How does the math of a record deal work?
The answer can vary significantly depending on the leverage of the artist and label. But I'm going to go through some math using numbers from an actual recording contract from a popular record label. The contract is from... the 21st century. It doesn’t seem that this artist was very popular when they signed.
(From my research, it seems like the deal described in this post is a commonly-used structure for newer artists signing with popular labels and it is similar to the types of record deals that Donald Passman describes in his book, "All You Need to Know About the Music Business".
Also, I made a post about the math behind record deal advances and recoupment. The purpose of that post was not to show all of the math of a record deal. It was to show how much an artist would potentially keep from a $100,000 advance and how much their music would have to generate to pay it back. This post does include additional label expenses.)
Recording Commitment and Master Royalties
This artist signs with the record label and agrees to record an EP. This contract allows the label to potentially ask for the first release to be an album instead of an EP. So for this post, I'll assume it's an album. The label also has options for the artist to record up to 5 additional albums. So it's potentially a 6-album deal. The artist grants all of their ownership of the sound recording copyrights aka the masters to the record label.
The artist's base master royalty for streams and sales is 15% for the first two albums, 16% for the next two, and 17% for the next two. For streams, this royalty is applied to the record label's net receipts. For sales, this royalty is applied to a wholesale price. For sync licensing, the artist would receive 50% of the label's net receipts.
There are 3 major caveats.
One, if a music producer or audio engineer receives points on the master, then those points would come out of the artist's share. So if the artist is getting 15% and a producer receives 3 points, then the artist's share drops to 12%. This type of arrangement means that the artist's master royalty is all-in.
Two, the artist receives a reduce royalty rate for sales outside of the U.S. For sales in Canada, they'd receive 90% of their U.S. rate. For Japan, Australia, New Zealand, and much of Europe they'd received 80% of their U.S. rate. And for other countries they'd receive 66 2/3% of their U.S. rate.
Three, if records are sold at a significant wholesale discount, then the artist's royalty rate would be reduced. So not only would the record be sold at a lower price, the artist would also get a lower percentage of it. Records sold at or near the full wholesale price are considered topline. For midline records, they'd get 75% of their full rate. For budget records, they'd get 50% of their full rate. For records sold for lower than budget or given away for free, the artist would receive no royalty.
(The contract I saw had "only" 40 pages. Some of the latter pages with important definitions seem to have been left out (including the discount percentage that defined the boundary between topline and midline records and the definition of "net sales".) However, I've read similar contracts before, so I had a good idea of what they meant. Typically a record is considered midline if it is sold at around 65% to 80% of the full topline price. Lower than that but not lower than 50% of the full topline price would be considered budget.)
The artist can receive up to three separate 0.5% royalty rate increases for album sales above 250,000, 500,000, and 1,000,000 sales. But the only sales that count towards these thresholds are U.S. Top Line Net Sales.
Expenses
So that's how the master royalties were split. What about the expenses?
Typically a record label will front all of the money for expenses. The question then becomes, "How much of these expenses will count against the labels share of the royalties vs the artist's share?" Since this label is getting over 80% of the royalties, it would make since for that same percentage of the expenses to count against their share. However, that is not what record labels typically do. In this contract, the vast majority of the expenses are recoupable from the artist's share of the royalties. This effectively makes the artist's royalty even smaller. Having a disproportionately high portion of the expenses count against the artist's share enables a record label to potentially make a significant profit even if the artist hasn't fully recouped.
The following costs are recoupable from the artist's share of the royalties.
- 100% of recording costs.
- 100% of excess packaging costs are recoupable from the artist's share. (It seems the label counts normal packaging costs against its share of the royalties. From my research, the cost to make one CD and its packaging is typically well under $1.00. For streams, there might not be any packaging costs save for perhaps artwork.)
- 50% of video costs up to $100,000. 100% of video costs above that amount.
- 50% of all television, radio, print, and movie theater advertising campaigns. (Excluded from this are direct response television campaigns.)
- 50% of independent promotion costs paid to third-parties.
- 100% of independent publicity and/or independent marketing costs.
- 100% of costs paid by the label in connection with live public performances by the artist.
- 100% of costs paid by the label for the artist's professional development such as vocal coaching, acting lessons, choreography lessons, personal trainers, cosmetic dental work, etc.
- 100% of costs paid by the label for clothing, jewelry, hair, and makeup.
- 50% of enhanced material costs, mobile material costs, and artist website costs.
- However, 0% of label payments to the AFM Special Payments Fund and the Music Performance Trust Fund will be recoupable.
There is also an advance, and I'll get to that, but just this structure alone is important. If there were no advance and the artist only ever made 1 album, then the only way the artist would make any master royalties from that album is if their, at best, 15% master royalty fully recouped somewhere between 50% to 100% of the expenses.
So if the label spent $100 on expenses and the artist had to recoup 75% of it, then the label would make that money back when the album generated $100 (the label would pocket its 85% and the 15% that would have otherwise gone to the artist.), but the artist wouldn't fully recoup until the album generated at least $500. ($75 is 15% of $500.)
If the artist bore expenses in proportion to their base royalty, in other words, if the label spent $100 on expenses and the artist had to recoup 15% of it, then the label would still make that money back when the album generated $100 (the label would pocket its 85% and the 15% that would have otherwise gone to the artist), but the artist would also fully recoup at that same point. $15 is 15% of $100.)
