What They'll Never Tell You About the Music Business

by Peter M Thall

  As people in general have become more aware of lifetime investment needs and opportunities, a growing segment of the music industry’s lawyers and accountants are no longer inclined to encourage artists to accept substantial advances. While it is true in most instances that advances are not repayable in cash, and are thus nonreturnable, they are always recoverable from royalties (that is, they are “recoupable”). That’s why they are called advances. And, as we shall see, sometimes they are subject to interest charges that can inflate what seemed to be a manageable sum into a totally unmanageable debt.

  A SAD STORY AND A HAPPY STORY ABOUT ADVANCES

  One day, not too many years ago, a hungry manager and a greedy lawyer decided that one of their artists needed a quick infusion of money. Whether this was because they were insecure about the artist’s continuing ability to feed the family of professionals around him by writing and recording hit records or because the artist had dug a financial hole for himself is not known. But the artist was not averse to a fat deposit into his bank account. What the manager and lawyer did, however, was to have a permanent effect on the artist and his family. These “caring professionals,” with the songwriter’s approval of course, sought and received several million dollars from the music publishing company to whom the writer had licensed his copyrights. The documentation concerning the payment referred to it as a “loan.” Of course, interest was chargeable to the songwriter at the prevailing rate for personal loans, and the loan was secured by the artist’s copyrights. The loan (together with its accumulated interest) was payable through the earnings of the songs, just as an advance would have been. However, it was not payable in the direct way that a loan ordinarily would have been. In other words, the loan did not have to be paid back—ever—out of the borrower’s (the writer’s) pocket. It just generated interest, and the accumulating interest, plus the unpaid balance of the loan, would simply be applied to the future earnings of the songs—songs that had been written over many years in the past as well as songs yet to be written.

  Because both the lawyer and the manager needed money also (and, in their own view, deserved it because of their successful efforts in getting the money from which they were going to be paid the money they deserved), they obtained a combined commission rate that exceeded 30% of royalties. That left 70% for the songwriter. (This sounds like a comedy routine, but it’s not funny.)

  Along came the IRS. They said, “Wait a minute, this looks like an advance to us: The writer never has to pay it back except out of earned royalties, and his representatives commissioned it just as if it were income. This is no loan!” The writer’s representatives cried foul. Loans are not income. Only advances are income. The IRS agreed, but found the payment to be an advance, not a loan, and therefore it was viewed as taxable income. The federal, state, and local taxes, interest, and penalties totaled—guess what—70% of the money “lent” to the artist in the first place.

  Unfortunately, the artist had retained very little of the 70% he netted after his representatives took their commissions. (He was not to enjoy a fabulous lifestyle after all.) So the money owed the various government agencies began to accumulate interest and by the time the IRS asserted its claim, the money owed had doubled.

  The artist not only had nothing left, but he owed the IRS an interest-accumulating amount equivalent to what he had received in the first place. Meanwhile, he owed the publishing company millions of dollars—to be recouped out of his songwriter earnings. Cash advances do not usually bear an interest rate. This “loan” did, and the debt accumulated interest charges rapidly. Remember that the publishing company could not request direct repayment, nor could the artist pay back the loan directly even were he able to raise the capital, so the publisher could forever hold on to the income generated by the musical compositions attributable to the writer.

  And now for a happy story. A publishing company liked a band and its songwriters and signed them to a typical copublishing relationship. They would receive royalties—as writers—representing 50% of almost every dollar earned by their songs and an additional 25% of the same dollar by virtue of the fact that they were copublishers and co-owners of the copyrights to their music. The idea of paying writers one-half of the publisher’s share of royalties in addition to their writers’ share so that they ended up with 75% of every dollar was one that developed as artists began to be solely responsible for recording their own songs—a responsibility that in olden days had been the music publisher’s. This particular artist’s advance was modest, too. Four years later, the band still had not been signed, but each member worked at a day job and the writers had been able to develop and demo their songs (thirty songs during this period). The band also showcased regularly and developed a fan base; in essence, they were helped financially and creatively over a four-year period to sharpen their skills and improve their craft of writing and recording.

  By the time a major record company recognized their appeal and signed the band to a spectacular agreement, their red position (the total of all unrecouped advances) under their music publishing contract was minuscule. This happy situation could not have occurred had the music publisher been simply parsimonious. It was the result of a carefully orchestrated process by the band’s proactive music publisher through which the advances they received were carefully thought through before they were paid out and they were applied to expenses only as necessary. In no other way could the music publisher have afforded to stick with the act for that long. Consequently, almost as quickly as this band’s records started selling, the company recouped its advances and the band started to receive additional money—money they earned, not money they had to pay back! The band was now in a position where they could actually revisit the publishing agreement from a position of strength and renegotiate some of the provisions that had given them pause at the beginning of their relationship. (There are always provisions that give one pause.)

