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Recording and Distribution Contracts with Independent Labels

Recording and Distribution Contracts with Independent Labels

by Edward (Ned) R. Hearn

An alternative to seeking a major-label recording contract or raising funds to produce your own recording is to approach independent record companies. Many independent record labels have become successful in reaching and developing niche markets. By researching these labels, you may find one that successfully markets music that fits your style and is interested in producing, manufacturing, and distributing your record.

Some independent labels have been so successful they have become subsidiaries of major recording labels, such as Def Jam (Universal), Aftermath (Interscope/Universal), Maverick (Warner Music Group), and LaFace and Zomba (Sony). Others have developed affiliations with major-label branch distribution, such as ATO (Sony/RCA, founded by Dave Matthews and Coran Capshaw), and Concord Music Group with Universal Music Group (Concord Records, Rounder Records, Fantasy, Razor and Tie, STAX, Wind-Up Records, Fearless Records, and Vanguard).

Small-Label Advantages

The chief advantages of releasing your album with independent record labels are similar to the reasons for signing with major labels. They generally have a distribution mechanism in place. They are organized to handle the time and costs of financing and administering the production, manufacture, marketing, and distribution of records. They can better absorb the financial risks and have more leverage in collecting money from the wholesalers and retailers of records. In addition, the company may have developed a reputation in the music community for a certain style of music and can move a respectable volume of records in a wide geographical territory.

Bear in mind, however, that if a small label invests time and money in your career and is successful in generating a reasonable level of income for you, you should carefully weigh the benefits of signing with a major label if asked, where you probably will be one of many, against staying with the smaller one, where you may be one of the stars. Far too often, the benefits of a smaller label are discovered only after an unhappy relationship with a major recording label occurs.

Much depends on the style of music involved. For example, pop and rock may get more attention from a major label than music aimed at more narrow and focused audiences, such as Americana, jazz, new age, children’s music, or folk songs. Both small and large labels have demonstrated effectiveness at marketing heavy metal, dance, electronic dance music (EDM), hip-hop, and rap music.

Contracts

Although contracts with independent labels can be similar to those negotiated with major labels, smaller independent companies sometimes work out arrangements that do not mirror the majors’ standards. For example, indie labels may be willing to step away from obtuse and confusing language. Instead, they can create a contract in plain English that balances the record company’s interests and those of the artist to more equitably share the economic benefits realized from the artist’s skills and talents and the recording company’s business expertise and mechanisms. This balance can be reached by either paying a respectable royalty or providing for a profit split.

Smaller labels, however, increasingly are reflecting the contractual style and approach of the major labels, including 360 deals or variations of 360 deals (see the chapter titled “How 360 Deals Became Necessary and How to Negotiate Them” for more detail). They want to protect their investment costs and attendant financial risks incurred in developing an artist. They want to ensure their contract with the artist is sufficiently strong so that a larger label will not be in a position to tempt the artist to switch labels without the smaller label approving and participating in the hoped-for benefits of that switch.

Many smaller labels also insist on participating in some or all of the music publishing income of the artist. This issue needs to be carefully examined, particularly with regard to income derived from digital platforms. Ideally, publishing or co- publishing arrangements should be made in a separate contract.

The sections that follow are some options with smaller labels that are not usually available to musicians signing with major labels.

Distribution Deals

In this type of deal, you deliver an agreed amount of packaged compact discs to a record company. Some labels only distribute your product, while you do the marketing and promotion; other labels do everything. Most distributor deals will require the right to distribute your recordings in physical, as well as digital, formats on an exclusive basis in a defined territory.

In a distribution-only deal, the record label will either contract directly with stores or deal with networks of independent distributors or both, selling to them at wholesale prices.

If the company only distributes your record, you will receive a sum equivalent to the wholesale price, minus a fee of 20% to 30% and other direct expenses that you authorize the company to spend, but you pay for all the manufacturing costs and all associated marketing and promotion costs. A standard contractual agreement is that you receive money only on records actually sold and paid for, and even then reserves against returns will be held for up to two years and sometimes longer for physical product sold. Digitally distributed tracks should not be subject to any reserves against returns, since they are paid for and can’t be returned.

