How to Set Up a Money Deal for Your Music Project
This chapter explores some of the forms of financing available to you as a musician and shows how to analyze and structure a financial package to obtain the money for your project. The examples used will draw on the music industry, but the concepts and ways of structuring deals apply whether you are a musician, writer, or actor or, for that matter, if you want to establish another kind of business, like your own musical instrument manufacturing company or candy company with musical themes for different kinds of candy.
Developing the Business Plan
Almost every investor will require that you submit a business plan for them to assess before they invest. A business plan starts by telling potential investors who you are. It describes your professional goals, what you plan to do to achieve those goals, and how that achievement can generate income to pay back the investor (and hopefully generate profits) and further finance your career. An outline of the general headings of business plan is included in this chapter.
Identifying Your Goals
First and most importantly, identify the reasons you need to raise money. To establish a clear focus, you must determine your career goals, your immediate project goals, and your strengths and weaknesses as an artist. Identifying your goals, such as securing a recording contract, making music videos, or getting a big-name artist to record your songs, will assist you in determining feasible ways to achieve that end. The project might be producing an independent record and a music video so you can market yourself as an artist and demonstrate there is an audience for your product, or it could be preparing a publishing demo to shop your songs.
You need to analyze your strengths and weaknesses, and perhaps get input from someone in the business whose judgment you trust. What is your best selling point? Pinpointing your strongest talents will assist in determining the most appropriate project to achieve your goals. If your best skill is songwriting, consider raising funds to make a publishing demo of some of your songs to send to publishers and to performers who record material written by others. If your strongest talent is live performance, consider developing a music video that shows the style you use to slay your audience. Money can be raised for other projects as well—for example, producing a master sound recording ready for release to the public, backing a tour for promotional or showcase purposes, buying equipment to enhance your stage show, or hiring a music publicist to orchestrate a media blitz before you storm into Los Angeles or New York City.
Reaching a final decision on your goals and the projects designed to achieve them is a precondition to figuring out how much money you must raise and what kind of information to include in the business plan you present to prospective investors.
Preparing the Budget
Once you have decided on the project, your next step is to determine its cost. You must develop a budget that shows the amount of money you need and how it will be spent. To do this, you must research the cost of each of the various elements of your project. If you plan to produce and distribute your own recording, you must budget the cost of studio time, tape, musicians, arrangers, producers and engineers, mixing, mastering, manufacturing, cover art, design, packaging, distribution, and advertising and marketing. Each project has its own particular cost items. Your responsibility is to develop a concise picture of what those costs will be. The flip side of this, of course, is your anticipated income from your project. The section later in this chapter entitled “Identifying and Evaluating Sources of Income” discusses analyzing future sources of income to be used in scheduling payback arrangements with investors.
Preparing the Proposal
Once you have established your goals, identified the project, and calculated the amount of money you will need, you must distill all that information into a proposal or more formal business plan to submit to individuals who may have an interest in funding your project. The proposal should itemize the elements we have just explored and explain
what the end product will be; how your business operates; how marketing the product (for example, an album) or implementing the service (for example, engaging in Internet- based music performance concerts) will assist you in developing your career; and how money will be earned to repay the investors or the lender and leave them with a profit. The proposal should also contain information on your background and the current status of your career, and a clear statement of your goals. There is no better way to force yourself to develop a clear focus than having to articulate it in writing to others, especially if you are asking them for money.
Business Plan Outline
Even if you are not using a business plan to find financing for your project, the exercise of writing one will help identify your goals, outline the strengths and weaknesses of your project, and help determine when your project will make a profit. In short, a business plan is the map that shows how to get from an idea stage to project completion and profit.
When you want to obtain investment money, the business plan is a vital sales tool that can impress prospective investors with your planning ability and general competence as a manager.
