What's telling is just how long and hard that discussion has been. It took the pair about eight years after they began playing in bands together before they put their money where their hearts are. "When we started to develop our thesis about music 2.0, we were very cautious," says Mendelson, a managing director at Foundry Group LLC and the drummer for the band The Legitimate Front. "We looked around and saw all these venture-backed investments with massive capital burn and no exit."
"We probably placed the bar higher than we would have otherwise," continues McIntrye, who is also a Foundry Group managing director and The Legitimate Front's guitarist. "We didn't want to let our personal passion for music cloud our judgment."
Their first music-related investment came in 2008, shortly after Foundry Group closed its initial $225 million fund. (Mendelson and McIntyre are both refugees from Silicon Valley and former partners at Mobius Venture Capital Inc., so they have some track record.) Foundry Group led a "several million dollars" B round of Topspin Media Inc.
Topspin Media doesn't stream or download music, the typical focus in years past of capital aimed at digital music technology. Rather, it provides the tools for the digital marketing of music, a kind of enterprise software for musicians and their managers. Through one online dashboard, Topspin technology manages and promotes everything from merchandise to tour dates. Lady Gaga's and Paul McCartney's websites use Topspin. So did the late ukulele master Israel "IZ" Kamakawiwo'ole.
"Topspin is a technology platform [that] supports artists, management, their business," says McIntyre. "It recognizes their world had changed."
"Change" is a monumental understatement when it comes to music. It's been more than a decade since Napster and file sharing completely transformed recorded music and upended the industry. Peace in the music business is definitely not at hand. Look at what commands attention these days: warring Internet radio services, the guaranteed-to-be-bruising fight between three corporate behemoths and some pretenders over "cloud-based" music delivery and the major labels' endless bloodletting.
Music, the art of sound, is ubiquitous and harmonious, more firmly connected with human existence than ever before. Music, the business of sound, clangs and collides like an aluminum bat on a trash can.
To square the two, it's helpful to follow the money, far away from the biggest stages, such as the auction of Warner Music Group Corp. and anticipated sale of EMI Group Ltd.; the competing music storage plans of Apple Inc., Google Inc. and Amazon.com Inc.; the initial public offering in June of Pandora Media Inc., which a breathless media chronicled pretty much by the minute; and the long-awaited unveiling in the U.S. of Pandora's rival service, Spotify Ltd. These are mosh pits where hundreds of millions of dollars in capital slam together.
Instead, look at venture investing. See where capital is going -- or not going -- in the initial stages of funding, when checks are in the single millions. It's possible, just possible, to get some idea of what the business is going to look like.
"It's been 10 to 12 years into the transition, and we're at that stage where we're starting to see a small number of success stories," says Ken Umezaki, an angel investor in music technology-related companies, including the music-oriented Web design and services firm Section 101 Inc., where he serves as COO. "I don't think we're quite at the trough yet, but we're pretty close."
The industry's old guard continues to bemoan the declining market in recorded music, with revenue totals half what they were a decade past. At the same time, new models are emerging. They take a far more holistic approach to music as a business, see the musician as a generally small businessperson and largely cut out the middleman. They also make economic sense, investors maintain.
"There is a business that is emerging that is run like a business. That's why there's renewed interest in the space," says Nashville-based music and technology entrepreneur Mark Montgomery, who sits on Topspin's board of advisers. A pioneer in e-commerce, Montgomery sold his entertainment-related delivery and data management system, Echomusic LLC, to the Ticketmaster Entertainment Inc. unit of IAC/InterActiveCorp in early 2007 and has been investing in technology startups ever since. "Some people are starting to put it together," he says, adding, that it's "astounding how many people are angling at solving the music industry."
"Ten years ago, I was very reluctant to invest and was highly skeptical. Today, the dynamics of the industry, the way it sells to fans, is a much more interesting place to look for investments," adds Bill Ericson, a general partner with Mohr Davidow Ventures, which has, among other investments, taken a stake in Ticketfly Inc., an advanced-ticketing platform with music as its centerpiece. "The business model has changed because technology has allowed it to change," Ericson says.