These types of deals often result after bands release recordings in physical and digital media for a regional audience, find themselves with growing popularity, and use the added leverage to make a deal that will broaden their audiences.

Unlike major recording labels, independent labels sometimes encourage the sale of compact discs at performances or to fan mailing lists. In this case, a clause can be added to the standard recording contract that states the artists can sell their CDs at live performances or on their websites, with the principal caveat a distributor might have being that these artist sales must not interfere with the distributors’ own distribution networks. Most major recording labels actively discourage this practice.

Pressing and Distribution (P&D) Deals

In pressing and distribution (P&D) deals, you deliver a fully mixed recording master and artwork to the record label, which then assumes the responsibility of manufacturing and distributing your records in the form of compact discs—and vinyl, if you release your recordings in the vinyl medium. If the label advances the manufacturing costs, it will reimburse itself on a first-dollar-in basis out of the sales proceeds of your recordings, plus, perhaps, some value for the use of its money, in addition to a distribution fee.

If the record label also picks up promotion, publicity, and marketing, then the deal is usually structured as a royalty deal that will leave the record label with a sufficient margin to cover all of its costs and make a reasonable profit. Your royalty is sometimes higher than in standard recording contracts because you have already invested the costs of recording and producing. That is not always the case, however. When negotiating this type of deal, ask that any royalty percentages be specified as net cents per unit for each configuration for both physical product and digital deliveries so you will know just how much you are getting.

As an alternative, if the company provides marketing and promotion, these expenses also could be deducted as direct costs, along with the distribution fee and manufacturing costs, with the balance paid to you. But more likely the deal will be structured on a royalty basis, with a royalty of anywhere from 10% to 18% of retail, plus mechanical royalties on the music.

In either case, the label may encourage sales at live performances or on the artist’s website. In this case, as noted above, a clause should be inserted stating the wholesale price of the inventory, and perhaps advancing the cost of the physical inventory against artist earnings.

Production Deals

In this type of deal, you sign as an artist with a production company. The company is responsible for recording your music and for obtaining distribution through independent distributors or a record company. In many cases, contracts for these deals are structured similarly to record contracts because the production company will undertake to make a P&D deal with a record label that also includes marketing and promotion, and then contract with you to pay you a percentage of the royalty paid to it by the record company, say 50%.

A production company could have a deal with a record company that pays 14% to 18% of retail on records sold, depending in part on whether the recording costs are paid by the production company or advanced by the record company. The production company might also have contracted with the artist to pay a royalty of between 6% and 10% of retail or 50% to 60% of the royalty the record company pays the production company.

Net Profits Deals

Some indie labels have adopted policies of writing contracts with artists as 50-50 shares of net income in lieu of paying a royalty per unit sold. Once the label has recovered (recouped) all of its costs, the label then splits the remaining “net,” one-half to itself and one-half to the artist.

Whether this is a better deal for the artist will depend on the attitude and values of the people running the record company, how the term “net income” is defined, and, of course, the volume of sales and third-party license fees. The major part of the negotiation is nailing down costs. Easily defined costs are those that are fixed, such as manufacturing and packaging, and design costs. Some contracts provide “not-to-exceed” budgets for recording. Much harder to define are variable costs allocated for marketing, promotion, publicity, and distribution. Some labels also write in a percentage of income to be attributed to overhead, for example, 10%.

However, unless the record sells very well, many artists will not see any money on the sales of their records since there will be no net income. Of course, that often can be the case under the more traditional way of paying an artist a royalty per unit.

As there is a wide range of variables in these contracts, several examples of contract language are provided below, all with implications on actual net proceeds. For this reason, artists should seek out attorneys that have experience in making these types of deals.

