Government Assistance to Industry

Memorandum submitted by UK Music

About UK Music

UK Music is the umbrella organisation which represents the collective interests of the UK’s commercial music industry - from artists, musicians, record producers, songwriters and composers, to record labels, music managers, music publishers, and collecting societies.

UK Music consists of: the Association of Independent Music representing 850 small and medium sized independent music companies; the British Academy of Songwriters, Composers and Authors with over 2,200 songwriter and composer members; the BPI representing over 440 record company members; the Music Managers Forum representing 425 managers throughout the music industry; the Music Producers Guild representing and promoting the interests of all those involved in the production of recorded music – including producers, engineers, mixers, re-mixers, programmers and mastering engineers; the Music Publishers Association, with more than 250 major and independent music publishers representing close to 4,000 catalogues; the Musicians Union representing 32,000 musicians;

PPL representing 42,000 performer members and 5,000 record company members; and

PRS for Music representing 70,000 songwriters and composers and music publishers.

Government-backed loan guarantees and the UK’s music sector

Executive Summary:

UK Music welcomes the BIS Select Committee inquiry into Government Assistance to Industry. The evidence we submit demonstrates that the obstacles that music sector SMEs face in accessing finance amount to a market failure, and that Government assistance designed to stimulate the flow of finance to SMEs is still not reaching our sector.

"Difficulties in raising finance are affecting the ability of the music business to grow and prosper. Particularly worrying is the evidence……of a growing trend in recent years, of a lack of confidence in accessing external finance."

· So said "Banking on a Hit," published by the Department for Culture, Media and Sport in 2001. Words which resonate just as loudly today as they did almost ten years ago.

· In the intervening years it would appear that the inability of music industry SMEs to access finance has now become an established and increasingly entrenched obstacle and one which has intensified over recent months as the global financial markets have attempted to re-stabilise.

· For many music industry SMEs, access to finance might now be described as a systemic and worsening problem, the consequences of which will not only be detrimental to the music industry overall but to the UK’s economy more broadly.

Economic context

1. The UK’s music industry is a valuable cultural and economic national asset. The UK music industry was worth around £4 billion in 2009. [1]

2. The invisible earnings and additional value created by music is potentially immense. Music has driven the growth of digital services like high speed broadband and digital devices like iPods. Music also feeds a host of business that work directly with music such as film, television, games, advertising and fashion, which quite simply, would not be what they are without music.

3. Likewise, music inescapably, intrinsically and advantageously impacts upon the tourism, leisure and hospitality sectors. An ever increasing number of people both within the UK and abroad are choosing to spend their holiday money within the UK attending music events and festivals. Live music in the nation’s vast array of music venues and festivals each year attract visitors from all over the UK, Europe and the rest of the world.

4. The O2 arena in London, for instance, since opening has already attracted 12 million visitors and is now the largest ticketed entertainment venue in the whole world. The Cavern Club is at the centre of Liverpool’s tourist trade and draws in half a million visitors each year. Glastonbury festival annually accounts for approximately £73 million in spending, £36 million of which is spent directly within the local economy.

5. In absolute terms the UK is the third largest music market in the world while in relative terms, we are the largest. Per capita we purchase and consume more music than any other country in the world while the UK ranks second only to North America in the league of nations who are net global exporters.

6. Latest industry figures show that the UK music industry bucked the global downward trend in 2009 with a return to growth. [2] Added to this background is the prospect that the digital marketplace opens up further growth with the development of new music services, wider markets, and faster distribution.

7. As the industry continues to realise the potential value of music in the digital marketplace and live music continues to expand outwards from London, the ability to access finance becomes even more crucial. The innovators and entrepreneurs from our sector need to be able to finance their ambitions of tomorrow.

Music and access to finance: a structural problem

8. In this section we provide our analysis as to why our sector’s difficulties in accessing finance is a structural problem and not a transitional one.

9. The music industry is characterised by a very small number of large corporate organisations, and a very large number of small organisations. This remarkably diverse mix of company structures sustains a vast array of talent.