Technology drives these new services and revenue streams. It disintermediates what Montgomery calls "unnecessary links in the value chain" -- that is, distributors, promoters, wholesalers and retailers. That's an important part of what attracts venture money. However, at the center of the evolving model is something uniquely human: "The fan is driving pretty much all [venture] investments in music" these days, says Saul Klein, a London-based partner at Index Ventures, which has been backing music-related companies since the mid-1990s.
The more fans are engaged, the logic goes, the more willing they are to pay for what they consume. The key is to build both the number of fans and their level of commitment. "The questions for musicians are: How do I make compelling content connect from the ear to the heart? How do I get that through to an audience?" Montgomery says.
It's crowded. It's noisy. There's more music now than ever before. Despite increasingly sophisticated technology that attempts to marry preferred tastes with music exploration, consumers can easily feel overwhelmed by the sheer number of choices available.
Current technology and consumer behavior have pretty much broken down traditional patterns of music consumption. The listener is a much more active participant. "There's a seismic shift in the relationship between the artists and the fans," says Umezaki, who also plays bass in the electric blues band Fifth of Bourbon. "No longer is there a monolithic distribution process represented by the major labels, an old model that was very unidirectional." Under the old system, a label kept a tight lid on release, distribution, airplay and touring. The label fed the fan as it saw fit. In music 2.0, Umezaki stresses, "the artist is attached to the fan base directly. It's much more bidirectional."
Social media, everything from Facebook to Twitter, feeds into and facilitates these fan connections to the degree that some venture capitalists see one as an extension of the other. For example, another Mohr Davidow investment is in RootMusic Inc., a San Francisco-based company that offers Facebook-centric marketing applications to bands. RootMusic "creates a platform with the ability of connecting directly with the fan base," says Ericson. "Technology is enabling closer interaction."
The core assumption driving these investments is the converse of a post-Napster world, where free is the new standard payment for a piece of recorded music. The stronger the connection between musicians and their audience, the thinking goes, the more money will change hands.
These two phenomena aren't necessarily contradictory, argue those who finance music technology-related startups. Think of an environment where musicians encourage free downloads of their most popular recorded music as a kind of hook. "Bands are becoming aware that some version of free is an initial point of contact. If [the listener] likes it, then a relationship can be built," says Ericson, who, like other venture capitalists with music-related investments, challenges the label-centric orthodoxy that the age of digital delivery is a bad deal for musicians. "You don't hear musicians complaining about it," he says. "You hear labels complaining."
Austin Mayer and Brian Schopfel own Chicago-based Eyes & Ears Entertainment LLC, a music-related digital marketer and promotions shop. They describe the relationship between bands and potential fans as a series of conversations. "If you start a conversation with someone on the street and say, 'Give me five dollars for what I have,' what kind of response will you get?" asks Mayer. But if you first offer an opportunity for discovery and access, continues Schopfel, "by the third or fourth conversation, they will buy it."
Montgomery cites with awe Corey Smith, a singer and former high school teacher. Smith lives in the small town of Jefferson, Ga., and has grossed more than $7.5 million from his music. Smith gave away one million downloads but has sold another one million, Montgomery says.
Music "is an emotional product, and the value is in the emotional connection to the artist, to the musician," says Toni Schneider, a partner with early-stage investor True Ventures. "People don't buy music the way they buy a toothbrush or a plane ticket."
Three years ago True Ventures poured an undisclosed amount of money -- the fund invests on average $1 million in a venture -- in Bandcamp Inc., a popular destination for new and struggling musicians that offers artists a Web home. In Bandcamp, artists suggest minimum prices for their albums. According to Schneider, fans actually pay on average 50% above the asking price. Why? "They know the money is going straight to the band," he says.
That kind of fierce loyalty helps drive music's new economics, others agree. "Where in the value chain of the industry can you make money? Where there's a lot of value for both the fan and musicians," says Klein, whose firm has invested in such current startups as live events organizer Songkick.com Inc., ticketing exchange Viagogo Inc., audio electronics controller Sonos Inc. and audio-sharing service SoundCloud Ltd.