Comparison of a 50-50 Net Profit Deal with a Royalty Deal

Examples below compare potential income on sales of 10,000 units using the following cost assumptions:

Recording—$20 thousand
Manufacturing—$10 thousand
Art and design—$4 thousand
Marketing—$5 thousand
Promotion —$6 thousand
Publicity —$5 thousand
Mechanical royalties (9.1 cents x 75% of statutory rate x twelve songs per album x 10 thousand units)—$8,190

Distribution and shipping—$2 thousand Miscellaneous—$2 thousand
Overhead (10% of $75,000 in sales at $7.50 per unit for 10 thousand units)—$7,500

Total costs—$69,690

Deal with a 50-50 Split of Net Profits

Assuming that all 10,000 units are sold and paid for with an average wholesale price of $7.50, the aggregate income is $75 thousand. After expenses of $69,690, on a 50-50 split, the artist would see one-half of $5,310, which is $2,655. In addition, If the artist owns all of the publishing, and his/her share of mechanicals was not included in the 50% split, the artist would get an additional $8,190 for mechanicals. Sometimes labels will not pay mechanicals for the compositions on the album owned and controlled by the artist’s publishing company and instead will provide that the artist’s 50% share is inclusive of mechanical royalties. In the latter case, then the $8,190 noted above as an expense would be added back to the profit of $5,310 for a total of $13,500, which then, on a 50-50 split, would net $6,750 for the artist. Clearly, the artist is better off with mechanical royalties treated as a cost that is paid in full to the artist, since the artist would get the $8,190 mechanical royalty plus $2,655 as the artist’s share of the profit split when mechanicals are included as part of the costs, for a total of $10,845.

Deal with 15% Royalty of Retail Sales Paid to Artist

A 15% of retail ($15.98) per unit royalty, with standard deductions and other take-aways (for example, 15% packaging deduction and 20% new technology deduction) would generally net down to approximately 9.5% of retail. In this deal, the artist would see an aggregate (gross) royalty of $15,181 (9.5% x $15.98 x 10,000), assuming no free goods (for example, 15 free CDs for every 100 CDs ordered, so a royalty would be paid on 85 CDs and not 100 CDs). After applying that amount to recoupment of recording costs of $20 thousand, and 50% of marketing, promotion, and publicity costs, which equals $7,500, remaining would be an unrecouped negative balance of $12,319, that is, $15,181–($20,000 + $7,500).

Obviously, in the comparison above, the 50-50 split is preferable. Even in this example, if the artist is getting the more traditional royalty, the artist generally would still be getting his or her mechanical royalties from the first unit sold, since mechanicals are not usually used to recoup recording costs and other recoupable expenditures. Those mechanicals would be $8,190 as computed in the above illustration.

Example of 50-50 Deal Favorable to Artist

An example of a 50-50 clause from a label, which provides some likelihood that the artist may actually see a 50% share of net follows. The profits and costs assumptions are the same as those provided in the boxed story comparison.

Royalty. On paid-for phonorecords of the Album sold by Company under this Agreement, Company shall pay Artist an all-in master royalty (i.e., inclusive of Artist, producer, and any other person providing services and for any samples used on the Masters), at the rate of fifty percent (50%) of Company’s Net Receipts.

The terms are defined below.

1. The Master Royalty shall be computed on phonorecords consisting entirely of Masters subject to this Agreement and based on the payments received by Company from its Net Sales of phonorecords of the Album and other uses of the Masters, such as uses in films, television shows, video games, etc.

2. Company will pay Artist a Master Royalty after Company has recovered all costs paid by Company from all income received by Company for the Masters and their marketing and distribution.

3. It shall be the responsibility of Artist to pay producers, and all third-party royalty participants, including for samples, from Artist’s share of the all-in Master Royalty described in this Agreement. 4. No Master Royalty shall be paid to Artist under this Agreement until Company has recouped from all income received by and derived from sales of phonorecords of the Masters and other uses of the Masters a sum equal to all of Company’s costs for:

(a) Recording and mastering all of the Masters under this Agreement
(b) Packaging and manufacturing
(c) Costs incurred and paid by Company to third parties from time to time for noncontrolled compositions (i.e., cover recordings of compositions written by others and for which the Company must pay a mechanical royalty to third-party publishers that own the publishing of the cover songs)
(d) Independent promotion and publicity support
(e) Special marketing procedures, such as, say, social-media interviews, YouTube-based videos, and electronic press kits
(f) Travel costs, accommodations, and meals of Artist in connection with fulfilling public relations and promotion activities
[Note: Artists can negotiate for amount limits on these costs and/or provide for an opportunity to mutually approve the budget for such costs, which, in turn, can be listed in a schedule that is attached to the Agreement.]
(g) Artist’s mechanical royalties for Controlled Compositions (note the illustration on this point in the prior paragraphs) will be included in Artist’s fifty-percent (50%) share of Net Receipts.
(h) The term “Net Sales” shall mean one hundred percent (100%) of sales for which Company has been paid, less returns, credits, and reasonable reserves against anticipated returns on physical product and credits, and less free goods as from time to time prescribed by the policies of Company or its primary distributors.
(i) The term “Net Receipts” shall mean all money paid to and received by Company for its sales of phonorecords and other uses of the Masters minus all of Company’s out-of-pocket costs incurred in connection with the Masters.

In the above example, the 50% allocation to the artist is a true split of net, and if the label does not overspend on marketing relative to paid-for sales, there is a reasonable likelihood that there will be some net for the label and artist to share at the end of the day, if sales are successful. The reason this contract is favorable to the artist is that all costs are recovered first, and then the balance, if any, is the net that is split.

Example of 50-50 Deal Favorable to Label

This deal provides little likelihood that the artist will see any 50% share of money:

Net Profits: We shall pay you the following Net Profits:

  1. “Gross Income” is hereby defined as all income received by us from all sources in connection with our commercial release of records embodying the Masters or any other exploitation of the Masters, prorated if applicable (but not including any any shipping- or handling-type charges received by us) and including any synchronization fees paid in respect to the Masters in the Territory, except as otherwise provided for herein.
    1. Unless otherwise specified herein, “Gross Expenses” is hereby defined as:
      (a) $1.10 per unit manufactured by us in eco-packs 4/1 folder, 4/0 tray card, 3 colors on compact disc (other configurations to be marked up at similar ratios); and
      (b) all expenses incurred by us related to all sales and marketing hereunder, including, but not limited to, artwork/packaging, photographs, shipping/mailing/courier service and supplies, phone costs, advertising, point-of-purchase displays and related costs, publicity, promotion, video production, additional manufacturing costs/overruns, taxes (e.g., sales tax and VAT, but excluding income tax), licensing costs and expenses, and collection fees. Notwithstanding the foregoing, you shall be charged the so-called published rates by companies with which we have procured discounts.

Further, notwithstanding the foregoing, you hereby acknowledge that the cost of administration of certain expenses (e.g., postage and supplies) would exceed the actual cost or expense of such materials, and therefore our estimate of such Expenses shall be conclusive and binding upon you. Prior to the release of each Album, you shall have reasonable approval of the total expenses to be deducted hereunder for each sales level, provided, however, in the event of a dispute between you and us in connection with such expenses, our decision shall be controlling.

  1. “Net Profits” (i.e., your share of Net Profits) is hereby defined as:

(a) 45% of the first $350 thousand of Gross Income in any one calendar year; and
(b) 60% of Gross Income which exceeds $350 thousand in any one calendar year;
(c) after deducting any and all Gross Expenses, returns, and reserves from such 45% or 60% share.

[This means that all expenses are taken from the artist’s share of Gross Income and not off the top; not a very attractive deal.]

  1. Product sold to you for your resale: We hereby agree to sell to you, solely for your resale at live concerts, a reasonable number of copies of any of your physical Albums distributed by us at a per unit price equal to $4.50, plus any shipping and credit card (if applicable) charges. All invoices must be prepaid. Any monies received by us in connection with this subparagraph shall not be included in Gross Income.
  2. Your share of Net Profits shall include all royalties and other monies payable to any producers, mixers, third-party publishers, or any other persons entitled to royalties and other monies payable in connection with the sale and other exploitation of the Masters (including, without limitation, mechanical and synchronization royalties). You hereby agree that your share of Net Profits as described in this paragraph is in lieu of all other royalties with respect to the sales of records embodying the Master(s), including, without limitation, any mechanical royalties which would otherwise be due and owing to you, and any other exploitation of the Masters hereunder.