10. The signature of many of these companies is the long-term development of their relationships with their artists, to support, to nurture, to sustain an artist’s career and therefore the company prospects over a long periods of time. What these SMEs achieve is to create steady employment and the continued production of IP assets and creative goods. Sustainability is key. The thousands of small yet steady musical enterprises for whom rapid growth is not an immediate priority form the backbone of the UK’s music industry.

11. In reality the majority of record companies working within our sector would employ less than 10 people. By way of example a recent survey of the 850 companies who make up the membership of the Association of Independent Music showed that the average employee headcount was two people per company.

12. Size has a strong bearing on the ability of a firm to access to finance. The Association of Chartered Certified Accountants says that, "the financing of small businesses is manifestly different from that of large businesses…there have been persistent concerns that the finance markets do not always fully meet the needs of small firms who can find it harder than large firms to acquire finance that is accessible, appropriate and affordable." [3]

13. If only because of their large numbers of small firms, the creative industries may therefore experience greater difficulties in accessing funds.

14. To compound matters, small music firms face additional challenges to those SMEs in more traditional sectors because of the intangible quality of their assets.

15. While many other small enterprises may trade on intangible assets, such as graphic design or consultancy services, the value of a cultural good can only be approximated in hindsight, that is, after the music has already been created, recorded, released and promoted. The Work Foundation report into the economic performance of the UK’s creative industries refers to this underlying problem of market uncertainty as the ‘nobody knows anything’ scenario’. [4] Other sectors trading in intangible assets would be less exposed to the vagaries of personal taste as those trading in cultural goods, and so are able to tabulate and valuate their assets more predictably.

16. The CBI recently published a blueprint for the creative industries in which it acknowledged that "the unpredictability of consumer reactions can make it difficult to gauge the success of a product before its launch. This can affect access to finance for creative businesses." [5]

17. There are further knock-on effects. The loan applicant’s track record is an important criteria that bankers use in making lending decisions. It is likely that many small firms and entrepreneurs in the music business will have ‘misses’ for every hit. In more traditional industries, such a chequered track record might reasonably serve as a warning against further investment. In the music industry, such a record is the norm and is a less reliable an indicator of risk.

18. One way that banks can mitigate their exposure to uncertainty and risk is by demanding security against assets. However, for many creative businesses, the firm’s assets are intangible, tied up as they are in copyrights. Their value can be difficult to gauge at any one point in time, as the value of copyrights can fluctuate. While the income from a few back catalogues have maintained a consistent value over many years, most are less constant. Indeed, the value of a copyright in a piece of music can suddenly rocket in value, for example, if a piece of music is used in a popular film, television series or commercial.

19. These characteristics of our sector – the ‘no one knows’ factor of a cultural good, an inconsistent producer track record, difficulty in valuing IP assets and offering security – all conspire against our sector over and above those experienced by other SMEs in terms of obtaining finance from banks. This is partly because the standard criteria used by banks to assess loan applications cannot usefully gauge whether a proposition represents a reasonable level of risk in our sector. The error will therefore almost always be on the side of caution.

20. While the music industry has reported difficulties in accessing finance for many years, the problem appears to have become even more exasperated of late. Several reasons account for this. First is the global downturn.

21. Industries with large numbers of small firms tend to suffer particularly severely in cyclical downturns according to a number of studies. [6] In a letter dated 11 August, the Governor of the Bank of England observed "many businesses have had difficulty accessing bank credit…these appear to have been most testing for small and medium sized firms for which bank lending is a particularly important source of finance." [7]

22. The CBI also conclude that "the recent credit crisis has added to the already difficult task of securing traditional sources of funding, reducing further the finance options available for the [creative] sector." [8]

23. Certainly our own research and experience confirms that the difficulties that small music firms report in accessing finance have intensified during the global downturn.

24. Secondly, the music industry is in the midst of significant structural change. One result of this change is that the internal investment model that sustained the music industry in the past is no longer a viable option.

