This article is first in a series about music industry entrepreneurship and financing music tech startups. For more info in person, visit amplitude.ventures.
Through our work at Amplitude Ventures and the Sound Conductors Podcast, we've gathered many insights into challenges and opportunities in music tech investment. With almost 20 investors and soon close to a million dollars in funding, we've seen patterns and made strategies that could help other music tech startups with the complex fundraising landscape.
I haven't said this publicly before, but besides my master's in Music Technology/production, last year I started research at University of Agder in Music Business, focusing on music startup financing. This, plus many talks with industry professionals and on the Sound Connections Podcast, has given me a good foundation for understanding investment dynamics in music technology. These are my initial findings.
These insights are part of bigger research efforts that will become two upcoming projects:
"A Founder's Guide to Music Industry Entrepreneurship": This aims to give a full guide for new entrepreneurs in the music industry. It will cover starting a music tech company, understanding market dynamics, industry market fit (thanks to Vickie Naumann for this term), getting funding, partnerships and general startup advice.
"Financing for Music Tech Startups": This looks into the specifics of getting funding in this unique sector. It will explore different funding options, investor relations, and ways to increase your chances of success.
Even though I have good experience myself, it's also very much built on conversations with industry leaders and their experiences.
These projects want to bridge the gap between traditional music industry practices and the innovative potential of technology. By sharing these initial findings, I hope to start discussion, get feedback, and invite contributions from other industry professionals and investors. This article is a teaser for these projects, showing some key insights and strategies we've developed.
Please write to me if you want to add to the conversation.
Behavioral Finance in Music Tech Investment
One of my recurring theories in this research is viewed through the lens of behavioral finance.
Behavioral Finance Definition: Behavioral finance studies how psychological influences and biases affect the financial behaviors of investors and financial analysts. It helps explain why investors might make irrational decisions based on emotions rather than facts.
In the context of music tech investment, behavioral finance provides valuable insights:
Universal Emotional Ties: Virtually every investor has a personal relationship with music. This emotional connection can significantly influence their decision-making process.
False Sense of Expertise: Due to their personal experiences with music, investors often believe they "know music". However, this rarely translates to a deep understanding of the music industry's complexities.
Self-Disqualification: Paradoxically, many investors quickly disqualify themselves from due diligence. They recognize that while they love music, they lack the industry-specific knowledge to properly evaluate a music tech startup.
Investment Hesitation: The combination of emotional ties and acknowledged lack of expertise often leads investors to shy away from the music tech industry altogether.
Biased Valuations: This emotional bias can lead to overvaluation of familiar projects and undervaluation of those that are less familiar, regardless of their actual potential.
To address these challenges, it's essential for startups to focus on storytelling through "parallel narratives". This approach involves creating two narratives:
One that appeals to the emotional aspects of music
Another that frames the business in terms investors from other sectors understand
For example, instead of pitching a publishing company by focusing on potential hit songs, you could explain the historical stability and high returns of IP rights. Highlight that IP rights for music have been consistently traded between major companies, with evergreen songs being sold for 8-10x multiples of their yearly returns, and major hits fetching up to 25x multiples.
IP rights can be explained as an alternative asset class uncorrelated to general equity markets, and have proven to be quite recession-resistant. They can provide yearly dividends in close similarity to semi-passive income such as real estate. This framing helps investors see music rights as a stable, diversifying asset within their portfolio.
By framing your startup as an investment in a stable asset class, where creating a hit song that generates $1 million annually could be sold for $10-25 million on the open market, you provide a more tangible and familiar investment proposition. This approach helps investors feel more confident in their ability to evaluate your startup, increasing your chances of securing funding.
Parallel Narratives
Parallel Narratives is a concept I've developed through last years of research and practical experience in the music tech industry. It's a strategic approach to presenting your startup to investors, particularly those from outside your specific sector.
Definition: Parallel Narratives is the practice of crafting your startup's story in multiple, complementary ways that align with different investors' backgrounds and expertise. It involves translating your core business proposition into language and frameworks familiar to investors from various industries, enabling them to evaluate your startup using their existing knowledge and due diligence processes.
Key Principles of Parallel Narratives:
Speak the Investor's Language: Present your startup using terminology and concepts from the investor's background. If they're from fintech, use fintech analogies. If they're from e-commerce, draw parallels to that industry.
Minimize Industry-Specific Jargon: While your startup may be deeply rooted in a particular industry, your pitch shouldn't be. Focus on universal business concepts that any investor can understand and evaluate.
Enable Due Diligence: Frame your business model, market opportunity, and growth strategies in ways that allow investors to apply their existing due diligence processes. This builds their confidence in evaluating your startup.
By employing Parallel Narratives, you can effectively bridge the gap between your industry-specific innovation and the broader investment world, opening doors to a wider range of funding opportunities and strategic partnerships.
At Amplitude Ventures, we've put this strategy into practice. Out of our 20 investors, only one comes from a music background. This diverse investor base wasn't accidental; we deliberately sought out investors from various sectors to test and refine our Parallel Narratives approach. This strategy has allowed us to build a strong, diversified investor portfolio while validating the effectiveness of our communication method.