The following topics are usually covered in business plans:
- Summary of your project, including the money you need to successfully launch it and reach your market
- Company description (history, background, and management)
- Description of your background
- Description of industry you are operating in
- Project description and planning schedule
- Description of the market for your project
A. Market size
B. Market trends
7. Marketing plan
A. Estimated sales and market share
D. Sales and distribution
E. Publicity and advertising
8. Operations: If project is a product (e.g., musical recording or new software), describe how it will be produced, manufactured, marketed and distributed
9. Project timeline
10. Critical risks and problems
11. Financial information
A. Financing required
B. Current financial statements
C. Financial projection (three-year profit and loss, cash flow and balance sheet projections)
Your project, most likely, will be financed by one of four methods: self-financing, borrowing, third party investments with a profit sharing schedule, or crowd funding using such services as Kickstarter or Indiegogo. This section will discuss these methods and the advantages and drawbacks inherent in each.
The best way to retain full control of your project is to use your own money. It is the only technique that allows you to be free of financial and time obligations to lenders or investors and gives you maximum artistic and financial control. Although it means you must bear all the risk of the project, it also means you will enjoy all the benefits.
Self-financing also minimizes the paperwork, record keeping, and other business complications involved in other ways of raising money.
If you are not in a position to self-finance, borrowing is the second basic technique for raising funds. Borrowing means accepting a loan for a fixed sum and agreeing to repay that sum plus a specified percentage of interest by a certain time. Arrangements where the return to the lender depends on the success of the project will be discussed under the section on “Investments and Profit Sharing.”
Loans are usually absolute obligations that must be repaid whether or not the project is successful. If the rate of interest is high, you will have to earn a substantial amount of money from the project to make any profit. For example, on a loan of $l0 thousand at 12% annual simple interest payable in two years, your interest obligation would be $2,400. To pay back the principal and interest on a self-produced recording that sells for $7.25 (average wholesale price), you would have to sell about 1710 recordings, plus an additional number to cover your cost of sales. Only then would you be able to sell for a profit. As costs climb, of course, the number of recordings you must sell to break even also rises.
There are several possible sources of loans. The first are commercial sources. They include banks, finance companies, and savings and loan associations. Some musicians, instead of going to family and friends or third-party lending companies, choose to rely on their credit card as a way of getting started, using it for cash advances and to pay suppliers, like studios or manufacturing.
Secured loans—that is, secured by collateral such as a home, auto, or recording or performing equipment—bear less interest than unsecured loans—loans for which the lender has no security. Your interest rate will also be lower if a creditworthy person cosigns the loan, because the lender’s risk of not being repaid lowers. Loans backed with collateral or a creditworthy cosigner are also easier to obtain and secure.
In deciding whether or not to give you a personal loan, a bank looks at your credit rating and whether you have property that can be used as collateral. Unfortunately, musicians’ credit ratings are not always stellar because of the fluctuating conditions of their employment. But if you have a credit card or two and have lived in the same place for a couple of years without having trouble paying the rent, you may be able to convince a bank to loan you a modest amount of money (for example, $5,000). Some banks will loan more than that amount if your credit rating is strong. As part of their due diligence, banks may want to see your income tax returns for the last few years.
Some banks refuse to make a personal loan of more than $5,000 unless it is secured by collateral, such as a house in which you have equity. If you are looking for a loan to buy new keyboard equipment, you will find that banks generally will not consider using the equipment itself as collateral to secure the loan. Some banks will let you use an automobile as collateral, however, provided you have clear title to it.
In the event you do not qualify for a personal loan, you can ask a creditworthy relative or a friend to act as a cosigner, which means they promise to make the payments if you are unable to. Naturally the bank then also will be concerned about your cosigner’s credit rating, but it will still want to make sure you actually have the ability to make the payments so they don’t have to look to your cosigner.
In addition to personal loans, banks regularly make commercial loans to businesses. You may feel you belong in this category since music is your business, but commercial loans have their own rules and regulations. If you have a solidly established band with ongoing income, a commercial loan might be your
best option. But if you are not a band with ongoing income and what you have in mind is borrowing money to start a project, you will probably have to go with a personal loan. When you become more established, some banks, especially those with operating offices in Los Angeles or New York, may lend money secured by the copyrights in your songs, master recordings, and other intellectual property, if you still own them and have not transferred those copyrights, for example, to a record company or a publishing company.