In this example, all of the gross expenses incurred by the label are deducted from only the artist’s share of gross income rather than from the total gross income. So, while this deal is described by the label as a share of gross, all of the expenses are charged to the artist’s share, and the computation is much different from that provided in the first illustration, which is a true equal share of net.

Other Examples of 50-50 Contract Terms

In these examples, how terms are defined have major implications on the net income that the artist is likely to see.

  1. Master Royalty. Income from the Masters will be shared on a fifty-fifty (50-50) basis as further provided below, with 50% to Company and 50% to Artist and producers on Artist’s Masters on a Net Receipts basis (“Master Royalty”); i.e., after expenses as provided below, inclusive of Recording Costs for the Masters and other out-of-pocket expenses as provided below from gross income, before the 50-50 split is applied, computed on the payments received by Company from its Net Sales and Net Licensing Receipts for the Masters. Company will pay Artist the Master Royalty prospectively after Company has recovered from all income from the Masters its recoverable costs as further described below.

[This clause says that the company will cover all costs, and then, after it has recovered all costs from gross income, it will split the balance, that is, the net, with the artist.]

  1. Cost Recovery. No Master Royalty shall be paid to Artist under this Agreement until Company has recovered on the basis of all income received by and derived from the uses of the Masters, i.e., Net Receipts as a sum of Net Sales and Net Licensing Receipts, an amount equal to all of Company’s costs for recording (i.e., Recording Costs) and mastering all of the Masters under this Agreement, and all of the costs incurred and paid to third parties from time to time for special marketing procedures, such as, for example only, audio interviews and social media markets; videos; travel costs, accommodations, and meals of Artist in connection with fulfilling public relations, promotion activities, and tour support; and album packaging, manufacturing, and all other out-of-pocket costs and ongoing costs after recovery of initial costs detailed above related to the Masters.

Further, Artist shall reimburse Company for overpayments made to Artist on written notice and demand, or if Artist does not reimburse Company, Company shall have the right to recoup such overpayments from all Master Royalties and mechanical royalties otherwise payable to Artist under this Agreement.

[This clause means the company will tally all the up-front and ongoing costs it incurs and will account to the artist on those costs, which sometimes may be based on pre-approval, or at least pre-discussed budgets.]

  1. The term “Net Sales” shall mean 100% of sales for which Company has been paid, less returns, credits, and reasonable reserves against anticipated returns and credits, and less free goods as from time to time prescribed by the policies of Company or its primary distributors.

[This clause means the company will aggregate its income from all sales, both physical (subject to reserves against returns that may be held back for a time; for example, one year) and digital, and will add these sums to the calculation of net receipts (defined below).]

  1. The term “Net Licensing Receipts” shall mean all monies paid or credited to Company by Company’s licensees with respect to the Masters less Company’s following expenses: costs of collection; payments to third parties, such as mechanical royalties and producer payments; agent fees; shipping; taxes (other than income taxes); union and guild payments, including their trust funds.

[This clause means that when the company licenses the Masters to third parties, those license fees, less expenses, are included in gross income from which all company costs are deducted before arriving at Net Receipts (defined below).]

  1. The term “Net Receipts” shall mean all money paid to and received by Company from Net Sales and Net Licensing Receipts for its sales of phonorecords and other uses of the Masters minus all of Company’s costs incurred in connection with the Masters.

[This clause means that the company will determine net receipts by adding the sum of net sales and net licensing receipts, with the total applied against the company’s total costs for cost recovery. If the result leaves a net profit, then that net profit will be shared with the artist, and the artist’s share will be deemed the artist’s royalty. If the net receipts are less than the total costs to be shared with the artist, no royalty will be paid to the artist. The company would still be in the negative, as it will have spent more than the total income received.]

