Britain's complicated music royalty system is killing online innovation, according to one of the founders of internet radio service Last.fm.

Martin Stiksel, who helped oversee the $280m acquisition of the London-based music recommendation site by American media conglomerate CBS in 2007, told the Guardian that the situation was becoming increasingly problematic.

"Where we're standing, it's not only more complicated, but also more expensive," he said. "It's an absolute nightmare in the grand scheme of things. We are further away from a simple licensing model – the sort of thing FM radio has – than ever before."

Unlike traditional radio stations - which pay rates for the right to play music over the air, depending on the net revenue they make from advertising - for the right to play music over the air - websites that allow users to listen to music are subject to higher tariffs based on their gross income.

These payments must be negotiated and paid to those holding the rights, including record labels, music publishers and sometimes the artists themselves. Meanwhile, websites such as YouTube have negotiated flat fees to cover the royalties for any music with a UK copyright that users upload.

Stiksel believes that the increasingly complex rules and mish-mash of collection agencies have become so difficult to navigate that they could stifle innovation, killing new music startups before they have even begun.

"It wouldn't be that easy to start out again," he said. "Expectations are different now, and people want large compensation right from the start.

"To even be allowed to enter the club, you have to pay a fee. The space is radically changing all the time… but I can't see the fog clearing in the short term."

Last year the situation became so treacherous and confusing that US-based music service Pandora decided to stop offering its service to British users.

At the time, Pandora founder Tim Westergren said the rates demanded by record labels and music publishers were "far too high to allow ad-supported radio to operate", and that they were pursuing a course that was "nothing short of disastrous for artists whom they purport to represent."

Calls for a simplified system have gone unheeded by the British government: indeed, the communications minister, Lord Carter, recently announced plans that would further complicate the situation by creating another agency to oversee the enforcement of copyright.

In his Digital Britain report last week, Carter outlined his plan to create a rights agency to seek out and prosecute people who illegally downloaded music and films over the internet.

Despite concerns about the impact of the licensing regime, Stiksel said that growth at Last.fm had not been affected.

The site now boasts more than 25 million monthly users. Stiksel attributes some of this success to the sale to CBS and the subsequent redesign.

He said the website would continue to branch out in its search for new users. In addition to its mobile phone applications, Last.fm was working on building its software into other apps for home use.

The company has deals with sound equipment manufacturers Sonos and Logitech to incorporate Last.fm into their devices and more could be on the way.

"I can't go into details but… we are busily developing a couple of things to bring the Last.fm experience to new platforms," he said. "We want to be everywhere where people want to listen to music."