A commercial loan package usually contains your business plan, the profit and loss statements of your business, tax returns for the last two or three years, and a personal financial statement. Banks will check your credit history. They need to know you have a sound financial plan and are financially responsible. They generally insist you put up as much as 50% of the money needed for your project out of your own pocket, with the loan supplying the balance.
Since commercial lenders have varying rates you should shop for the best deal. This should also apply to loans from individuals that lend money to you for your project as a business venture, even if they are personal friends.
A second source for loans is family and friends. Usually, they will lend money at a rate lower than that of a commercial lender. Consider, however, when borrowing from family and friends, that strong pressure for timely repayment may result, and often is more burdensome (because of the personal nature of the debt) than the legal obligation to repay.
When you borrow from family and friends, the usury laws of most states come into play. These statutes, which vary from state to state, limit the amount of interest a private lender can charge a borrower. In California nonexempt lenders (your family and friends) cannot charge more than 10% per year, or 0.833% per month. Banks and other commercial lenders are generally exempt from the usury limits and can charge higher rates.
Whether you borrow from friends or from commercial lenders, you will want to structure a written repayment plan that states the amount of money borrowed, the rate of interest, and the repayment method.
The plan can be a simple written promissory note: “On or before June 15, 2018, John Debtor promises to pay Sally Lender the sum of $2,500 plus 9% interest per annum from January 1, 2016. (signed) John Debtor.”
The note from a commercial lender is more complex, but contains similar elements. Sometimes commercial loans are structured so that you pay a smaller monthly amount the first two years and a larger one the next two to three years. Once again, you should shop for the most favorable terms, especially interest and monthly payback amounts.
Investments and Profit Sharing
If self-financing is not an option and you have not been able to obtain a loan, the third option is to find candidates to fund your project, such as investors, and offer them a profit share. The arrangement can take several forms, depending on whether the investor is “active” or “passive.” The different alternatives are discussed below.
Active investors are individuals that put up money to finance a project for another person and become involved in the project (or fail to take adequate action to insulate themselves from responsibility). They assume all of the risks of the business, including financial liability for all losses, even if the losses go beyond the amount invested. Generally, such individuals are responsible for the business’ obligations even if they have not given their approval or have not been involved in incurring business debts.
The forms of businesses in which the financing participants are active include general partnerships, joint ventures, corporations, and limited liability companies (LLCs). The profits or losses of such businesses are shared among the participants according to the nature of their agreement. These business structures are discussed more fully in the chapter, “Business Entities.”
A general partnership is co-ownership of an ongoing enterprise in which the partners share both control and profits/ losses. A joint venture is a general partnership that either has a very short term or a limited purpose and in which the joint venture participants share both control and profit/losses. For example, the production of a single recording by a group of people could be structured as a joint venture.
The general partners and the joint venturers are each personally liable for all the enterprise’s debts. The liability is not limited to the amount they invested or to the debts incurred with their approval. All personal assets of each general partner or joint venturer are liable for repaying debts the enterprise incurs.
If a corporation or an LLC is formed, then even if the project is a total failure, only the assets of the corporation or the LLC are vulnerable to the business creditors. A corporation is a separate entity formed under state laws, as is an LLC. A corporation’s ownership is divided among its shareholders, and an LLC’s ownership is divided among its members. A corporate structure provides limited liability to the shareholders; the same is also is also true for the members of an LLC. If you are thinking about setting up a corporation or an LLC, you will need sound advice from your lawyer, your accountant, or both.
A more complex category of investments is one in which backers provide money for the project but take no role in the project’s management and affairs. Such backers are passive investors whose return is based on the project’s success.
The primary advantage of profit sharing arrangements, from the viewpoint of the person getting the money, is that downside risks are shared. If a project fails to recoup the money invested, you are not obligated to repay the investors. Offsetting this advantage are several problems that make profit sharing the most complicated form of financing a project.
