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[Excerpt from Document prepared by KEA European Affairs on behalf of the Department for Arts, Sport and Tourism, Ireland for the Creative Financing + Music Seminar] (http://www.creativefinancing.org)

The challenges of developing and growing business, especially in the digital environment, demand consistent adaptation efforts from music companies. The majority of music businesses are small and medium-sized enterprises, with limited inhouse resources to undertake the requested changes. External finance is essential to them - however they face growing difficulties in getting access to credit from financial institutions.

Multiple reasons lie behind this situation, but the main problem seems to be an insufficient level of mutual understanding between the music business and the financial community. The investors- common opinion is that music is a difficult and high risk sector. Music executives are at pains to raise awareness on the opportunities offered by copyright-backed assets. The reassessment of accounting standards, in view of better estimating the value of intangible assets, could maybe help gaining a more positive perspective on the economic potential of the music business.

Fresh injection of capital is needed in particular to support:

- The development of businesses in a context of tremendous changes:
* To enable companies and artists to apprehend international distribution and the European market in its diversity
* To promote on-line trading. This requires the greatest attention to patterns of distribution and consumption of digital content. The creation of a viable business also requires accurate assessment of possible licensing practices or alliances with other digital players (digital distributors, ISPs)

- Digitization of assets. For traditional music companies it is essential to transform the existing catalogue into an asset that can be easily transferred in a digital format

- Investment in technology. Licensing schemes, management of revenue streams, payment systems, accounting standards, contract signature, marketing and promotional initiatives - all the range of activities that constitute the backbone of the music business needs to be re-invented and adapted to the digital market

- Secure delivery of content by investing in Digital Rights Management (DRM) systems.

Finance for Music Businesses

Over 90% of music businesses are small and medium sized enterprises.

According to a report published in December 2003 by the European Commission, SMEs in Europe suffer from inadequate access to financial markets, especially in the sector of early-stage financing. The Commission observes that a gap persists in the availability of micro-lending and loan guarantees for small businesses.

Small music labels have similar patterns of financial needs as SMEs active in other business sectors. They rely very often on personal capital and retained profits to finance their usual operations, they make a modest use of venture capital and they are in need of bank finance in their start-up phase or to develop and expand their activities. However, some issues of financing seem to be peculiar to the music industry: music SMEs are more oriented toward the use of internal finance, and they use a lower proportion of external financial instruments compared to small business generally.

The main instruments for getting access to external finance for SMEs in general and small music businesses in particular, are:

- Debt finance: banks offer various types of debt financing, including loans, overdrafts, leasing, etc. The interest rate and reimbursement delay may vary according to criteria such as the flexibility of the instrument applied, its immediate or long-term availability and other financially relevant factors

- Venture capital: this form of financing is more risk-friendly than traditional credit. It usually targets start-ups and small businesses with growth potential. Enterprises are sometimes fearful of venture capital, as it implies that the fund investing into a company takes an equity stake in the company-s capital - the company founders and managers are afraid of losing control over their business

- Public funding: public authorities may intervene in various ways to support access to finance from SMEs. They can offer grants and subsidies, repayable or not. More often, they provide for guarantee schemes that help the financial institutions lending money to SMEs to lower the risk factor of their investment20. Such schemes are widespread in the film sector, almost non existent for music.

- Tax breaks: another form of public intervention is the establishment of tax credit schemes.

However, there is also limited access to these instruments. If we look at bank finance, there is a reciprocal lack of confidence between music businesses and the financial community. Music companies are perceived as being often short in the necessary business skills to approach external financing in a familiar way, whereas the banking sector has a perception of music as an unstable and high risk investment area. Small music businesses usually lack the human and technical resources to cover managerial, financial and commercial activities along with the traditional business of artist signing and record production. They are in need of specific training aimed at enhancing their business management skills.

There are many factors which explain the mistrust that financiers feel when they face the opportunity of investing in the music business. First, financial institutions usually look for operational efficiency, stable sources of revenues, tangible assets and solid business plans when they decide to invest money into a company. In this perspective, music businesses are not the ideal client for a bank manager. Another problem is the amount of money required which is not sufficient in size to trigger interest from the lender.

SMEs in search of credit often face difficulties in having access to micro-finance. Microfinance is usually defined as a loan below - 25,000. This form of credit characterises the demand for finance coming from very small enterprises - firms with no more than 10 employees. Micro-loans are usually exploited to finance start-up activities or the launching of new business initiatives by music SMEs.

However, in spite of the small amount of money involved, SMEs face increasing problems in having access to microcredit. Banks often perceive micro-credit as high risk and low return activity, for the relatively high percentage of small businesses that disappear from the market in the first year of existence and for the elevated handling costs that micro-loans imply.

A report prepared last year by the European Commission analyses the situation of micro-credit for small businesses in Europe. The Commission identifies a market failure of financial institutions in providing micro-loans to SMEs in their early phase of development. It also examines examples of best practices existing in EU member states and candidate countries. Amongst the remedies proposed to bridge the gap between micro-enterprises and financial institutions, the Commission mentions the possibility to improve public support policies, which are already available, though inconsistently, across member states.

Intangible assets, limited amount of capital to be raised, insufficient knowledge of the sector, valuation of music catalogues perceived as less attractive then audiovisual, lack of business and financial training amongst music executives are issues that need to be addressed if the sector is to be encouraged to make the most of market opportunities.

It is essential for both the SMEs and the investors to have a clear appraisal of the revenue prospects and the return potential of investing in the music industry.



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