The deeper, the more varied, the more constant, the more reciprocal connections are, the better off bands will be. Venture capital tends to fund the technology that enables and strengthens these connections, which could result in anything from a head start on concert tickets to limited-edition merchandise. One increasingly popular example: An artist will offer a free music download in return for e-mail addresses, which become the basis of a fan roster. With this information, analytics can determine, say, which cities are particular fan hotbeds, or even which cities are partial to similar-sounding groups. All this can be used to plan concerts and personal appearances.
"Knowing who the fans are is very valuable," says Klein, who throws out this metric: "Twenty percent of consumers account for 80% of the spend."
This isn't to say that venture capitalists speak and invest with one voice. Many remain deeply distrustful of the music business, which has an almost mystical allure, but which is also like some Indiana Jones adventure, full of both exhilaration and every imaginable pitfall and peril.
Music-related enterprises are "a pretty dangerous place to invest," says Dennis Phelps, a general partner with Institutional Venture Partners, whose firm, he says, has "shied away" from most of these investments. "The graveyard for music-related companies is pretty broad."
What investors seem to fear most is getting caught between the overpowering forces of free-and-easy downloads and the rear-guard actions of the four major labels. Led by Universal Music Group, the four companies controlled 88.2% of recorded music last year, according to Nielsen SoundScan. They continue to make legal licensing costly, uncertain and time consuming.
"It's an industry encumbered by tremendous legacy costs and a bloated infrastructure," says Timothy Komada, co-founder and managing partner of venture capital firm Deep Fork Capital, an investor in digital-music service Amie Street Inc., which Amazon acquired last September for an undisclosed amount.
As a result, many venture investors, who in the aftermath of the recession have had a tough couple years to begin with, stay away from the sector entirely. "They're skeptical about the ability to make money," says Greg Beattie, a partner with San Francisco-based MVP Law LLP who advises startups. "It's more difficult to persuade them to invest in music-based entities."
The history of venture-backed music business exits is, in fact, fairly paltry. Pandora's IPO, which valued the Internet radio service at $2.6 billion, is by far the biggest liquidity event ever in digital-music-related startups, eclipsing rival service Last.fm Ltd., an Index Ventures-backed company acquired by CBS Corp. for $280 million in May 2007. But it took Pandora 11 years and some near-death experiences before it was listed on the New York Stock Exchange.
Many venture-backed streaming music services did, in fact, go bankrupt or bust, including SpiralFrog Inc., SeeqPod Inc. and Playlist Inc. Many more languish.
More germane, say critics, is the trajectory of social media site MySpace, which News Corp. bought in 2005 for $580 million and unloaded earlier this month to a consortium including Justin Timberlake for a paltry $35 million. MySpace at one juncture completely dominated music-related websites. But it failed to fashion them with the kind of state-of-the-art technology that companies such as Topspin Media offers and couldn't capitalize at all on its near monopoly.
The MySpace phenomenon illustrates another potential pitfall of music-related technology. MySpace attracted literally millions of bands, but only a few thousand actually make their music a business. Depending on garage bands that have trouble scraping enough money together to buy new guitar strings isn't exactly a recipe for affluence.
Billboard estimates first-quarter 2011 music-related venture investments totaled $123 million globally. Industry trade publication Digital Music News estimates venture investments for the first half of this year totaled almost $400 million, but that includes an unverified $100 million investment in Scandinavian Internet radio service Spotify. Topping the list was New York-based Beyond Oblivion Inc., which garnered $77 million from current investor News Corp. and from new entrant Wellcome Trust. Beyond Oblivion is competing with Amazon, Google and Apple in the delivery of music libraries through hosted, or cloud, services.
Digital-music-related startups continue to proliferate, and globally. The British digital music consultancy and research firm Musically Ltd. identified more than 100 digital-music-related startups in the first six months of 2010 alone, bringing a three-year total to more than 500. Most won't gain venture funding. Many will not survive.
Umezaki describes all these music-related startups as "incredibly diverse" and "still very much a cottage industry." As such, he says, consolidation is bound to take place and leaders will emerge. He cautions that in such an unsettled environment, both "upstarts and large tech companies may show up to usurp even these new leaders."
