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Imeem Gets License And Death Sentence

The press recently gushed over Imeem signing a deal with Universal Music Group -- the last of the four major labels to grant them a license to stream complete songs to visitors to their popular web site. The NYT said, "..[it] might be the breakthrough the music industry needs." Far from a breakthrough, it is a death sentence for Imeem. Under a dark cloud of looming lawsuits, Imeem entered into a crushing financial agreement that allows them to survive as long as venture capital money continues to flow into the company, but spells almost certain financial calamity once outside funding halts. Reporters classified the deal as a "license" with "advertising revenue sharing", implying it is a new structure from the labels. A more accurate description would be an ownership position with substantial upfront payments, plus required ongoing payments regardless of revenue generated by Imeem. To put it another way, it is the same onerous deal labels have foisted on digital music companies for the last decade.

Here are some of the notable deal elements that I have been able to ascertain from my sources. First, Imeem had to give UMG shares in their company. They demanded an equity position which would not be dilutable. Normally, an equity stake in a company can be diminished if future financing (investment) takes place, but UMG demanded that they get more shares each time the company accepts new investment so their percentage ownership in the company remains the same regardless of what transpires in the future. Simply stated, UMG received a double-digit ownership in Imeem.

In typical "advertising revenue sharing" as the Imeem license is described, advertising revenue is collected and then split between the parties. For example Google's widely popular Adsense program splits the monies about 50/50. Half goes to Google and half to the website operator. Traditional business relationships are usually either a low fixed rate guaranteed payment or a higher percentage payment with no guarantees. Imeem's contract with UMG calls for payments of just under one cent per song play, regardless of whether there's any advertising that actually happens. That's not a revenue sharing relationship. However, Imeem's obligations go beyond that -- requiring more money if total web site advertising revenues (not just from their music) exceeds a certain number. Imeem must then pay even more money -- the higher of either the song plays fee or a percentage of ad revenue. While technically it has an advertising revenue sharing component, it is not a typical advertising deal where both parties share in the risk on both the upside and downside. In this relationship UMG wins regardless.

Finally, Imeem is obligated to give to UMG a $20 million prepayment. A prepay is an advance of monies from which future royalties are deducted. Imeem doesn't have $20 million because they have yet to generate substantial revenues from their business. Consequently, they paid a portion of those monies now and are required to pay the remainder in the near future. A portion of future financing monies will go to UMG. Imeem has similar deals with the other three labels (Sony/BMG, WMG and EMI). Since UMG is the largest, its numbers were proportionally larger than the other labels, but Imeem has prepayments or guaranteed minimum payments to all the labels.

A financial analysis of a royalties plus operational costs reveals that Imeem cannot ever turn a profit with this financial structure. Setting aside the large prepayments, online advertising revenues will not even cover the one penny-per-play song, much less the operational costs of running a net company, such as servers, personnel and bandwidth. (This is only slightly worse economics than webradio which will never be profitable for all the same reasons.) Candidly, Imeem personnel will say that their hope is to sell Imeem to a large conglomerate that desires the substantial traffic Imeem currently receives and is willing to overlook the underlying economics. While this "YouTube" strategy may experience fleeting initial success, it's no way to build a long-term viable company, and it is most certainly not a blueprint for a healthy partnership between labels and digital music companies.

You might be wondering why Imeem's executives would enter into such a dubious financial relationship. First, it is helpful to understand their business. Imeem is a social network site where users upload media files (audio, video and pictures) that are then made available to others to view or listen. Very quickly Imeem has grown a massive library of popular music and videos. Earlier this year, Warner Music Group sued Imeem claiming their business is illegal because that music is unlicensed. Fighting in court can take years and millions of dollars. During that period is it difficult, if not impossible, to raise more money because nobody wants to put money into a company just to watch it get drained away by attorneys. Rather than battle in court, Imeem decided to settle. Their analysis is they might overpay for a legal settlement, but with strong traffic growth and a top 200 web site they will find a suitor who will desire them. That party won't look too deeply at the economics or they can renegotiate the terms as the music industry changes in the years to come. But this way the deck is cleared of lawsuits and they can focus on growing their business.

As someone who has been in, and is currently in, a lengthy legal battle with record labels, I am certainly sympathetic. EMI is suing MP3tunes because they want to block consumers from putting music they own into their own personal locker. (If this is true, you should think twice about buying music because you don't truly own it.) There is no right answer to this dilemma. Until more legal certainty is brought to the digital frontier, companies will have two risky propositions: battle in court in a do-or-die situation (MP3tunes, Veoh, Divx, etc) or settle and shoulder a crippling economic burden that you can try to escape later but probably won't. A middle ground does exist: a true partnership between technology companies and music companies in which both companies share in the risk and reward, but Imeem is most certainly not that. It is not ground breaking -- it's just breaking.

--MR

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