The artist can agree to pay the investors a percentage of receipts derived from all or some of a variety of music industry sources—everything from record royalties and advances to live performance fees and music publishing income. The nature of such receipts needs to be very carefully defined, and if you go this route, you need an accountant who is intimately acquainted with the idiosyncrasies of the music business to ensure that the parties are clear as to what investors are to receive and from which monies. Similarly, there should be a cap, or limit, on the amount of money investors can receive. For example, the agreement might specify that on a $1,000 investment, the investors will receive 25% of all advances and royalties received from the record company or publishing company up to a total payment of $2,000.
Royalty Points
An artist who has a well-negotiated record deal will generally receive (exclusive of what the producer’s royalty is) from 9 to 12 points. If an artist has a 10-point deal (net of producer), if the investor is promised 1 point, this entitlement will constitute 10% of that total. That must be added to the 15% or 20% of the total earnings that a manager receives, the 5% the business manager will likely claim, and legal fees, which, even if not specifically tied to a percentage of income (a practice becoming more and more popular), can be considerable. The cost of legal services can amount to anywhere from 3% to 10% of artists’ gross incomes—at least at the beginning of an artist’s career, when legal services are much in demand and gross income is likely to be low.
Thus, ultimately, the artist may have to pay out as much as 45% of his or her gross income. In such cases, since any well-run “business” is likely to require as much as 50% of gross income, or more, to cover operation expenses, the artist will be left with very little or nothing—and possibly even owe money. Even assuming the lower cost figures (that is, 15% for a personal manager, 5% for the business manager, and 3% for the attorney), the artist would end up with less than 20% of gross (15 plus 5 plus 3 plus the investor’s 10, plus the 50% for operational expenses, equals 83%).
Therefore, when artists still choose to pay investors a “point” or two, it is logical to establish some kind of cap on the amount of money to which investors are ultimately entitled. In this way, payments to the investors will not completely consume what is left of the artist’s income after professional fees and other costs are paid. Another possibility is to limit the sources of financial return. For example, if the investor’s entitlement is limited to record royalties, at least other sources are exempt from the potentially devastating effect on the artist’s resources that I have described above.
OVERCALLS AND CONVERSIONS
In cases in which the initial investment proves inadequate, artists may want to seek additional money from investors. This “last” money is often the most expensive a borrower can receive. For this reason, it is extremely wise to provide in advance, in a written document, for an overcall right—that is, a right for artists to claim from the investors an additional sum of money without changing the basic parameters of the understanding.
Artists may also negotiate the right to convert the investment into a loan, with interest (the conversion right), and have the option to pay back the investment within a particular period of time at an agreed-upon rate of interest. This option is of obvious value to the artist, and may sometimes be more appealing to investors than one would initially think. This right may mature under any of the following circumstances:
• upon the artist signing an exclusive recording or music publishing agreement within a certain period of time;
• upon the artist paying back a percentage (for example, one-half) of the investment within a specified period of time, in which case the balance owed would be subject to the conversion;
• upon the artist reconstituting him- or herself with another artist or artists—for example, by changing band mates and re-forming as another band;
• upon the occurrence of negative circumstances, such as the failure of the artist’s first album or the failure to enter into an exclusive recording or music publishing agreement within a certain period of time. (In such cases, all or part of the investment can be converted into a loan.)
COMMISSIONS
Borrowers may have more than investors to worry about. They may also have personal managers whose contracts permit them to commission all gross receipts. Not only may the investment itself be commissionable; when artists’ earnings are being directed toward paying back investors, the record sales that generate this income may be subject to commission as well.
Only one commission is considered fair. But which one? Presumably the second—that applied to actual earnings—because investment capital is hard to come by and to reduce it by 15% to 20% at the very moment it is paid out to the artist may not be the best use to which the capital can be put. On the other hand, the personal managers may be the ones who have obtained the financing. What is that worth? Or personal managers, understandably, may not want to work for free, and part of any money that comes into the coffers of the artists may logically be money that is legitimately commissionable by them.
No one approach will fit all circumstances. But the dangers described in the previous examples warrant careful consideration and discussion by all parties involved in an investment of this nature; then, once the agreement is reached and signed, no one should have reason to be angry later.
CROWDFUNDING
In chapter 16, I discuss in detail the benefits and the risks of using crowdfunding sites such as Kickstarter. While I am aware of no artist who has been pilloried by the securities laws (federal or state) for using crowdfunding to raise capital, I should nevertheless make some mention of the nature of these types of transactions in the context of the laws designed to protect “investors.”
Crowdfunding is not actually a recent concept.
