I”m an experienced veteran in the digital media business and thought I”d share my version of events that happened at YouTube. Some of this is based on talks with people involved and some is speculation based on my experience working in the industry, negotiating settlements and battling in court.
In the months preceding the sale of YouTube the complaints from copyright owners began to mount at a ferocious pace. Small content owners and big were lodging official takedown notices only to see their works almost immediately reappear. These issues had to be disclosed to the suitors who were sniffing around like Google but Yahoo was deep in the process as well. (News Corp inquired but since Myspace knew they were a big source of YouTube”s traffic they quickly choked on the 9 digit price tag.) While the search giants had serious interest, the suitors kept stumbling over the potential enormous copyright infringement claims that were mounting.
YouTube knew they had an issue and had offered a straight revenue share deal if the complainants would call off the dogs and give them time. The media companies quickly rejected this path for two reasons. First off YouTube wasn”t making any money and was fuzzy about how they would generate revenue in the future. But more important the media companies view is that there was a mountain of past infringement that YouTube had engaged in and built their business on and they felt they deserved some of this accumulated value. And who could blame them. In spite of the media “user generated” puff pieces it was clear to all involved that they generated that content by hooking up their TV tuner cards to their PCs.
It didn”t take a team of Harvard trained investment bankers to come up with the obvious solution and that is to set aside a portion of the buyout offer to deal with copyright issues. It”s not uncommon in transactions to have holdbacks to deal with liabilities and YouTube knew they had a big one. So the parties (including venture capital firm Sequoia Capital) agreed to earmark a portion of the purchase price to pay for settlements and/or hire attorneys to fight claims. Nearly 500 million of the 1.65 billion purchase price is not being disbursed to shareholders but instead held in escrow.
While this seemed good on paper Google attorneys were still uncomfortable with the enormous possible legal claims and speculated that maybe even 500 million may not be enough – remember were talking about hundreds of thousands of possible copyright infringements. YouTube attorneys emphasized the DMCA safe harbor provisions and pointed to the 3 full timers dedicated to dealing with takedown notices, but couldn”t get G comfortable. Google wasn”t worried about the small guys, but the big guys were a significant impediment to a sale. They could swing settlement numbers widely in one direction or another. So the decision was made to negotiate settlements with some of the largest music and film companies. If they could get to a good place with these companies they could get confidence from attorneys and the ever important “fairness opinion” from the bankers involved that this was a sane purchase.
Armed with this kitty of money YouTube approached the media companies with an open checkbook to buy peace. The media companies smelled a transaction when YouTube radically changed their initial ”revenue sharing” offer to one laden with cash. But even they didn”t predict Google would pay such an exorbitant amount for YouTube so when YouTube started talking in multiples of tens of millions of dollars the media companies believed this to be fair and would lock in a nice Q3/Q4. [Note to self: Buy calls on media companies just prior to Q3/Q4 earnings calls.] The major labels got wind that their counterparts were in heated discussions so they used a now common trick a “most favored nation” clause to assure that if if a comparable company negotiated a better deal that they would also receive that benefit. It”s a clever ploy to avoid anti-trust issues and gives them the benefit of securing the best negotiating company. They negotiated about 50 million for each major media company to be paid from the Google buyout monies.
The media companies had their typical challenges. Specifically, how to get money from YouTube without being required to give any to the talent (musicians and actors)? If monies were received as part of a license to YouTube then they would contractually obligated to share a substantial portion of the proceeds with others. For example most record label contracts call for artists to get 50% of all license deals. It was decided the media companies would receive an equity position as an investor in YouTube which Google would buy from them. This shelters all the up front monies from any royalty demands by allowing them to classify it as gains from an investment position. A few savvy agents might complain about receiving nothing and get a token amount, but most will be unaware of what transpired.
Since everyone was reaching into Google”s wallet, the big G wants to make sure the YouTube purchase was a wise one. YouTube”s value is predicated on its traffic and market leadership which Google needs to keep. If they simply agreed to remove all unauthorized content and saddle the user experience with ads YouTube would quickly be a skeleton of its prior self. Users would quickly move to competing sites. The media companies had 50 million reasons to want to help. Google needed a two pronged strategy which you see unfolding now.
The first request was a simple one and that was an agreement to look the other way for the next 6 months or so while copyright infringement continues to flourish. This standstill is cloaked in language about building tools to help manage the content and track royalties, some of which is true but also G knows that every day they can operate in the shadows of copyright law is another day that YouTube can grow. It should be noted that Google video is a capable YouTube competitor with the ONE big difference being a much more sincere effort to not post unauthorized works – and Google fully appreciates what a difference that makes. So you can continue to find movie clips, TV show segments and just about every music video on YouTube today.
The second request was to pile some lawsuits on competitors to slow them down and lock in YouTube”s position. As Google looked at it they bought a 6 month exclusive on widespread video copyright infringement. Universal obliged and sued two capable YouTube clones Bolt and Grouper. This has several effects. First, it puts enormous pressure on all the other video sites to clamp down on the laissez-faire content posting that is prevalent. If Google is agreeing to remove unauthorized content they want the rest of the industry doing the same thing. Secondly it shuts off the flow of venture capital investments into video firms. Without capital these firms can”t build the data centers and pay for the bandwidth required for these upside down businesses.
There are some interesting chapters yet to unfold. One is how much of this will become public. Google is required by the SEC to disclose material financial developments at their company. Working in Google”s advantage is their enormous market capitalization and revenues will give them considerable leeway to claim that a 50 million transaction is not significant to their business. If the other video sites have the wherewithal to put up a legal fight any decent attorney will demand access to YouTube acquisition documents. Expect a claim of collusion between Google and the media companies as a defense strategy.
Infringement lawsuits will be served on YouTube and the new proud parent Google in the coming months. Google will respond with two paths: an expensive legal fight or a quick and easy settlement with most choosing the latter. Are there any larger copyright holders such as music publishers, movie studios, or unlicensed record label EMI that put up a fight rather than accepting the check? We”ll have to watch and find out.
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