  The cautiousness with which both the band and their publishing company addressed the issue of advances and the band’s responsibility toward feeding and housing themselves also had the effect of restraining the band from having to go to its record company to seek additional advances in return for which they would have had to give up even more rights and options.

  A happy story.

  IS ONE PERSON’S MONEY ANOTHER PERSON’S MOTIVATION?

  Many of my colleagues and clients feel that if they hit up the record company or music publishing company for a lot of money by way of advances, the companies will fight harder for the artists under contract, if only to protect their own positions. On the contrary. My experience is that companies facing huge losses as a result of a contract with an artist who is not making it are more likely to write off the expense as a bad debt than to throw good money after bad. Nowhere is this more true than when a regime changes and the expenditure was authorized by the former administration!

  Many lawyers and managers will seek to express their machismo and their worth by waving big bucks in front of their clients—bucks received as advances. But by the time everyone gets paid their fees, and the IRS and state tax authorities take their pounds of flesh, there often is not enough left to do a whole lot of good—certainly not enough to effect real change in the artist’s life or career. And believe me, if the artist’s records do not return the investment fast, the record or music publishing companies move quickly on to their next dream act without losing a beat. The only one who loses is the artist, who is history, even though the lawyers and managers are already moving toward big deals for the next generation of clients.

  Obviously, I am not suggesting that artists should be underrepresented or represented less than aggressively in every way. But look at what happened to Alex Rodriguez after he signed a $252 million deal with the Texas Rangers: The public’s focus turned from his art, and his skills, to his money. It was distracting, to say the least.

  Commit another error or strike out too often and the money becomes the elephant in the living room that can
not be gotten rid of; the baseball player’s performance on the field, previously the sole reason for the player’s existence, is replaced with something totally extraneous to his function—whether or not the money that has been paid has been well spent and is being earned. This may be a mere distraction for sports stars, but in the music field it can be devastating, especially when the line between art and commercial viability is so indistinct, determined not necessarily by the artist’s talent, but by that intangible called “perception” or “image”—that is, how a potential (or former) audience sees the artist.

  4 • ROYALTIES

  Some Unvarnished Truths

  When a little girl asked Lew Grade, founder of ATV Music, now Sony/ATV, what two and two equals, he answered:

  “It depends on whether you’re buying or selling.”

  Except for a few glaring examples (for example, the creators of Superman were paid off with a flat sum of money and the only pleasure they received from the success of the motion pictures based on their story was the buttered popcorn they purchased at the theater), most creators of intellectual property and their eventual distributors, such as record companies, acknowledge that they cannot fix a value on the created property. The result? A stratagem whereby creators receive a share of the success of the exploitation of their property. In the record business, this share is called a royalty. A royalty is essentially a sum of money that represents a percentage of sales. But as we shall see, the distinction between royalty and nobility has come a long way since the days of King Arthur.

  The part of a recording agreement with the greatest consequence for artists is the section dealing with royalties. In contrast to salaried employees, who create a product or provide a service and receive a regular paycheck in return, artists, who produce what is known as intellectual property, are compensated on a totally different model—the royalty rate. But once compensation for services is calculated on the basis of a royalty, the floodgates open for every possible royalty-reduction device that can be dreamed up by the business affairs lawyers at the record labels. It is no wonder that the section in recording agreements dealing with royalties can be well over thirty pages.

  Before getting into the details of the numerous charges against artists’ royalties that are written into record agreements, I want to emphasize again that the cost of recording and marketing these days is astronomical, even as record sales and revenues have nosedived. Even with modern recording methods that can result in a top-quality result from essentially home studios, the costs of marketing and promoting a record remain high, and are even increasing, given the innumerable means now available to record companies on- and off-line to reach consumers. The royalty concept remains irreplaceable because record distribution, which remains the primary service provided by a record label in establishing an artist in the marketplace, still demands the royalty model in order to create manageable participation in income among all involved parties. Once royalties are implicated, charges against royalties have a rationale. Therefore, the following discussion remains as pertinent as ever.

  However you may feel about the propriety of record companies charging so much against artists’ accounts, you cannot deny that the investment by record companies in signing new artists is phenomenal. When A&R people observe artists at club dates, they know that if they sign the acts, their companies will have to invest upward of half a million dollars per act to break them. No small risk. No small risk for the A&R people either! How many acts can they sign without success before their record companies look cross-eyed at them?