  1. The term “Recording Costs” shall mean (a) all costs (including wages, fees, advances, and payments of any nature) incurred with respect to the recording, preproduction, and production of Masters, including, without limitation, union scale, the costs of all instruments, musicians, vocalists, conductors, arrangers, orchestrators, copyists, and the like, payments required by law or any agreement between Company and any labor organization or trustee, sampling fees and costs, all studio costs, tape, editing, mixing, remixing, mastering to tape, engineering, costs of cutting references, living accommodations, travel, per diems, advances, production fees and/or advances (other than those paid to producers who are to receive royalties to recoup such fees/advances), rehearsal halls, costs of non-studio facilities and equipment dubbing, transportation of instruments, and all other costs and recoupable expenses incurred in producing the Masters hereunder which are customarily recognized as recording costs in the recording industry; and (b) per Master fees
    for producer services in amounts that Company reasonably deems appropriate and commercially reasonable within, from time to time, prevailing music industry marketplace parameters.

[Recording costs are one of the costs that the company will accrue, along with the other costs calculated in its cost recovery, to compute its total out-of-pocket costs to be recovered in the calculation of net receipts to determine whether there is a net profit to split with the artist.]

Arrangements on Digital Rights

Most independent labels, like major labels, insist on the right to handle the artist’s product not just in the physical medium, but also in the digital medium. Current digital outlets include Apple’s iTunes, Napster, Google Music, Amazon Digital, and the like, including downloads to computers and over-the-air downloads to mobile devices for both full track downloads (OTAs), ringtones, ringbacks, and other wireless uses, as well as streaming, which is an increasingly important income stream that is eroding sales of both physical product and downloads.

Most labels that work on a royalty basis will try to maintain the payment of just a royalty to the artist in the same way a royalty is paid on a physical sale, but generally without factoring in packaging deductions and free goods, since those elements are not relevant. The labels obviously get a good advantage on this approach, as they have no need to incur manufacturing, warehousing, shipping, or distribution costs. Payment of a 15% royalty on a 99-cent download (i.e., 15 cents), plus statutory mechanicals (namely, 9.1 cents, at the rate in effect as of January 1, 2016), leaves a nice margin for the label, with the digital music service downloader paying the label 70 cents on the download.

If the label goes to an aggregator that acts as an intermediary distributor for labels and artists who cannot get a direct deal with an iTunes or other digital music distributor, like The Orchard or TuneCore, then that label likely will pay the intermediary aggregator distributor about 15% to 20% as a fee for providing the “middle person” service. Even with an aggregator as part of the picture, the label on a 15% royalty to the artist is still doing very well, netting approximately 36 cents (70 cents minus 9.1 cents mechanical, minus 15 cents to the artist, minus 10 cents to the aggregator). Note the current mechanical royalty rate is under review, although it has been reported that, by agreement between the record labels and music publishers, the existing 9.1 cent mechanical royalty rate per song (or 1.75 cents per minute for recordings of songs greater than five minutes and zero seconds) for physical product and downloads, and 24 cents for ringtones, will be maintained through 2022, but there most likely will be a new formula that will be applied for computing streaming mechanicals to go into effect in 2018. We recommend that you periodically check from time to time the United States Copyright Office website (www.copyright.gov) for any adjustments to the compulsory mechanical royalty rate.

If the artist’s deal with the label, however, is for a 50-50 split of net, the artist will do much better than a royalty deal of 15%. On a 50-50 split of the net, even with an aggregator, the artist will see about 25 cents (70 cents minus 15% or 10 cents to the aggregator, minus 9.1-cent mechanicals, divided by 2), plus mechanicals at 9.1 cents, for a total of 34.5 cents, whereas with the royalty deal, the artist will see just 15 cents against a 99-cent retail download, plus the 9.1 cents for mechanicals if the song is the artist’s, for a total of 24.1 cents.

The other consideration to keep in mind is whether the label will account on a 50-50 split separately for the digital downloads or whether it will apply its receipts from that distribution mechanism against its costs in the physical medium. The former clearly is better, but not too likely. Some labels have taken the approach of distributing the product only digitally and leaving rights to sell the masters in physical media, such as CDs and vinyl (physical rights), at least to some extent, to the artist, and then reassume physical rights if the artist gets sufficiently established so that the costs of being in the physical market are more likely to be covered by receipts from that market.

Conclusion

With so many variables that can be structured in the deals between labels and artists, the use of an attorney to negotiate them is recommended. Equally important is trying to find the right indie label to partner with for the type of music you create.

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