Is SoundCloud Shutting Down?
And two other important questions about the company’s future
Since my SoundCloud piece from last week, a lot has happened. If you haven’t been following the story, there’s a good roundup by Sam Shead on Business Insider. I don’t want to reiterate the news you could read elsewhere but dive straight into three critical questions about SoundCloud’s future: Will the company shut down? Is it going to be acquired or will it get fresh capital? What is the strategy going forward?
Let’s go.
Will SoundCloud Shut Down?
If you followed the recent developments at SoundCloud closely, you likely have encountered users and journalists who fear a nearing exodus of the service. That, though, is highly unlikely. SoundCloud has somewhere between 70 million (a MIDiA research estimate) and 175 million (official figure) monthly active users. Even the number on the low-end still renders SoundCloud a reasonably large platform. This number alone is reason enough to be optimistic that, if worse came to worse, somebody would buy SoundCloud.
But its not the only reason. Many folks simply equate SoundCloud to Spotify, Apple Music and other subscription streaming services and assume its not competitive. But they overlook an important fact: SoundCloud’s heritage isn’t subscription streaming; it started as a creator-centric tool for music distribution. And it still is that service, even though it’s now also a subscription streaming service. As a result, it has a library of exclusive music like no other streaming or music service. In a market where differentiation isn’t easily achieved, that’s a unique asset.
Thus, I state with a high degree of confidence: no matter how SoundCloud the company fares in the upcoming months, SoundCloud the service won’t shut down anytime soon.
That said, all the chatter about a possible shutdown has some side-effects and those are worrying indeed. As I documented on Twitter, a fair number of SoundCloud users — both listeners and creators — entered panic mode. As a result, you can find many warnings floating around which tell people to download/backup their SoundCloud music. If this sentiment were to prevail, it would be really dangerous for the company.
The obvious problem here: SoundCloud depends on the creators’ trust. As I just explained, their content is SoundCloud’s major asset. If they were to stop uploading, fearing a shutdown, this would also quickly diminish SoundCloud’s usefulness to listeners. The result would be a vicious cycle.
Some fundamentals: Any platform business is (at least) a two-sided market. There is a supply and a demand side, and both are interrelated. One of the key challenges in the early stages of building a platform business, is to solve a chicken-and-egg problem: on which side should we I focus to scale successfully? While suppliers will usually go where their customers are, there won’t be any customers without sufficient supply.
If a company gets the first phase right and manages to grow, platforms can be great businesses. (In case your wondering why SoundCloud isn’t: it doesn’t have a proper business model in place.) The great thing about platforms is that they can immensely benefit from network effects, i.e. the value the platform provides to a user increases with the platform’s size. Those can be leveraged to create virtuous cycles which result in strong growth (Andrew Chen’s post about Uber’s virtuous cycle is always worth reading).
But this works both ways: If a platform loses the trust of users on one side of the market and usage/participation declines, this can break the network and set off the opposite effect. Thus, it’s worth to remember that platform owners are in the business of maintaining trust with all market participants. Particularly, if their platform isn’t clearly dominating its market.¹
For that reason it is not only reasonable but mandatory that SoundCloud declines the sh*t out of all shutdown rumors. Turning Chance the Rapper into a spokesperson with a high popularity among users was a smart move, too. Still, rumors and fake news often leave a mark in the public’s consciousness, even after being refuted. From New Scientist:
Back in the 1940s, researchers found that “the more a rumour is told, the greater is its plausibility”. They suggested this means that a rumour born out of mild suspicion can, by gaining currency, shift public thinking and opinion.
Maintaining the artist community’s trust better be high on SoundCloud’s priority list.
New Funding or an Acquisition?
Last Sunday, I wrote in my newsletter (emphasize added):
CEO Alexander Ljung re-emphasized in the denial that the company intends to remain independent. But it’s hard to see how this is anything but an attempt to not further hurt the valuation. At this stage, I consider an acquisition much more likely than a new funding round.
I have to admit: I wasn’t aware at the time that SoundCloud is in the process of raising a new funding round. It’s rumored to be around $250 million. While it didn’t particularly surprise me, I should have known.
Anyway, if the rumors are correct, this would be 2.5x the amount of SoundCloud’s failed funding round earlier this year. Which would present an expression of confidence by SoundCloud’s management in their ability to close this round (I should note that the reports didn’t mention the valuation at which it tries to raise the capital). As I’ve been less optimistic, it’s worth to ask where their confidence comes from — and to reevaluate my assessment.
Let’s start with the obvious. The job cuts profoundly changed SoundCloud’s cost structure. It has been reported that SoundCloud had to agree to the cuts as part of the $70 million credit line they secured earlier this year. Apparently, investors regarded SoundCloud’s spending as a major issue. The Business Insider piece contains some interesting numbers:
A Companies House filing shows that it spent €26.77 million ($28 million, £23 million) on wages and salaries in the year [editor: 2015]. That meant the average annual salary at the company hit €90,729 ($95,000, £77,000) in 2015 — up 19% on the €75,979 ($80,000, £65,000) average wage paid out to staff in 2014.