Before retiring in 2009, Umezaki spent 20 years with Lehman Brothers Inc., including a position as global head of fixed-income business strategy. The music industry, he says, has undergone a decade of "complete chaos," which offers wide-open opportunities in years ahead. "From an entrepreneurial point of view, this is going to be supercool."
Conversations with more than a dozen venture capitalists and startups reveal several investment strands and some fundamental underlying assumptions: a foundation of great technology, of course, but also strong management, a worthwhile market and customer demand.
One trend is clear: Many of these technologies, from marketing to analytics, are designed for use in more than music. "Music becomes a gateway to other media," says Antonio Rodriguez, a Boston-based partner at Matrix Partners, which invested in Echo Nest Corp., a music intelligence service, and no relation to Montgomery's old company.
One big indication of this came in June, when Shazam Entertainment Ltd. announced it had raised a new, $32 million venture round. The London-based company made its mark with a wildly popular phone app that listens to music and names the tune. The new funding will allow the company to develop its technology for use in television. "We don't look at [Shazam] as purely a music technology," says Phelps, whose firm led Shazam's latest round. "We believe it will become more and more ubiquitous."
Two Finnish startups illustrate this approach. Thinglink Oy embeds images with links. These interactive images allow everything from biographical sketches to audio clips to ticket sales. They are linked to social media titans Wikipedia, Facebook Inc., Vimeo LLC and Flickr Inc. But unlike current technology, the user doesn't leave the original site.
Neil Vineberg, the company's chief marketing officer, says the click-through rate is exponentially higher than is traditionally the case. He calls it "engagement technology," and adds that the company's initial focus on music, with Atlantic Recording Corp. an early client, is a natural. "When you think about trying to engage audiences in technology, music is one of the most engaging activities imaginable," he says.
Thinglink, founded in 2008 by well-known Finnish designer Ulla-Maaria Engeström, has been given an undisclosed amount of seed funding by Tekes, a Finnish government technology incubator. Vineberg says the company will look for venture funding by the end of this year.
Hitlantis in June closed on a $1.5 million angel round. The Helsinki-based company has developed a visual-mapping technology. Its first application centers on unsigned bands, each represented by a bubble in a kind of complex, molecule-like schematic, color-coded according to musical genre. The more online interest a band generates through the Hitlantis site, the more centrally located the bubble is. The more music the band offers, the bigger the bubble becomes.
"Unsigned bands are the tip of the iceberg," says Hitlantis co-founder Timo Poirjarvi, who worked for a decade with Sony Music Entertainment in Helsinki and London. He sits in the bar of a Manhattan hotel, demonstrating the service on his iPad. "The platform doesn't have to be music. Every bubble could be a conversation. In a large corporation, every employee could be a bubble. This could be a visual map for political elections. These are social objects."
Topspin Media represents another trend. It operates as far from music industry's scorched earth as possible. By design, it isn't taking sides over, say, which cloud-based service, which Internet radio or which media giant comes out ahead. "It's not betting on any band, or any particular label, it's betting on choice," says Mendelson. Montgomery, who has invested in several music startups, calls this "the plumbing side of the business." He adds, "It's unsexy."
Venture capital finds that kind of neutral approach appealing. To keep the battlefield metaphor going: "I'd prefer to be an arms merchant and not deal with who's going to win the war," says Vince Vannelli, founder and managing partner of San Francisco-based KPG Ventures, an early-stage VC. KPG invested $2 million in TuneUp Media Inc., which cleans up song listings information on iTunes.
Vannelli stresses that he didn't invest in digital music per se, but a software company and a service that "makes the consumption of music easier and better." TuneUp was founded in 2007, and has attracted a total of about $8.5 million in venture funding.
Topspin was also founded in 2007 and is now "close to breakeven," according to Mendelson. Like TuneUp Media, it avoids the two often-fatal traps music startups must maneuver around: licensing rights and trying to make money off consumers downloading music. "From an investment perspective, there are two things to keep in mind," says Topspin CEO Ian Rogers, a music technology veteran who briefly served as general manager of Yahoo! Inc.'s ill-fated music service. "One, we don't need broad-based licenses from the labels. Two, we're not playing in the ecosystem of commodity downloads."