25. To put this in context: historically, there has been an internal investment model within the music industry. Entrepreneurial individuals have started bands, management companies, publishing companies and record labels with personal money or personal borrowing; and been prepared to reinvest profits into their businesses.

26. Music businesses have also invested in each other, with established companies using their knowledge of the key indicators of success in the music industry to invest in artists or in other small firms. This has provided both equity and debt finance, as well as management support. For example, small record companies have used advances against future income from their distribution companies or collection societies to provide working capital, and have entered into joint ventures or other equity deals with major labels and large independents in order to grow.

27. Record companies used profits from the record sales of their most popular acts to reinvest in new talent, so the cycle continues. For composers and songwriters, the situation was similar.

28. However, liquidity for an internal financing model has all but disappeared. Record sales are down nearly 30% from 2004 levels. Sales of digital music and online music services have grown but the revenues generated from digital sales have not made up the shortfall. The live music sector has also grown, but revenues generated from live concerts and festivals do not get reinvested in nurturing a new raft of talent. Concert promoters and organisers do not "sign" new talent or give out advances, as that is not their function. The result is less revenue to go around for investment in new talent.

29. Today, record companies and music publishers are still the primary investors in new music. But they are not able to invest in as many new musicians, and the pressure to back those hopefuls who are most likely to generate a return is considerable.

30. This raises questions about how those that might be termed "experimental" or cutting edge can get the opportunities they need. It also raises questions about how those who are just starting out can get the nurturing they need, as well as ongoing support for those who are able to sustain steady careers.

31. Stepping up into the frame are thousands of small record labels, publishers, band managers, promoters and agents. These small enterprises do not have the ability to negotiate with the major music retailers (such as Tesco) and broadcasters, and so are more likely to pursue alternative approaches to marketing and distribution in order to promote their roster. While there is much innovation, the ability of these entrepreneurs to finance their initiatives is a serious stumbling block.

32. Obtaining finance is particularly difficult when sums of finance required are too low to be of interest to venture capitalists, but deemed too risky to be of interest to high street banks. Music enterprises seeking relatively small amounts of finance, either to ease short-term cash flow issues, or to finance a venture, are finding themselves unable to get the finance they need. This appears to be the case generally, even for those who have demonstrated great entrepreneurial flair in the past, who have a good credit history, and a solid business plan with credible revenue projections.

33. This combination – historical difficulties in accessing finance, exacerbated by more recent developments – is leaving many in the music sector unable to access finance. The current situation is unsustainable.

Government-backed assistance in the form of the EFG

34. The Enterprise Finance Guarantee seemed the perfect finance vehicle to address the difficulties of the music industry in accessing finance. In announcing the money at the start of the scheme in 2008, the European Investment Bank said it would be designed for SMEs throughout Europe to "help them weather the global financial storm." The new loans were to be channelled through existing commercial banks , with the aim of being "simpler, more flexible and more transparent, making it possible to reach a greater number of European SMEs." [9] As the creative industries account for 2.8% of the GDP of Europe, this sector anticipated sharing in this lifeline.

35. In January of 2009 the UK Government announced that the funding would be made available via the new EFGS. Upon initial inspection the EFGS would appear to have been the answer to the historical funding issues within the industry yet this has not provided to be the case. Government also specified that the scheme should be open to artists and songwriters.

36. UK Music investigated the extent to which music enterprises were able to access loans under the Enterprise Finance Guarantee through a survey of our members. We learned that many companies had applied for a loan under the EFG but were turned down. Only one business was offered a loan under the EFG (and only on the condition that the applicant’s primary residence was provided as security against the loan).

