In my first few months at Venrock, I have seen many music deals. I’m happy that entrepreneurs and existing digital music companies have sought me out to look at their companies. The unfortunate truth, however, is that we are unlikely to invest in many music companies in 2009. Here’s why.

The digital music business is not an attractive sector for VCs and investors in general. This is largely due to the economics of the underlying licensing deals. The great mistake the major labels made was to set licensing terms in punitive ways, treating start-ups as predators instead of partners. They still have not realized that they must innovate their way back to consumer relevance. The best way to do that is to partner with leading entrepreneurs. If they treated these relationships as partnerships, they would have set terms which allowed joint business success. But voluntary licenses never allowed for that, and as a result, I can think of only two or three digital music business (out of hundreds) which have built actual businesses on top of licensed music (iTunes, eMusic & Rhapsody — note Pandora is successful but does not depend on voluntary licensing.). Even sadder, the best entrepreneurs have moved on. I have seen dozens of great pitches in the past few months and none are around music.

I don’t expect this reality to change in any meaningful way in 2009. The record labels and publishers need a generational shift in their management teams and a drastic alteration to their compensation structures to encourage risk-taking, investment in new businesses, and allow for cannibalization of their existing, declining business. They need to embrace come-one, come-all licensing, offer simple, transparent and equitable licensing without demanding arbitrary advances and guarantees. Otherwise, the only businesses which reach scale and are interesting to consumers will be the infringers (like Project Playlist) which we’d never fund as infringers.

I honestly hope this all changes. I still believe there are far more interesting digital music services that consumers would support, but there is little incentive for great entrepreneurs to build them.