For the past half-century, recorded music and the major labels completely dominated the standard business model. That no longer applies. "For years, music, its creation and publication, was the domain of the labels. Over time, it is shifting," says Ericson, who gigged in a band in Japan years ago. His conclusion: "The industry will redefine itself regardless" of what major labels do.
Change has swept across multiple fronts: production, distribution, delivery, marketing and live performance. Revenue sources have fragmented and defused.
That's true despite two recent eye-popping events that appear to show the old guard has life left. One was the auction of the third-largest major, Warner Music, completed in May. Billionaire Len Blavatnik, through his private equity vehicle, Access Industries Holdings LLC, won the spirited bidding with a $3.3 billion offer. Citigroup Inc., which now owns EMI after previous PE owner Terra Firma Capital Partners Ltd. defaulted on its £3.4 billion ($5.4 billion) debt, is expected to follow suit with its own auction.
The other is the latest release from that demure performer Lady Gaga. "Born This Way" sold 1.1 million albums its first week out in May. It was the biggest debut in the past six years. "ET," the album's "single," has sold more than 4 million digital downloads.
"Where the music industry gets in trouble is the Lady Gaga effect [saying], 'Oh, never mind, we're golden,'?" says Mayer. "That's not going to happen."
The digital download of a song is defined by Apple's iTunes and the 99 cents offering. Few now believe it is a long-term economic replacement to the album. To begin with, numbers don't jive. The average iTunes transaction is a little over $2, a far cry from the $15.99 price tag that for years propelled CDs. The dramatic growth rates that characterized paid digital downloads over the past five years have begun to slow. According to Nielsen SoundScan, the number of digital tracks downloaded in 2010 totaled 1.17 billion. That amounts to only 1% more than the previous year.
Conceptually, it's hard to break out of this recorded-music-equals-the-music-business straitjacket. Even the numbers that define the business remain firmly anchored to the sale of a recorded song. When describing the industry, it's common practice to quote the Recording Industry Association of America, which estimates recorded music sales in 2010 totaled $6.85 billion, a decrease of almost exactly half the sales total a decade back in 2001.
However, that figure does not begin to capture total revenue, which also includes merchandise and live performances. The top 50 tours alone worldwide grossed $2.93 billion last year, according to live performance research organization Pollstar Inc.
The recorded-music industry commands discussion and skews the debate. The International Federation of the Phonographic Industry, the global equivalent of the RIAA, warned last year, for example, that Europe's "music industry" will lose 1.2 million jobs by 2015.
Nancy Baym is a University of Kansas communications professor who studies and writes extensively on music's evolving landscape. She questions whether there's been any job loss at all, if the effect of music-related technology is included in the numbers. "Think about all those startups and how many people they employ," she suggests.
Overall revenue may decrease, but a larger percentage will in fact flow to the artists themselves. Topspin, for example, boasts average transactions of more than $20, with higher margins than straight digital sales. "If Topspin accounts for 20% of sales, it might be 40% of your margin," says Mendelson.
It is an extremely musician-centric model. "Rather than having to go through a traditional system where the labels provide the marketing, or radio provides airplay, artists function as a channel," says Komada. "You circumvent traditional stakeholders."
Baym fashions the change in sociological terms. She sees the current music environment in terms of "social exchange," as opposed to a strictly economic exchange of money for goods or services. Social exchange means building communities, which can translate into bigger audiences and more active -- and lucrative -- markets.
Advocates of the new models stress that the industry is fragmenting, and so are money streams. The majority of musicians, who can only dream of superstardom, may actually do better in this kind of environment. They could make less money, but keep a much higher percentage of what they earn. "Musicians are taking more control of their business," says Ericson. "The industry is changing, and that is good."
Lady Gaga and a few other artists aside, the age of the megahit is ending. As it contemplates what music-related startups to underwrite, venture capital should take that message to heart, says Mendelson. "It's a hits-driven business backing a single," he says, as he explains why he and his partner waited so long to invest. "We wanted a solid album."