Business

Is Another Tech Bubble Forming Around Music Streaming?

Money bags
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Some of the most well known venture capitalists have sounded an alarm over the state of startups in the United States. Put simply, they think startups' burn rate -- the amount of cash used in excess of cash received -- points to a high level of risk.

Bill Gurley, a partner at Benchmark Capital, told the Wall Street Journal that the burn rate at the average, venture-backed company in Silicon Valley is the highest since 1999, and more people in Silicon Valley are working for more money-losing companies than since 1999.

"I think that Silicon Valley as a whole, or that the venture-capital community or startup community, is taking on an excessive amount of risk right now -- unprecedented since '99," said Gurley, whose firm has invested in such companies as Instagram, Zynga and Zillow.

Venture capital creates something like an arms race. Gurley explained that startups in a competitive market are raising large amounts of money and increasing their burn rates in order to spend that money. He believes startups have the implicit approval of investors to behave in this way: a startup will see the funding and spending of other startups, believe it should spend more money, and receive additional venture capital that allows it to increase its burn rate. It's a vicious cycle.

Fred Wilson of well-known investment firm Union Square Ventures agrees. In a post at his blog, A VC, Wilson calls burn rates among U.S. startups "sky high" and says his firm's portfolio "is not immune to it." Union Square has backed such companies as SoundCloud and Kickstarter, although neither was mentioned in Wilson's post.

Investors need to demand more from companies with high burn rates, Wilson says. "At some point you have to build a real business, generate real profits, sustain the company without the largess of investor’s capital, and start producing value the old fashioned way."

Music startups should be part of this conversation. Digital music is a notoriously treacherous endeavor that requires significant investment and a willingness to endure heavy losses. And yet hundreds of millions of dollars have flowed to companies attempting to disrupt the market for music consumption.

Financial information, although scarce, shows that these companies continue to lose money as they grow. Pandora, a publicly traded company, lost $11.7 million on revenues of $218.9 million in the second quarter. Rhapsody, the on-demand streaming service, posted a loss of $4.7 million on revenues of $42.4 million in the second quarter. Aspiro Group's music service, WiMP, lost $1.5 million on revenue of $6.9 million in spite of having 580,000 paying users.

Spotify, the largest music subscription service, is also losing money. In 2012, the latest year financial results are available, Spotify lost $80 million on revenues of $434.7 million, according to PrivCo. The company announced in May it had 10 million subscribers and 40 million monthly users worldwide.

The situation is not totally hopeless, however. Music streaming services are growing. Consumers are warming to the concept of paying to access music. And the products are continuously improving. Today's subscription services are far better than products available just 2 or 3 years ago, and they're light-years ahead of the offerings a decade ago. With growth comes a better chance to eventually, some day, turn a profit.

The pressure to burn cash should be obvious. The music streaming market is far from maturity. The products are also far from maturity. Consumer penetration has a long way to go. Any music service that de-prioritizes growth will cede market share -- in a growing market -- to a laundry list of competitors.

But one has to wonder how long the losses can last -- not just with music startups but with all venture-backed companies. How long will investors put money into money-losing operations? Not forever, according to Gurley. "No one's fearful, everyone's greedy, and it will eventually end."