On Wednesday Spotify announced a whole new raft of services for its users; video streaming, podcasts, and an extremely impressive ‘running mode’ (from a tech-geek’s point of view anyway… I’m certainly no great runner). The first of those two features didn’t come as great surprises and pundits (including yours truly) were all over the news talking about them some time before they were officially announced.
So that’s all good then. Spotify has a raft of flash new features to help it beat its competitors and finally start turning a profit. Next stop an IPO in 2016 (for which Goldman Sachs is understood to be retained already), and huge cash payments for everyone involved. The territory is ripe for the kind of easy-reading headlines that we all love to talk about; slick new features for the techies, share price speculation for the financiers, and dreams of making it as big for the entrepreneurs.
But because I’m a lawyer, I don’t want to do any of that, instead I want to sound a note of caution and direct your attention to some of Spotify’s other less happy news. Why? Because the company’s recent fortunes spell out a vital lesson for anyone starting, building, or running a tech business. Specifically, they can teach you how to make more money.
Lessons for Entrepreneurs
Underneath the big headlines that it likes talking about, Spotify is still making a loss.
- For all the flash new features, the big deals with Starbucks, and the market leading paid-user count; Spotify is a company that just can’t seem to turn a profit. Its 2014 results indicated that, for yet another year running, its outgoings were rising faster than its revenues. In 2014 it lost €162 million euros. No matter how high and how fast its revenues climb, its outgoings seem to get even higher even faster.
- Spotify’s biggest single outgoing is the 70% of its revenues that it claims to pay to ‘rights holders’ each year (i.e. to musicians who aren’t called Taylor Swift) but its recent annual results indicate that in 2014 81% of its revenues were paid as ‘Royalties & Distribution’ costs to record labels. That’s an immense bill; it’s a higher percentage than that paid to record labels by Spotify’s nearest competitors, and it’s still not enough to prevent awkward headlines for Spotify about artists being underpaid.
- We have a pretty good idea of why Spotify can’t seem to get that 81% figure down, because its contract with Sony leaked online. A quick look through it reveals some absolutely horrific clauses from Spotify’s perspective and gives us some real clues as to why its outgoings keep spiralling upwards.
To summarise that 42 page deal very briefly:
- Sony gets paid regardless of Spotify’s fortunes.
- Sony doesn’t just get paid, it gets to choose the yardstick by which its payment is measured. If it’s a good year for Spotify then Sony can pick a revenue-share type deal, if it’s not been so good then Sony can pick a payment-per-stream deal.
- Sony doesn’t even have to wait to get paid, it receives guaranteed minimum advance payments several times each year. Those payments aren’t technically earmarked as being ‘royalties’ either, so it may well be able to pocket them rather than passing them on to artists.
- Sony doesn’t just get paid cash, it also gets additional sweeteners on top. Foremost among them free advertising space on the Spotify platform (which it appears that Sony may be free to sell on if it wishes, effectively becoming a competitor to Spotify itself).
- Finally, to really rub it in, Sony has a ‘most favoured nation’ clause in its favour – which means that if any other record label gets an even better deal (whatever that looks like) then Sony is entitled to the same deal itself.
… and that’s just the deal that Sony managed to get. It may well be that other major record labels got even better terms.
Basically, it looks like the reason that Spotify can’t make a profit is because, no matter how much money it makes, it’s bound into agreements that let its suppliers gobble up its revenues as fast as it can bring them in.
So don’t sign that, or that, or that…
So, without wanting to seem as if I am criticising Spotify or their legal advisors (I’m not; they were almost certainly under certain commercial pressures when they signed the Sony deal) there are certain clauses that you just shouldn’t sign unless you absolutely have to:
Particularly distressing to a lawyer’s eye is the ‘most favoured nation’ clause, which is an incredibly onerous provision that we would usually advise clients to avoid like the plague. Beloved though they are by multinationals who find themselves in strong bargaining positions ,these clauses need to be resisted at all costs and are often the first thing on the agenda in a negotiation. Their presence effectively hamstrings the affected party’s ability to negotiate with other suppliers/customers, as the cost of granting any kind of concession or sweetener to make a deal happen has to be multiplied by the cost of also granting it to your ‘most favoured nation’. In cases like this, the existence of one or more of them in your contracts can make it nearly impossible to keep a cap on your costs.
Similarly, the idea of advance payments combined with a choice of payment measure is a no-go. Sure, suppliers might wish to be paid a share of your revenues, but they ought to be electing to pick either a safe option or a risky one, not getting the best of both worlds. If the Supplier fears that you might be unable to pay them in the future, then let them take advance payments and a fixed price. If however they want to share in your potential financial glories with a revenue share, then let them wait until you’ve made the money before they get paid it and don’t let them switch back to the safe fixed-price method only after seeing that you haven’t hit your targets.
… and get control of the deal early.
The simple lesson from the above? Remember how crucial the contracts that you sign are for your financial health. A contract isn’t just 42 pages of dense legalese, it’s the framework that sets out who gets paid what and when. Onerous clauses like those noted above can lock you into a position of perpetual loss making that you simply can’t earn you way out of.
So when you’re negotiating these kinds of deals, get a specialist technology lawyer (and maybe even an accountant if it’s critical) involved early to make sure that you keep the terms under control. Trying to minimise the costs of professional advice is a false economy, your lawyer can only do so much if you bring them in at the very end of the process to “check it all works”.
Get a specialist, get them involved early, and don’t get stung by the those clauses that sap your profits. All of the fancy video streaming in the world can’t get you out of a bad deal once you’ve signed it.
Raoul Lumb – 22 May 2015