The foremost problem is security laws requirements. Any time you enter into an agreement in which people give money for a project with the understanding that part of the profits are to be shared with them and the investors do not actively participate in the funds management or the business operation, a “security” has been sold. A security can be a promissory note, stock, membership interest, points, or any other form of participation in a profit sharing arrangement, either written or oral, where the investor’s role in the business is passive. The investments of a general partner or joint venturer may be treated as a security, but they are a different class of security because those investors are actively involved in the business. The level of protection required for active investors is less stringent than for passive investors. Active investors are liable for the debts of the business beyond just the amount of their investment, while passive investors are only responsible for business debts up to the amount of their investment.
Limited partnerships, promissory notes structured with profit sharing, corporate stock, LLC membership, and contracts providing for points participation, where the individuals that put up the money are not active in your business, are all securities, and state and federal securities statutes must be satisfied when these types of funding are used. Failure to comply may have serious civil (including penalties measured as a multiple of the investment received) and, in extreme circumstances, in situations involving fraud, even criminal consequences.
What does this legal talk mean to you? Why should you have to worry about it if all you want to do is raise some money to record some music or finance a performance tour? The securities laws were enacted to protect investors from being defrauded, their own lack of sophistication, or even inability to afford losing the money they invest in the project. The legal burden falls on the one seeking to raise the money to make certain investors are getting a fair deal and fully understand the risks involved. “Let the seller beware” is the rule that operates in this arena.
If you want people to invest money without allowing them a hand in controlling the project, then you should be willing to accept some responsibility to them. Willing or not, state and federal statutes place responsibility on you.
Investment Loans Conditional on the Success of the Venture
In these types of loans, the debt is evidenced by a promissory note and repayment is conditional on the success of the funded project. The note should set out the terms of repayment, including interest rates and payment schedules.
A common form of this kind of loan is a point arrangement in which a percentage (one percent is a point) of sales from the funded project is shared with an investor who puts in only time or with some other investor who puts in only money. Another form is a percent interest in the income (or losses) generated by the business. This arrangement can be provided in a written contract rather than in a conditional promissory note.
Like a general partnership, a limited partnership has co- ownership and shared profits/losses, but only some participants are entitled to control or manage the enterprise. Those persons are termed the general partners. The other investors are called limited partners and their only involvement is the passive one of funding the project.
A partner receives the percentage of the business profits or losses set out in the partners’ agreement, for example, 20% of the net profits up to $10 thousand and 10% of the net profits after the first $10 thousand. The term of the limited partnership is often limited to a specified period. If the project has not earned the hoped- for return by the end of the term, the investor has to absorb the loss.
As discussed in the following section about sales of shares, the federal rules and several states regulations that apply to limited partnerships, LLCs, corporations, and other security investments structured as private offerings (i.e., to only a small number of people) are less complicated to use than the laws regarding public offerings (i.e., to the general public).
Corporate Shares and Limited Liability Company Memberships
Another way to raise investment capital is through the sale of shares in a corporation or of membership units in an LLC. Corporate shares and LLC memberships units are securities that usually are sold for a stated number of dollars per share or membership. That money is used to operate the business or pay for a specific project. Shareholders or members own whatever percentage of the corporation or LLC their shares or units represent in relation to the total number of shares or units sold.
Shareholders or members participate in the profits of the corporation or LLC when they are distributed as dividends or profit shares and vote on shareholder or member issues based on their percentage of ownership. Equity-based crowdfunding as distinct from donation crowdfunding (see below) also can be considered an investment tool, and so the following discussion on satisfying the applicable laws on investments would apply to such crowdfunding efforts also.
Whatever method of financing you use, it is wise to check with your lawyer and set up a good financial record-keeping system with your bookkeeper.
Another source of project funding, crowdfunding, has become more common over the past few years—using the Internet to solicit contributions for an artist’s project, such as with Kickstarter, Indiegogo, and Go Fund Me. This approach is more flexible than the loan and investment approaches described above in this chapter, but also has certain legal requirements that need to be satisfied.
The principal crowdfunding approaches include charity, equity, and donation based. Charity-based crowdfunding is typically fund drives for local community projects and public broadcasting.