Even if salaries had remained stagnant since then (unlikely), the recent job cuts would translate to over €15 million lower annual cost. Because investors asked for that step, SoundCloud having executed it, certainly benefits their relationship. But it’s hard to see why it would, on its own, be enough to justify new investments. After all, the cuts were part of a past deal and SoundCloud already received the money for it (in the form of said credit line).
Thus, it comes down to two key questions:
- Is a further investment likely to result in significant growth?
- Can a further investment protect an earlier investment?
The reason why a VC fund starts to invest in a company is pretty straight-forward: the leading partner is optimistic that the company can allocate the capital in such a way that its value is going to multiply, preferably by many X’s. Once the VC can exit — usually when the company IPOs or gets bought — his investment will have multiplied as well.
The last bit is critical. Once you invested in a company, your money is stuck there until you can exit. Startups aren’t liquid assets (like, for instance, stocks are). You are in until you’re not. That’s why protecting your initial investment can be an important consideration in later investment decisions. While every investor hates to throw good money after bad money, there are situations when a new investment likely won’t result in 10x growth but can avoid more significant losses.
With that in mind, let’s look at SoundCloud.
Last week, I wrote at length about the theoretical potential of Soundcloud. I’m still convinced that, with the right strategy and enough time, SoundCloud could turn into a very good business. However, time is of the essence here. The company is nine years into its existence and, per any publicly available information, still not close to profitability. At some point, investors get impatient and want to exit, particularly if further exponential growth is doubtful. While there are some good signs that SoundCloud is finally making progress on the strategy front (more on that in a minute), I doubt that there is, at this moment, a credible growth story that’s compatible with the investor’s wish for an exit sooner rather than later.
What about protection, then? Before this years failed round, SoundCloud received a $70 million investment from Twitter at a $700 million valuation in June 2016. The valuation had, by the way, stagnated at that level since 2014 when the company successfully closed a $60 million Series D round. In its failed acquisition talks, SoundCloud reportedly tried to sell for $1 billion. That would have been a decent exit. However, it didn’t happen. Instead, Google was allegedly only willing to pay $500 million, while more recent rumors suggested SoundCloud’s potential price could go even as low as $250 million (which would roughly equal the total amount of capital it has raised so far). Clearly, SoundCloud’s valuation has spiraled downwards over the last year or so.
While investors would at least avoid severe losses at a $250 million price, nobody would be particularly happy with it either. Also, it’s now broadly believed that SoundCloud only has sufficient liquidity until the end of this year. It doesn’t particularly improve your bargaining position if everybody knows you have to sell. Under these conditions, it might cross an investor’s mind to invest for protection purposes.
Of course, this would require the investors to at least trust the company that it can stabilize its business (hint: significantly cutting costs helps). It would be even better if they thought an upswing was possible. Thus, if SoundCloud’s investors have reason to believe that the company can recover from its $250 million low-point in a reasonable timeframe — but not before the end of this year — they might invest.
So, is there a reason to believe that?
SoundCloud’s Strategy Going Forward
The widely-quoted TechCrunch article that initiated the entire “SoundCloud has only 80 days left” storyline also contained some interesting bits about the company’s plans going forward. From that piece (sorry to my newsletter readers who already know the quotes):
“In the all-hands, both sources say Ljung discussed SoundCloud getting back to its roots by prioritizing its open creator platform and the mid-tier Go subscription plan, rather than focusing on Go+ and the mainstream music of major record labels.
One source said Ljung explained that SoundCloud is not a giant streaming company and didn’t want to directly compete with the $9.99 plans like Spotify. Our other source said ‘the plan is to concentrate on the content where they don’t have to pay our part of the money to the labels.’”
Since these suggestions are pretty much in-line with my recommendations last week, I’m naturally inclined to be favorable. And I am! As I have explained in detail, SoundCloud’s best option is to focus on it’s strength — independent artists — and build the best possible platform for them.
I’m convinced that it will take further innovation in the business model domain, but Ljung’s leaked quotes suggest that the company has set the right focus. And his latest public statements at Berlins TOA conference support that reading, too:
Looking ahead, Ljung said SoundCloud will put more of a focus on the creators that upload content onto its platform. “We’re going to be doing less things that other people are doing and more things that are completely unique to what SoundCloud can do because of the creators and the content,” he said.
Talk is cheap and so far Ljung’s statements are little more than lip service. But at least he speaks the right words. If the company executes on them, it’ll move in the right direction.
Predicting investor behavior isn’t easy, particularly from the outside where one naturally is at an information deficit (thus, take my next words with a grain of salt). Still, I’ve come around on my thinking about the likelihood of a new funding round for SoundCloud. I think it’s going to happen — except if a buyer shows up very soon and is willing to pay significantly more than the alleged $250 million.
But if it happens, it’s going to be a round with the goal to protect earlier investments. Therefore, I still stand by the general reasoning that led me to my former statement: even if it doesn’t happen this year, SoundCloud’s most likely mid-term future is being acquired.
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¹ Market-dominating platforms can — by virtue of “owning” the demand side — control suppliers and dictate terms to them. So their major concern needs to be staying the preferred solution on the demand side. The most dominant platforms further manage to build infrastructure that can’t be easily replicated and becomes essential to the market participants. Arguably though, nobody in the music market is even close to being in that position.¹