Multiples and Investment in Music Tech
A common argument against investing in music tech is that the industry is too small to be of interest to investors. However, this perspective lacks nuance and overlooks key opportunities.
Lower Valuations, Higher Acquisition Rates
While it's true that music tech startups often face lower valuations compared to other tech sectors, this is balanced by a high rate of acquisitions. Many music tech startups are acquired early in their development, before reaching high market valuations. This dynamic creates a unique investment landscape:
Frequent Early Exits: The high acquisition rate provides opportunities for early exits, making music tech startups attractive to investors seeking quicker returns.
Lower Entry Point, Attractive Multiples: Lower initial valuations combined with steady acquisition activity can lead to attractive investment multiples. While individual exits might not reach "unicorn" status, the return on investment can still be significant.
Ecosystem Integration: Many acquisitions in music tech are driven by larger companies looking to integrate new technologies into their existing ecosystems. This trend supports the frequent acquisition activity.
Leveraging This Dynamic
As a founder, you can use this industry characteristic to your advantage:
Emphasize Acquisition Potential: Highlight the active M&A landscape in music tech. Showcase examples of successful acquisitions in your specific niche.
Focus on Realistic Growth: Instead of promising unicorn-level growth, present a realistic path to a valuable acquisition. This approach can be more credible and appealing to savvy investors.
Highlight Efficiency: Demonstrate how your startup can achieve significant milestones and market penetration with relatively modest investment, making it an attractive acquisition target.
By presenting this nuanced view of the music tech investment landscape, you can effectively counter concerns about market size and valuation. The key is to shift the focus from achieving massive standalone valuations to positioning your startup for strategic acquisition, emphasizing the potential for attractive returns through this path.
Remember, while you might not be building the next tech giant, you could be creating a valuable component that a larger company will be eager to acquire. This narrative can be compelling to investors who understand the value of strategic acquisitions in building their portfolio.
Ecosystem Integration in Music Tech
Many startups aspire to create entire ecosystems in the music tech space. However, this approach often overlooks crucial industry dynamics and financial realities.
Key Considerations:
Financial Constraints: Valuations in the music tech sector are typically lower than in other tech fields, and available capital is limited. Building a comprehensive ecosystem requires substantial funding, which is often unrealistic for most startups.
Acquisition Trends: Consistently, we see larger players acquiring smaller, specialized companies. This trend suggests that being an attractive acquisition target is often a more viable path to success than trying to build a standalone ecosystem.
Competitive Landscape: The music industry already has established ecosystems with significant resources and market presence. Competing directly against these giants is an uphill battle for most startups.
Founder Experience: The startups that succeed in creating large, independent ecosystems are typically led by highly recognized, established founders or music industry professionals. If you're not in this category, it's crucial to adjust your strategy accordingly.
A More Realistic Approach:
Instead of aiming to build an entire ecosystem, focus on creating niche solutions that can integrate into existing ecosystems. This approach offers several advantages:
Lower Capital Requirements: Developing a specialized solution requires less funding than building a comprehensive platform.
Faster Market Entry: Niche products can be brought to market more quickly and can start generating revenue or proving their value sooner.
Increased Acquisition Potential: By solving a specific problem within the industry, your startup becomes an attractive target for larger companies looking to enhance their offerings.
Realistic Growth Path: This strategy aligns with the industry's dynamics and provides a more achievable path to success for most founders.
The Bottom Line:
Statistically, you have a higher chance of building something of worth and value by positioning your startup as part of a larger ecosystem rather than trying to create one from scratch. Understand your place in the industry, be realistic about your resources and experience, and focus on creating targeted solutions that fill specific gaps in existing workflows or platforms.
Remember, success in the music tech industry often comes from being a valuable piece of a larger puzzle, not necessarily from trying to be the entire picture yourself.
Conclusion
The music tech investment landscape presents unique challenges and opportunities. Success in this space requires a nuanced approach that considers investor psychology, market valuations, and ecosystem integration.
Key takeaways for music tech startups:
Utilize Parallel Narratives: Frame your startup's story in terms that resonate with investors' expertise, minimizing music-specific jargon.
Embrace Realistic Valuations: Understand that lower valuations can be balanced by high acquisition rates, leading to attractive returns.
Focus on Ecosystem Integration: Develop niche solutions that integrate into existing ecosystems, reducing capital requirements and increasing acquisition potential.
Highlight Acquisition Potential: Emphasize how your startup could be an attractive target for larger players.
Be Realistic About Growth: Present a credible path to creating value within the existing industry structure.
By adopting these strategies, music tech startups can position themselves more effectively for investment and long-term success. The goal isn't necessarily to become the next industry giant, but to create a valuable component that enhances the existing music tech ecosystem.
Founders, if you need help positioning your company for investment, don't hesitate to reach out to us.
For industry professionals with experience in this space, we'd love to hear your thoughts! Let's jump on a call.
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