  It is no wonder that A&R people are extremely cautious before committing their company to a potential financial disaster. This old joke about A&R people is funny for a reason:

  Question: How many A&R people does it take to screw in a lightbulb? Answer: I don’t know. What do you think?

  One or two misfortunes and the A&R person will be dusting off the old bass and looking for a gig. I use the word “misfortunes” rather than mistakes because the commercial acceptability of art being what it is—intangible, uncertain, and highly speculative—many brilliant and even potentially era-defining artists fail to break the commercial barrier for a long time, if ever.

  By describing the various charges against artists’ accounts with record companies, as with other descriptions and disclosures made in this book, I am not expressing an opinion about the correctness of the procedures; it is the job of artists and their representatives to seek a balance in the negotiations or renegotiations of their record agreements. However, the information needs to be in hand so that artists and their representatives can negotiate from an informed position. Remember, your adversaries are not going to transform themselves into teachers. Neither the lawyer in the negotiations nor the auditor who ultimately examines the royalty statements can look to the record or publishing company to walk them through the minefields and obstacle courses that have been set up specifically to divert and confuse. Therefore, as I repeatedly advise in this book, it is essential to call in an expert who has the experience, the relationships, and the drive (the need to win?) to ask the right questions and to elicit complete answers.

  While this may sound obvious, young professionals who do not have these qualifications enter the music industry every year. What they may have is a new, nonjaded way of looking at a situation; they may have a hunger that older professionals may have lost years before, but they are nevertheless inexperienced. It should not be insulting to them to seek a second opinion or to offer to bring in a consultant to ensure that the myriad of obstacles that are placed before all negotiators in the music business (no, the companies don’t discriminate) will be identified and addressed. It is never too early to call in an expert.

  HOW THE ROYALTY PIE IS SLICED AND WHO GETS THE PIECES

  The parameters that I have chosen for the following scenario are but one of many combinations that can describe a royalty structure. (For example, I have assumed that the producer of the record in my illustration is an independent producer and not either the artist or a producer employed on the staff of the record company.) Suppose the suggested retail selling price of a CD is $16.98, and the record company agrees by contract to pay you a royalty of 12% of the suggested retail selling price of the CD (12% or even 13% rates are the current going royalty rates for new artists). Not bad, you think: about $2.04 per copy. If you sell a mere 25,000 copies ($50,940), you’re on the way to financial glory. (And that doesn’t even take into account the publishing royalties, the merchandising, the touring.) Right? Wrong! (As you will soon see, this royalty is more than likely to be closer to $0.80 than $2.04—partially because the independent producer’s royalty must be cut out of the 12% or 13%, leaving the artist with only 9% or 10% of the total.) In fact, you won’t see $50,940 for a long, long time, if ever.

  In the following sections, I will introduce you to the myriad items, in addition to advances, routinely deducted before an artist starts getting any royalties. Prices other than the suggested retail list price—for example, the published wholesale price or the ever-more-popular published price to dealers (PPD)—can be used as the royalty base (see the table on this page for a comparison of retail and PPD calculations for an $16.98 CD), but the examples in this chapter apply to the suggested retail selling price.

  None of the following is meant to suggest that all record companies are rolling in money while their artists are starving. Since the first edition of this book was published in 2001, nothing could be further from the truth. Nevertheless, the universal music industry practice that artists pay recording costs out of their own royalties is unique to the music business. This does not happen in the book publishing business, where writers receive a royalty from the first book sold and production costs are not recoupable from the writer’s royalties. The only monies recouped by the book publisher are the advances paid to the authors as cash or as a contribution toward publicity expenses and other promotional costs. The book royalty rate will invariably be lower than, say, 12 percent of r
etail, but it is exempt from the reductions prevalent in the music industry. Classical music record royalty rates are also traditionally lower because classical music labels do not usually recoup recording costs from the artist’s royalties.

  RECORDING COSTS

  Recording costs are recoupable against the artist’s royalties as if they were paid out in cash to the artist. These costs include everything imaginable, including studio costs, engineering costs, musicians’ and singers’ costs (including union payments), and the cost of tapes. They also include mastering (putting the recording into a form from which copies can be made), an item once absorbed by the record company as a manufacturing cost, not a recording cost, and one which can exceed $10,000 for an album. (With vinyl LPs, the mastering process involved making an acetate disc from which a metal “mother” master was created. Duplicate masters were made from the mother master, and these were used to press the records. Mastering is now a totally digital process—it consists essentially of balancing and equalizing the recording so that the copies made from the resulting master achieve the highest possible quality of sound on playback systems—yet the record companies routinely list it as a recording cost.)