Equity based crowdfunding is when businesses offer equity in the company in exchange for investment capital from qualified investors, which, again, requires certain securities laws be followed. The JOBS (Jump Start Our Business Startups) Act made securities-backed crowdfunding sites possible. The Securities and Exchange Commission (SEC) has published rules and regulations surrounding the use of the JOBS Act provisions. For example, participation in securities-backed crowdfunding sites is limited to certain kinds of businesses and investors that meet minimum qualifications under the Act. Since the JOBS Act is intended to apply to situations in which many millions of dollars are to be raised, the details are not appropriate for this chapter, but the segment, “Following the Rules” provides an overview of the applicable rules and regulations.
Finally, donation-based crowdfunding is when solicited funds are used to support the project. The project developer owns the results and provides donors product or experiences—for example, a signed copy of the recorded music, video, or film; music lessons; or a house concert. This crowdfunding type is the most common, especially for lower cost projects, partly because it minimizes the need to be concerned about investors/securities laws requirements.
Various donation-based crowdfunding sites use different business models. Many popular crowdsourcing sites, such as Kickstarter, use the “all or nothing” approach, under which you must reach or exceed your goal in an allotted time frame or you lose any funding. Kickstarter keeps a percentage of the money raised in exchange for using its services. The risk is you may put in the effort to reach your funding goal but come away with nothing to show for it.
United States Securities and Exchange Commission (SEC) (www.sec.gov)
Jumpstart our Business Startups (JOBS) act
SEC Headquarters 100 F Street, NE
Washington, DC 20549 (202) 942-8088
Other donation-based sites offer a “cumulative cash” approach, which usually charges a higher percentage fee than the all or nothing model, but allows the project developer to take all the money pledged during the crowdfunding campaign, whether the campaign goal is completely met or not. This approach is attractive because at least you get something for your effort, but you must choose the proffered perks carefully. You don’t want to get caught unable to provide, say, signed copies of a completed album, which would be financially difficult or impossible to deliver, if you didn’t collect enough money to make the project happen.
Some donation-based sites are curated, meaning the crowdfunding site’s organizers evaluate each proposed project to see if it satisfies their criteria. Curation may provide potential investors comfort that the project has been vetted and thus less of a potential risk. All comers sites, on the other hand, apply little to no project evaluation, leaving the project developer to prove legitimacy to the potential contributor.
Another variation among donation-based crowdfunding sites are those that provide value-added, or additional, services such as fulfillment or marketing and distribution opportunities. One-off crowdfunders, however, provide no follow-up, leaving you to make the project work once the funds are distributed. When evaluating whether to launch a donation-based crowdfunding project, consider these key issues:
- Make sure your offered goals and services can be delivered in a timely fashion; your donors will expect this.
- Include the costs of fulfillment (e.g., shipping signed copies of an album) when calculating the costs you need to over with the money raised.
- When opting for a cumulative cash fundraising arrangement, do not promise something you cannot deliver without full funding. It may potentially lessen your chance of repeat or new funding later. But also, most donation-based crowdfunding sites are used as conduits for goods and services in exchange for the contribution and are treated as such by the law. If you do not deliver on promises, you will be held responsible.
- Discuss with your accountant or tax advisor whether this income is taxable and thus requires you follow tax filing requirements.
- Plan on delays between the end of the fundraising cam- paign and when you receive the collected funds, as well as that you may never receive some pledged payments.
- Review how other similar, successful crowdfunding projects and use them as templates or models for how to successfully pitch for crowdfunding project.
Following the Rules: The JOBS Act’s Effect on Public Crowdfunding
Presented here are highlights of the SEC rules for public web-based crowdfunding offerings under the JOBS Act.
The rules, among other things, enable individuals to purchase securities in crowdfunding offerings subject to certain limits, require companies to disclose certain information about their business and securities offerings, and create a regulatory framework for the intermediaries facilitating crowdfunding transactions. More specifically, the recommended rules:
- Permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
- Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
- If either their annual income or net worth is less than $100,000, than the greater of:
- $2,000 or 5% of the lesser of their annual income or net worth.
- If both their annual income and net worth are equal to or more than $100,000, 10% of the lesser of their annual income or net worth.
