Looking at DRM through a Non-CRAP Prism

The focus on digital rights management software not should be viewed only through the prism of greedy copyright owners playing digital dictator. True enough, there are numerous well founded gripes about the state of DRM and the patchwork of control mechanisms that frustrate and undermine the enjoyment of many a title (see ZDNET’s editor talk about DRM as “CRAP.”) However, the overall concept of managing rights through hardware as opposed to business models may warrant frank discussion. In particular as the traditional theatre to DVD/ancillary trajectory is compressed and challenged (when was the last time you were eagerly awaiting the arrival of the DVD after seeing the move in theatres?), the role of DRM becomes critical.

Where the consumer has the final say on the how's and when's of seeing a movie through various home devices, DRM may play a pivotal role in shaping that culture. For the economics of such a system to work the provision of content cannot be utterly unrestricted. It is important to recognize that the content industries cannot simply TIVO or DVD everything without going bankrupt. Yet with the promise of video on demand through the Internet, TIVO, etc., that is exactly what is happening.

In the absence of limitations imposed by business models, DRM may fill the void. For example, as release windows shrink, experiments with overlapping windows must rely on DRM. A release window with an unrestricted DVD simultaneously available with the film in theatres would likely result in a zero sum game. The DVD would likely sap the theatrical release of viewers. However, a theatrical release in conjunction with a restricted DVD, one that plays for only a week, can exploit two distinct audiences and promote the film for subsequent releases, such as pay TV and unrestricted DVD's. In addition, the appeal and price point of an unrestricted DVD will be preserved allowing consumers who want that experience the opportunity to have it.

This concept has attracted the interest of groups other than the industry juggernauts typically associated with DRM, such as Sony and Microsoft. The UK Film Group, for example, has recently opined on the close relationship between DRM and the changing world of film distribution. They argue for a deep exploration of DRM's application in the future. Hopefully they have a balanced approach that can serve as a real model.

Preferred Notes and Profit Participation Versus Equity

Financing for small companies is always a challenge. Among the many dilemmas faced by entrepreneurs is the prospect of allocating equity to investors. With a brand new baby business, many feel their only choice is to throw the baby with the bath water out to whomever will give them money. This often means disproportionate partnership interests being given to relatively small investors. Worse still, the entrepreneur has not planned for the future, resulting in a "crowding" out of potential future investors.

It is here that the entrepreneur must distinguish between "equity" and "profit participation." When an investor is given equity, for better or for worse, that investor has rights that only someone with an ownership stake can get. For example, they may get voting rights at one end of the spectrum, or full blown managerial rights at the other end. This can be a very difficult scenario, especially for the entrepreneur who gave multiple small investors such rights. Consider the difficulty encountered with dealing with such investors if the company needs emergency cash infusions, or worse, the company needs to fold.

Instead of giving away partnership interests which entail equity or actual ownership, an entrepreneur may consider extending preferred notes to such small investors. With a preferred note, the entrepreneur can give an investor a return on his investment in the form of interest, without making them a partner. Moreover, since the note is preferred, you can give the investor a modicum of security by agreeing to subordinate other debts to theirs. Secondly, the note purchase agreement can provide the investor with a profit participation as opposed to equity. This essentially means that if the company makes money, the investor will get some percentage of that. On the other hand, that's the extent of the investor's right--they do not get any managerial rights or percentage of any losses. In addition, the notes can be made part of a series, whereby a group of investors sign on to the same purchase agreement and receive roughly the same note. This is critical to avoid a patchwork of rights and obligations.

One should not rush to give friends, family, or investors significant stakes in your company without real sums of money in return. Consider notes instead of an equity stake. So now when the investor that wants the moon and the stars approaches you with money that you can't afford to turn down, you may be able to counter with just the moon.