Seattle looks fantastic in the summer sunshine. The Emerald City, as it is now officially nicknamed, is surrounded by mountains. Every view features trees and water. Ferries to outlying islands cross the bay, and atop the Space Needle, the city's best-known landmark, a flag flies proudly, bearing the words “SUB POP”.

It marks 20 years since Jonathan Poneman and Bruce Pavitt, familiar as DJs and record store owners in a then tiny local music scene, turned Pavitt's occasional Sub Pop imprint into a serious set-up. The label broke out in 1988 with Touch Me I'm Sick, the glorious debut single by the local heroes Mudhoney. Overnight this overlooked town began to fascinate music lovers around the globe.

In the intervening years Sub Pop has released nearly 800 records of varying quality, introduced the world to Nirvana and grunge, flirted with bankruptcy more than once and now enters its third decade more successful (and profitable) than ever. At their own party, SP20, a festival featuring generations of Sub Pop acts and held in a country park in Microsoft's home suburb of Redmond, the founders ponder their achievement.

“It could have happened anywhere, but there was a lucky set of coincidences,” explains Poneman, a sleepy- eyed figure now pushing 50. “Charles Peterson [photographer] was here to document the scene, Jack Endino [producer] was here to record the scene. Bruce and I were here to exploit the scene.”

He must have used the line before, but such passive-aggressive humour instantly endeared this tiny company to cynical journalists. Pranking was part of their MO. They persuaded the giant Tad Doyle, in fact a college graduate, to pose with a chainsaw like a wild woodsman. Their records sometimes came in supposed limited editions of 500,000, mocking the collector's mentality even as they exploited it, famously persuading punters to subscribe to their Singles Club of rare 45s and coincidentally securing the label's cashflow. Their last anniversary bash in 2003 was promoted as “Sub Pop's 15th Anniversary - Ten Years of Great Music”.

“The isolation helped create a culture that didn't care about trends. People played for each other because they didn't expect to make a living,” says the bald and bearded Pavitt, vaguely monkish in demeanour, “Jimi Hendrix went to high school here and that was it for music.”

“It was a remote corner of the United States with loggers and fishermen and yetis,” adds Poneman. “In Seattle, there was no music industry infrastructure. No one thought they would make it. It wasn't an anti- career attitude, more a ‘what career?' attitude,” Pavitt says, “But the bands were reflective, smart people listening to a wide range of music.”

Remembering how Hendrix had conquered London before returning triumphantly to America, Sub Pop wooed the novelty-obsessed British music press and were rewarded with coverage that far exceeded their status. The quality of the music helped, along with a label aesthetic created by straitened circumstances - with a limited choice of studios and engineers, the “Sub Pop sound” was no myth. Famously, their most successful record appeared on another label. The ambitious, suspicious Kurt Cobain had insisted on signing a formal contract. When Nirvana moved on to a major, Sub Pop received royalties from the megaselling Nevermind that kept them going for years. “Our belief in the bands was boundless,” says Poneman. “We knew that in a just world Soundgarden and Nirvana should be huge. But the game was fixed.”

“Imagine how we felt when Nevermind sold ten million. We were right!” recalls Pavitt. Seattle hosted a second goldrush. Hopefuls poured in. Anyone with a guitar was signed. It couldn't last. By the time the dust cleared Sub Pop needed to reposition itself. Its founding fathers fell out.

“We had a disagreement about the direction of the company in 1995,” Poneman says. “He wanted it to be big and successful and I didn't,” says Pavitt, explaining why he quit.

“I wanted to run it into the ground. There's still time,” adds Poneman.

In the mid-Nineties, the label opened offices worldwide, spending like a major without notable success. Scaling down operations, Sub Pop retreated to Seattle and became just another big indie, albeit one with history and a fine back catalogue. To young musicians in America and beyond, such as the recent signings CSS from Brazil and Foals from Oxford, it still had cachet. By necessity it also had strict cost controls.

Ethan Miller of Comets On Fire accurately describes his own band as sounding “fairly agitated”, but is impressed with the firm. “It's so much more interesting that they are not just a “golden child” record label. At a point in the Nineties they didn't seem to be doing so well,” he says. “We loved the staff there. I don't think we knew what they were doing like they did. But they did it.”

The label's revival is often credited to the return of Megan Jasper, the former receptionist who once, straight-faced, gave Time magazine an entirely fictitious glossary of “grunger slang”. Jasper, now vice- president, reminded a demotivated Poneman of their original ethos. Pavitt was reconciled after a company “retreat” held near his island home. The Shins and the comedian and actor David Cross released unexpected, inexpensively recorded hits and Sub Pop was back.

The old guys still have a place. The SP20 festival includes an unlikely reunion of Green River. The first act to release an album on the label, its members later formed Mudhoney and the huge Pearl Jam. Supposedly they split because the guitarist Steve Turner was unhappy with their heavy metal tendencies (“I couldn't play the songs,” he now admits), while bassist Jeff Ament, later of Pearl Jam, was unfashionably determined to succeed. “I didn't think Sub Pop was the answer. We needed a van,” says Ament, several million record sales on.

Green River are great fun - middle-aged men making a stodgy racket - but there are other varied highlights, from the minimal punk-pop of No Age to the hugely popular local lads Fleet Foxes. Watching the deadpan Kiwi comics Flight of the Conchords in a church hall at the Edinburgh Fringe five years ago, I never imagined them headlining a rock festival or having a Top 5 US album.

The still excellent veterans Mudhoney remain the label's heart and soul. No other act has released so many Sub Pop records. They could go on for ever - after all bassist Guy Maddison is a cardiac nurse (he offers me advice about cholesterol). Even the young ones recognise their genius. “We played with them in New York and they were as great as ever. They weren't hanging on at all,” says Bradley Fry of Pissed Jeans.

“I ran out of mistakes to make, I had made so many,” admits Poneman. “But the industry is not the fixed game it once was. Sub Pop is not alone.” Contemporaries Merge and Touch and Go have also lasted. “I am a business person and a music fan but I'm a music fan before a business person. But I'm not afraid of change. We adapt or we die,” he adds.

At the Space Needle, as well as the flag, the roof of the revolving restaurant has been transformed into a yellow and black Sub Pop label, though to see it you would need a bird's eye view. You have to take their word for it, which has always been the case.

Sub Pop stars

Nirvana

The suspicious Kurt Cobain, leader of the ill-fated superstars, insisted on a formal contract.

Soundgarden

Followed Nirvana to the top, selling 20 million albums.

CSS

Brazilian hitmakers who have helped to revive label's fortunes.

Foals

Fashionable Oxford band who are also a recent signing.

Flight of the Conchords

The deadpan Kiwi comics have followed an unlikely career path via Sub Pop to huge US acclaim.

Mudhoney

The label's heart and soul with the most Sub Pop releases.

Explore Music

• CD Reviews

• Live Reviews

• Classical

Editor's choice

• The 100 Best Films of the Decade
• 70 facts you didn't know about Marvel
• The 50 Biggest Movies Of 2010