For years there has existed a financial mechanism, used traditionally for financing the cost of college, which is referred to as a human capital contract. This product provides funds to an individual through an “equity-like” arrangement where the funding party receives, usually for a limited period of time, a portion of the individual’s future income. I am not describing some kind of backroom loan-sharking scheme here. Human capital contracts have been advocated by a number of Nobel Prize–winning economists and were originally proposed by Adam Smith in The Wealth of Nations as a way to make human capital a tradeable asset. Most often, this arrangement is characterized by the funding party receiving different percentages of the results of the venture being funded, depending on how much the artist earns. What is attractive about this kind of funding is that the artist is neither “borrowing” nor “going into debt” but rather is utilizing a structure that provides him with what he needs, while not risking his future financial stability. Before an artist decides to take this path, I urge him to check with an attorney to ensure that what he is doing does not run afoul of the securities laws in his state, or otherwise.
There are innumerable entities that provide funding via human capital contracts, but www.upstart.com might be a good place to visit to begin to understand what they do. Upstart was established by a number of former Google employees. They have established a fairly well-respected algorithm that forecasts future income for those whose projects they fund. How they can do this in the music business is beyond me, but it is worth the time to research them and to listen to their pitch. Those seeking to raise money via crowdfunding can accept investments up to $1 million from companies and from $2,000 to $100,000 from individuals, depending on earning and net worth.
SHOULD HE WHO PAYS THE PIPER CALL THE TUNE?
Over the last decade, the music industry has begun to attract traditionally conservative Wall Street types as investors. While on the face of it, this sounds like a good thing, it can cause problems for the group or company that obtained the investment. For example, one independent company, a clever, creative group of music industry neophytes in San Francisco, was shut down by its Silicon Valley f
inanciers after only a few months of operation. The label had signed a number of acts, but the terms of the artist deals (required by the investors) were so brutal that many of the artists represented by reasonably competent counsel were invariably lost to another, more competitive (and more experienced) label. The labels that acquired those acts had flexible, long-term thinkers who understood the concept of compromise in their negotiations. The investors in the company, who were not music industry professionals, decided that they had no time to be flexible. They wanted it all, and they felt that they knew better. The result: They ended up with nothing. All that was left was another defunct label to add to the scrap heap of the music business and one more anecdote with human consequences. Today they are probably bad-mouthing the music industry as a lousy business and a foolish place to invest one’s money. They’re wrong, but probably have no clue as to why.
It can seem amusing to observe the pratfalls and arrogance of people who are the “masters of the universe” on Wall Street but who are total idiots when it comes to the valuation and exploitation of intellectual property, and there are innumerable examples of investor-caused failures in the music business beyond the one cited above.
What is happening in the music industry is mirrored by what happened to the dot-com music businesses in the 1990s. The financial “experts” and their technology specialists established many music industry–oriented businesses, yet they neither understood the concepts of the industry, nor its history, nor the mistakes that were made before them from which they might have learned a thing or two. Perhaps most significantly, they did not know the people in the industry and did not gain their confidence. One particularly egregious example involved a record company that began its exploitation of music rights by appropriating digital files of sound recordings, but not the accompanying right to “reproduce” or “perform” these files. This was not a good idea.
A BACKER WHO KNOWS WHAT HE’S DOING
Brian Message, manager of Canada’s Radiohead, and Adam Driscoll of the British media company MAMA Group, have teamed up with Terry McBride of Nettwerk, a Canadian company that manages, produces, and publishers artists, (www.nettwerk.com) to set up a company that may mark the future of many young artists who want to avoid the processes described above in this chapter. They call it Polyphonic.
This is how it works at its most basic level. First Polyphonic invests in a band and helps them to create a kind of minilabel whose only artist is the band which is the subject of the investment. They provide many of the tools that a record company would traditionally provide (whether promotion, marketing or A&R advice), but only when needed, so that the “label” will not be burdened with large overhead costs. You could say that Polyphonic is assisting the artist in “doing it yourself,” but the artist who opts for this kind of assistance will never face the myriad situations that cause most fledgling artists to fail at their first or second attempts on their own without a professional support team. The belts and suspenders available from an institution like Nettwerk will not let that happen. In a way, Polyphonic is the ideal answer to the frustrations of depending on the majors (or even the independent record labels). Their assistance allows young bands to go beyond their own resources to establish their bona fides with the public. Polyphonic is extremely well-funded and intends to invest as much as $300,000 in each new band which they take under their wing. Frankly, they are doing what the major labels used to do, but with much more savvy in the new world of social networking and burgeoning digital services. Another company that is seeking to establish the same kind of service to bands is “Self Serve,” which is an offshoot of William Morris Endeavor Agency. It will be interesting to observe whether, or which of, the two (or perhaps more manifestations in the future) will succeed in their efforts: a conglomerate of incredibly connected and experienced music business professionals or a powerful multipurpose agency whose music business credentials are limited mostly to live booking.
—
It would be a mistake to suggest that the music industry is not a gold mine for intelligent investors who seek advice from those who understand the industry best. It is, and has been, and will be.
Those who are reading this book with the intention of becoming investors in the music business must realize that this industry has a long, complicated history, and that there are reasons some companies have survived and others have not: The stars of Wall Street who think the music business is not “brain surgery” are wrong. It is. The lessons to be learned are many and take years; there is no easy entrance into this industry. The contribution of music industry professionals is as invaluable as the investment itself.