37. The difficulties experienced by our sector with respect to the EFG have been recognised recently by the CBI. CBI President Helen Alexander [10] said: "Music, films and books are not seen as safe bets – and so don’t attract investment from banks keen to reduce their exposure to risk. The Government’s Enterprise Finance Guarantee Scheme is meant to help alleviate this, but evidence on the ground from CBI members suggests this isn’t the case... "

CASE STUDY: EFG AND ATC MANAGEMENT

The EFGS is proving inaccessible to applicants from the music sector. ATC Management have run a test case with ‘the Rifles’, applying to every high street bank for a loan for working capital to allow them to record and tour their new album. The EFGS is specifically for viable plans from small businesses without sufficient access to capital to secure their loans. The criteria explicitly include songwriters and artists, and should be the idea vehicle for debt financing in music – but in practise there are no banks willing to back our businesses.

The Rifles, artists managed by ATC Management (management company of well known artists Radiohead and Kate Nash) have applied for an EFG-backed loan of £200,000 to cash flow their second tour and album.

Their proposal is based on a track record of a successful first album and a national tour of venues of 1000-2000 capacity.

Their applications have been presented by ATC director Brian Message. Brian is a chartered accountant and chairman of the trade body for artist managers the Music Managers Forum. He has successfully applied for the Small Firms Loan Guarantee scheme for music businesses in the past. Another business which Brian owns a stake in has obtained an EFG-backed loan. This was not, however, a creative company.

When the EFGS was opened to own-account artists, Brian decided to apply as a test case, hoping that this would be of benefit to managers of other artists with viable businesses who require debt finance to cashflow their businesses.

Over the last 8 months, Brian has applied on 8 occasions to a number of the high street banks for funding for the Rifles business including HSBC, Lloyds, RBS and Barclays. All have been refused an EFG-backed loan for different reasons.

The banks "would offer an EFG-backed loan for a domino’s pizza franchise", or "would take a charge over the property of the directors of the management company", but will not lend to a viable small business in the music industry without security. Even an offer of a deposit of £50,000 (25% of the loan amount) thereby providing the bank with an 100% security when added to the EFG was rejected.

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There is frustration in the music sector that the EFGS is effectively closed off to music companies.

The lack of data to inform the effectiveness of Government assistance

38. There is no lack of evidence of the difficulties in accessing finance from the demand side. [11] What is lacking is statistical evidence from the supply side. However useful and illuminating case studies from our sector are, we need information from lenders, not just borrowers.

39. UK Music sought to obtain data from across a range of lenders in order to aggregate lending statistics, so that comparisons could be made and the results analysed. For instance, we wished to see how many loan applications or overdraft requests have been made by music businesses, how many were granted, the total value of finance made available to music businesses over a given period, and the rate of default. We wished to compare these statistics for music businesses versus statistics for SMEs as a whole.

40. UK Music approached the largest high street banks (Barclays, Lloyds, Santander, HSBC, NatWest) to enquire whether they keep statistics about their lending on a sector basis. However, these banks were not able to disclose whether or not they keep such statistics.

41. UK Music maintains that such data is essential in order to establish whether lending patterns have changed over time, and assess whether music businesses or other IP based firms experience difficulties over and above other sectors.

Conclusions

42. Government have a duty to ensure that all business sectors of the economy are able to access appropriate sources of finance. This is a basic requirement for any functioning economy.

43. Difficulties in accessing finance have plagued our industry for the best part of a decade. This is primarily due to the specific characteristics of our industry that lead banks to judge lending to our sector as too risky.

44. The difficulties faced by the music sector in accessing finance have intensified in recent years. The economic downturn has resulted in banks tightening up their lending criteria further, and structural changes within the music industry have resulted in the disappearance of an internal financing model.

45. The UK’s music sector is a cultural and economic asset with a global reputation. The potential for growth is strong as the digital economy continues to develop. Music also has a significant role to play in driving tourism as live music continues to grow.

46. The music industry will be unable to meet its ambitions for growth unless it is able to access appropriate sources of finance. Government assistance to industry, through loan guarantees such as the Enterprise Finance Guarantee, has so far failed to reach our sector.

47. Data that could help Government target its assistance to industry better and assess its effectiveness, such as aggregated lending statistics by sector, is patchy or nonexistent.

48. The Government’s review into sources of finance, led by the Treasury, presents an opportunity for Government to correct this serious market failure.

15 September 2010