countries in Europe already testing the waters, among them the UK, Italy, and France.

Moving Forward

Here are various possible scenarios for the music industry with equity crowdfunding.

First, a management or production company could solicit funds online and use the cash to sign up artists or maintain a roster of talent. It would bring more money into the business, but it could also make the production of music depend less on the manifestation of a creator’s will, for production houses tend to be less about the artist themselves than the needs of music in the marketplace.  The US record label system, for all its faults, allows an individuality of expression that the current crop of Japanese production houses, for example, do not.

Second, the above could further erode the tenuous hold of the record labels on the business. However, if the record labels themselves resorted to equity crowdfunding to defray the risk of signing artists (applying it to the second choice, say, of two artists vying for a recording contract), equity crowdfunding could be a boon for them. There are limitations to the amount that could be raised, but parceling talent into a holding company, as discussed by Miguel de Braganza in this issue of The Music Business Journal, may circumvent that limitation.

Third, the JOBS Act might help a publishing entrepreneur both advertise for an investment in a new catalog of songs and seek the exploitation and marketing of a lucrative collection of classic tunes; it could spurn a cottage industry of small publishers raising money and offering terms, on a selective basis, to the established houses.  Or the larger publishing houses could, just like the record labels above, use equity crowdfunding for their purposes too.

Fourth, and perhaps the most remarkable change of all, the JOBS Act could convert fans into shareholders in an artist’s career. At present, such a Faustian exchange seems unlikely to be embraced by artists. They would, presumably, be loth to surrender what would seem like an unprecedented amount of control to their fans.

However, commercially oriented talent has been in the rise since the 1980s, when crisscrossing the world of commerce and music became less objectionable for artists. Megastars have embraced extra-musical sources of revenue to establish their brand, and the trade on the whole has become much more dependent on non-recording sources of income. Commercial sponsorships are so common today that even a soda company like Coca-Cola is used to discover talent for use in its own label, Music Dealers; the artists that are willing to sign up for commercials, do so presumably, as a means to jettison their careers. Therefore, the current pragmatism of musical talent could conceivably morph into a piece of equity bought by a fan. Historically, music patrons have come in all forms and sizes, as Mozart and Beethoven knew. A question that may well be asked by financial experts is this: for artist stocks to trade and be made liquid at short notice, and so continue to encourage fan investment in the first place, will there be enough exchange to justify a critically necessary secondary market?

Caveat Emptor!

Music is likely not even a partial concern for SEC regulators. After all, the JOBS act is meant to stimulate new startup businesses, whatever their focus, and create jobs. Yet it might definitely energize the creative arts sector and especially music, as fans are already engaged with, and thus informed about, the artists they support. JOBS would also grow the online economy, and boost the use of social media, a tool that is vital in today’s music business.

For a technology-based economy, JOBS encourages a more agile supply of ordinary people’s savings towards the trade. Major and indie-recording labels should, for instance, be able to accept many small contributions from investors without the stringent requirements associated with SEC regulations for investor numbers. This, as argued, is welcome.

Still, regulators will have their job cut out for them just by tracking investors’ income or net worth for compliance with JOB’s crowdfunding provisions. Moreover, as JOBS also relaxes terms in the market for IPOs (initial public offerings), and allows less stringent reporting requirements for companies selling under $1 billion a year, such as Pandora, it introduces an element of moral hazard. This will be compounded when firms advertise freely for stocks that institutional investors will not touch. In the end, it must be remembered that the JOBS Act will encourage inexpert individuals to risk their savings, so fans will have to use their head as well as their heart when supporting their favorite artists. Caveat emptor!

By Peter Alhadeff

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