- During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
- Securities purchased in a crowdfunding transaction generally cannot be resold for one year.
Disclosure by Companies
- The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
- A discussion of the company’s financial condition.
- Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless the company’s financial statements audited by an independent auditor are available.
- A description of the business and the use of proceeds from the offering.
- Information about officers and directors as well as owners of 20% or more of the company.
- Certain related-party transactions.
In addition, companies relying on the crowdfunding exemption would be required to file an annual report with the SEC and provide it to investors.
Complying with Legal Statutes
After deciding on the legal structure to use in raising the money for your project, you must make certain your efforts comply with state and federal law. California statutes require that (unless an exemption applies) the party raising and accepting investment capital must file documents with the Division of Corporations explaining, in part, the proposed investment project, how the money will be used, all of the risks in the venture, the investors’ financial ability, and the background of those seeking the funding. The commissioner must conclude that the proposed offer and sale is “fair, just, and equitable.” On an affirmative finding, the commissioner issues a permit authorizing the sale. A negative conclusion bars the sale. Most states have statutes imposing similar requirements.
Fundamental to any public or nonpublic offering of a security is disclosing to potential investors all inherent risks in the project, including that the project may fail, that no profit may be made, and the investors may never have their investment returned. In seeking investment money, you must disclose, in writing, the risks, the background of the principals (the people starting and running the business), the nature of the proposed business, the manner in which the money will be used, and the way the investor will share in any profits or losses. Also, the offer and sale of securities that involves an interstate transaction may require registering those securities with the Securities and Exchange Commission (SEC) in Washington, D.C. Obtain knowledgeable legal counsel before seeking to offer any securities.
State Law Exemptions
Under most states’ securities statutes and regulations, there are certain exemptions from the requirement to obtain a permit. These exemptions occur only in specific situations. Three common exemptions are the nonpublic partnership interest, the limited number of shareholder exemptions for corporations, and the nonpublic debt security (a promissory note for a loan). In California, a limited partnership interest, corporate shares, LLC units, or other security is presumed a nonpublic offering and not requiring a permit from the commissioner, provided: (l) the investment is not advertised; (2) no more than thirty-five investors contribute to the project; (3) the investor represents that he or she is purchasing the interest for his or her own account and not with the intent to distribute that interest to others; and (4) either the individuals investing the money have a preexisting business or personal relationship with you, or their professional financial advisor can reasonably be presumed to have the ability to protect their interests because of the advisor’s business experience.
In California a notice detailing information about the investment must be filed with the California Division of Corporations.
If the financing arrangement is to be in the form of a debt secured by a note, with the investor being paid from any proceeds from the venture, then the requirements just described must be met to qualify the arrangement as an exempt nonpublic debt offering under California law. However, such investments may not be taken from more than ten people.
This description is by necessity oversimplified and not intended to fully explain all the nuances and requirements of the security statutes and regulations, but merely to give you a sense of how the laws operate in general. There is no replacement for getting sophisticated legal counsel in these areas.
Identifying and Evaluating Sources of Income
If you lack your own money for your project and don’t have the collateral or credit to borrow money, and decide to seek investments but not crowdfund, you must deal with raising investment capital and comply with the appropriate securities statutes discussed above. Probably the most frustrating aspect of this quest is identifying an angel investor who will give you the money you need. Frequently, investors are attracted by the idea of putting money into entertainment projects because they desire to be associated with a so-called glamorous business, or they have read the entertainment industry can generate a substantial amount of money and wish to gamble that they will earn a great return if your project is successful.
For the most part, however, investment money usually comes from family, friends, or people who have seen your talent and basically want to help develop your potential. If you are lucky enough, a manager will be willing to invest in your career. If the money comes from family and friends, it is critical you act in a businesslike manner to help preserve your personal relationships.
Unfortunately, there is no one magic source of money. It is up to you to identify who has enough faith in your talents and future to make their money available. Other possible sources of money are investment counselors and accountants searching for reasonable business opportunities for their clients. In reviewing proposals for investments, financial advisors analyze the possibilities of the eventual return on investment (ROI) and associated tax benefits, if any.
