Music Start-Up Takes on Apple's iTunes

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LOS ANGELES (TheStreet) — The scarcity of venture capital is forcing start-ups to take bold steps to raise money. The digital music start-up Masterbeat.com, which specializes in new dance mixes, decided to go public only 14 months after launching.

The Los Angeles company started trading on the Over-the-Counter Bulletin Board this week through a reverse merger with Green Mountain Recovery, a debt collection company that Masterbeat bought and spun off as a private entity. It's an unusual way to access the market, especially for a company that didn't set out to become publicly traded.

Check out Masterbeat's Mad Money music mix

"I don't think we envisioned that we'd become a public company," says Masterbeat Chief Executive Brett Henrichsen, a dance club DJ and former marketing executive at IBM. He quit Big Blue after discovering there was a market for the dance CD compilations he was creating for his friends, and founded the Masterbeat brand in 1996. But it takes months to bring a CD to market, and eventually Henrichsen realized that the short attention span of the dance club audience didn't mesh with physical music distribution.

"Dance music is very timely," he says. "It's only a hit for a little while. I could see that I was going to have to reinvent or die."

He revamped Masterbeat as a digital music distribution site similar to Apple's (Stock Quote: AAPL) iTunes. He secured seed funding from New York attorney Jon Biondo, and the two of them launched Masterbeat.com in 2008.

Striking distribution deals was a challenge at first because major labels had typically created remixes to promotion the original versions of songs. "The labels didn't understand anything anymore from a technology standpoint," Henrichsen says.

Within months, the team convinced the big guns that a small player like Masterbeat could bring new dance music to the public faster than a giant like iTunes. Masterbeat.com now has deals with Vivendi's Universal Music, Sony Music (Stock Quote: SNE), EMI Group and Warner Music Group (Stock Quote: WMG). Warner gave the company exclusive digital distribution rights for several Madonna remixes. Download revenue doubled in 2009.

It all sounds like a great pitch for investors, but in terms of securing venture funding, Masterbeat's timing was bad. Venture capital firms raised the smallest amount of funds in 15 years in the third quarter of 2009. And while a recent survey of venture capitalists showed that the majority expect an increase in late-stage funding in 2010, fewer predict an increase in funding for start-ups.

"Everyone got extremely cautious, and things just dried up," Henrichsen says. "You had to be profitable and growing before they would look at you, but why would we be looking for funding if we were profitable?"

A reverse merger seemed like a logical way to raise funds without having to pitch to individual investors. The process has helped the firm attract seasoned executives to its board, including Dick Wingate, an industry veteran who oversees the East Coast operations of the music consulting firm TAG Strategic; Ted Green, CEO of China MediaExpress Holdings (Stock Quote: CCME), which runs a TV advertising network on Chinese buses; America Online (Stock Quote: AOL) executive Malcolm Bird; and Richard Rowe, who previously ran Sony's music publishing arm. Rowe's father, Dick Rowe, was famous for signing the Rolling Stones — and infamous for turning down the Beatles.

"We're light years ahead of iTunes in terms of the way we display our catalog," Henrichsen says. "But we haven't had the working capital to tell the world we exist."

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