But lest we forget, whether investors are seeking to invest their money solely for profit, for artistic participation and expression, or merely for the opportunity to be patrons of the arts in a time-honored tradition, their contribution is enormously valued and can mean the difference between an artist’s gaining the attention of the world and struggling during yet another unsatisfying—and unfulfilled—period.
* * *
* There was a time when the federal government divided potential investors into two groups: sophisticated investors and the rest. There were no limitations on the number of “sophisticated investors” one could solicit. As to “the rest,” there were limitations. As it turned out, the sophisticated-investor exemption was interpreted by different federal courts in different states in different ways. The result was that a person seeking investment from an array of investors would never know whether, down the road, he or she might be found to have violated the federal securities laws or not. This uncertainty resulted in an awkward and costly situation in which people raising money would set up different companies in different states to avoid running afoul of the federal laws in any state, and, ultimately, led to the creation of Regulation D. The sophisticated-investor exemption still exists, but it is rarely used. Regulation D has effectively replaced it in practice.
3 • ADVANCES
Why They Seem a Lot Like Loans (and Vice Versa)
Ah, take the cash, and let the Credit go
Nor heed the rumble of a distant Drum
—EDWARD FITZGERALD, THE RUBÁIYÁT OF OMAR KHAYYÁM
The New York music business’s nickname, Tin Pan Alley, hails from the early part of the 20th century, when music publishers were concentrated on Twenty-Eighth Street in Manhattan. As the story goes, the name was coined by a reporter who said that the paperroll pianos being played in publishers’ demo rooms sounded like the pianists were pounding on tin pans. In fact, he said, the whole of Twenty-Eighth Street was beginning to sound like a tin pan alley.
In the early days of the music business—from the late 19th century to the 1950s—a music publisher would take everything from a songwriter, perhaps even put the publisher’s president’s name down as a writer, and give the actual songwriter a bone (maybe a pink Cadillac, maybe something a bit shadier). Things have not changed so much. Only now instead of bones, they give writers advances. Remnants of Tin Pan Alley remain, even as the music industry itself has matured in a multitude of ways. The paper that muted the piano has been replaced with the paper constituting the contracts that too often compromise artists’ ability to glean financial security from their creative efforts.
What is an advance? In a word, it is cash. In the music business, it is cash given by a record company, production company, or music publishing company to an artist—cash that the company is entitled to have returned, however. And there’s the rub.
If you look up “advance” in the dictionary, you will find it has an unusually large number of synonyms—among them “debt,” stampede,” and “loan.” In the music business, the word takes on an almost metaphysical dimension. Eyes light up, those who commission earnings get all excited, and everyone tries to convince everyone else that they are getting something for nothing. Although the advancing party does not receive any perceived value from the receiving party at the time the advance is given (except promises), the r
eceiving party is now about to enjoy a bottle of champagne, a new car, and the opportunity to treat many friends (probably newfound) to a night or week on the town.
What are the real characteristics of advances? Their implications? The advantages? Whatever you can do with the money—live, eat, pay rent, pay the phone bill, buy some equipment, rent a rehearsal room, outfit your band with instruments and clothes, pay your lawyer, your accountant, and your manager something “on account,” provide your fans with updated website information or postcards about upcoming dates. And don’t forget union dues, without which you might not be able to afford medical insurance. There are lots of reasons for artists to take advances. Without them, most artists would be unable to function, and the record companies would be the eventual losers.
The disadvantages? The entire burden of paying back cash advances is the artist’s alone. And, even if they are ultimately repaid, the publisher or record company will have acquired, via these advances, long-term equity in copyrights in both musical compositions and recordings, as well as the right to control and share financially in these potentially vast income-producing assets “in perpetuity” (read “forever”). This is because all monies going in the direction of the artist, or songwriter, are advances. Music publishers do not “purchase” your copyrights, or the right to control them, when they enter into a typical copublishing agreement. Rather, they advance, to the artist or songwriter, money that must be returned—if only out of the artist’s or songwriter’s share of earnings. And yet they wind up owning the writer’s or artist’s assets.
Shocking as it may seem, artists in the music business begin their careers more in debt than doctors who have borrowed their way through eight years of college and medical school. At least doctors own a medical degree. Artists do not even own their masters; on the contrary, as we will see, they have to pay for the records they make, for recording costs are advances, too. Songwriters have to return the money they receive for selling their copyrights and the worldwide administration rights, but they do not get their copyrights back. They receive equipment loans, but often have to return the equipment. They look to the record company to provide services including, obviously, the promotion of their records, yet they are charged for the tens of thousands of dollars that it costs the record company to hire independent promotion people—people who used to work for the record companies, but who are now operating under their own umbrellas so that record companies (at least three of which at one time were operating under federal license to run enormously lucrative broadcast networks) would not be tainted with the same brush that the less reputable promotion people have been scarred with. (For more about independent promotion, see chapter 4, this page, and chapter 9, this page.)
What They'll Never Tell You About the Music Business Page 5