Educating Investors about Risk
Once you have identified individuals willing to put money into your project, make certain you compare their expectations with your own. Educate your investors about the risks, possible rewards, and all potential problems and variables you may have little or no control over. Investors need to know how much money your project requires, to evaluate whether they can afford it. If they have any reservations, try to uncover what those reservations are. If their reservations cannot be resolved, do not accept money from them. Spend time talking with them, and make certain you really understand each other and that they are people with whom you want to be committed.
Measuring Fair Return for Profit Sharing
In discussing payback with the investor, essentially as profit sharing, you need to identify and explore three specific areas: (1) what will be the share of the investor’s participation; (2) how long will the investor participate; and (3) f0rom what sources of income will the investor be repaired? The argument an investor can make—and it is a good one—is that he or she is taking a substantial risk in putting money into your project that could be invested in other ways for a more certain return. As a consequence, the investor will insist on a very healthy return. This requirement is not unreasonable, provided it leaves you with enough to continue your life and career.
Measuring a fair return for or profit sharing with the investor is a function of how badly you need the money and how eager the investor is to put money into your project. The two sides of this proposition frequently determine how much each side is willing to offer and accept. Investors generally have alternative places to put their money for a good return, and if you have no other source of income for a project, you may not be in a position to do much negotiating. If you have to give up an amount you feel will hurt your business or ability to fund your career, then you should not accept the money; go look for another investor.
A more constructive way of measuring a reasonable return is to look at the amount of risk the investor assumes in relation to the amount of money invested; the smaller the number of dollars and the smaller the risk of failure, the smaller the return. For example, if your project cost $2 thousand, it would be hard to justify returning 10% of your income for life to an investor. A fairer return would be the return of the money plus an additional percentage, for example, 50% to 100%. If, however, the investor puts $200 thousand into your project, you can more easily justify committing a reasonable percentage of your income (e.g., 10% to 15%) to the investor, after out-of-pocket deductions, for a substantial period of time or until a return of a multiple of the original investment amount, whichever happens first, at which time the participation stops. Out-of-pocket deductions typically include payments to certain third parties, such as managers and business creditors, and documented ongoing business expenses incurred for your project.
A typical reasonable return agreement, then, might look like this: The investor puts $200 thousand into your project, you commit 10% to 15% of your income to the investor for three to five years or until a return of two to four times the original $200 thousand investment, whichever happens first, at which time the participation stops.
If the investment is for a specific project, such as a full album of your recorded musical performances, first dollars in minus ongoing expenses could be used to reimburse the investor, with additional money being split evenly until the investor has received two to three times the investment, and thereafter a reduced percentage (e.g., 20% to 25%) to the investor for as long as that recorded project is generating income, without any restrictions in time or for an additional defined time period, such as three to five more years.
You can determine the proper percentage to offer to an investor by looking at how much you can afford to give up. Remember, the money pie only has so many slices, and if you give up too many slices, you’ll be left with little to eat. Consequently, identify all of your existing commitments, such as those to managers, attorneys, other investors, partners, and the like. After you pay those people, you will still need money to run your business and support your personal needs. You must carefully analyze your income potential and anticipated expenses.
Also, specify the income sources from which the investor will be repaid. Will the money come from revenue the project generates or from other sources such as record sales, live performances, music publishing, or merchandising? Carefully consider these points before you commit to participation with an investor.
There are no simple answers. Deals can be structured in many ways. Your decisions depend on a business analysis of your funding sources, the urgency of your needs, the risks investors are taking, their alternative investment possibilities, and your other money commitments. Do your homework and be careful about the commitments you make. When in doubt, seek professional advice from a lawyer or accountant. If the deal does not make sense or does not feel good to you, trust your instincts and walk away. Do not be pressured into a commitment that may later hinder your career. In any event, be honest with yourself; figure out your goals, your value system, and what you are willing to give up or not. Only by taking all these factors into account can you arrive at a financial package that will work for you. Once you set up such a package, however, you may be able to accomplish career objectives otherwise beyond your reach.