So one 85/15 royalty split may not be equivalent to another. How the expenses are split can make a big difference in how much money the artist makes. If the album in these two scenarios only generated $1,000, then in scenario 1, the artist would receive 15% of $500 and in scenario 2, the artist would receive 15% of $900. If the album only generated $500, then the artist wouldn't make any money in scenario 1 even though the label made $400.
Some record labels may understand that this structure would likely be more scrutinized and not last long if the artists didn't receive at least some master royalties in exchange for the rights they gave up. This may be one of the reasons that many record labels also offer artists an advance.
Advances and Cross-Collateralization
For the first album, the label gives this artist a $60,000 advance. (If the first release was an EP, the advance would be $35,000. If the first release was an album, the advance would be $60,000.) This advance is fully recoupable from the artist's share of the royalties. Advances are not loans. In most scenarios, advances and other recoupable expenses do not have to be paid back out of the artist's pocket even if the music does not generate enough money for the artist to fully recoup. This advance would be considered taxable income for the artist and they may need to pay a lawyer and manager from it.
For each of the next 5 albums, the artist would receive 6-figure advances based on a min-max formula.
Basically, if the label picks up an option, then it commits to a minimum advance size, but there is also a performance-based formula that would be used instead if it would result in a higher advance for the artist. However, there is also a cap on high that advance would be allowed to be.
The minimum amounts are $250,000, $250,000, $275,000, $300,000, and $350,000.
The formula has two components. Basically, 70% of the average royalties earned by the artist on US Top Line Net Sales of the last album or 70% of the average royalties earned by the artist on the last two albums, whichever is greater.
The maximum amounts are $500,000, $500,000, $550,000, $600,000, and $700,000.
(There are some caveats to that advance formula. Also, it wasn't clear to me how that formula would work for the first option period if the first release was an EP and not an album.)
The albums would all be cross-collateralized. So unrecouped expenses from one album would count against the other albums. So if there are $100,000 in unrecouped expenses for Album 1, then even if the artist fully recouped Album 2, they would have to also recoup an additional $100,000 to make up for Album 1 before they would receive any master royalties for albums 1 or 2. However, even if the artist is unrecouped, a record label may still have made a significant profit and they would still give the artist the agreed upon advances.
There's also a controlled composition clause that pertains to mechanical royalties, a type of publishing royalty.
Controlled Composition Clauses
I made a video about these which can be found on my TikTok page, but basically in order to reproduce and publicly distribute a sound recording of a musical work they don't own and that is not public domain, a record label needs a mechanical license for that musical work. In exchange for that license, they pay mechanical royalties.
Mechanical royalties are a type of publishing royalty (and thus separate from a master royalty). They are typically paid to songwriters, music producers (who typically also receive master royalties), and music publishers. If the artist also writes and produces the music they record for the label, then they would be owed publishing royalties. The label would pay them mechanical royalties in addition to their record deal master royalties.
A controlled composition clause essentially sets a cap on how much mechanical royalties the label would have to pay for an album, EP, or single.
In this deal, the cap for albums is 11 x 100% of the minimum statutory rate (which is currently $0.12 per song, but was lower at the time this contract was signed; also the minimum statutory rate is not the same as the full statutory rate because the former does not include the latter's higher rates for songs over 5 minutes). These numbers are better than typical, but there are also additional provisions that would reduce the mechanical royalties further.
If the mechanical royalties exceed the cap, then the label can deduct the excess from the artist's master royalties. So these clauses may put pressure on the artist to put pressure on the songwriters and music producers they collab with to accept lower mechanical royalty rates.
The Digital Performance Right in Sound Recordings Act of 1995 prevents controlled composition clauses from applying to digital sales and streams for most recording contracts made after July 25, 1995.
Recoupment Example
Here is an example of what it would take for this artist to fully recoup Album 1 from interactive streams alone.
For that album, the artist has a 15% base master royalty. I'll assume they don't produce their own music and give music producers an average of 3 points on the master. The producer's points to would come out of the artist's share leaving them with 12%.
For that album, the artist would receive a $60,000 advance that is 100% recoupable and I'll assume the label spends $40,000 on recording expenses that are 100% recoupable and $100,000 on other expenses, such as marketing, that average to 75% recoupable. So the label spent $200,000 and $175,000 of it is recoupable from the artist's share of the royalty.
For a 12% master royalty to fully recoup $175,000, the artist's music would have to generate about $1,458,333 in master royalties.
Interactive streams pay about $0.005 per stream. Typically, about 75 to 82 percent of that are master royalties and the rest are publishing royalties which would not help the artist recoup their record deal. So if 78.5% of the streaming payout is a master royalty and 12% of that goes towards the artist's recoupment, then it would take about 371,549,894 interactive streams for the artist to fully recoup from interactive streams alone. ($175,000 / $0.000471 ≈ 371,549,894)
- At that point only master-side revenue that the artist would have received would've been the $60,000 advance less taxes and potentially lawyers' fees and manager's fees. If the artist also contributed to the writing or production, then they may have also received publishing royalties, though 15 to 50 percent of those would likely be shared with a music publisher.
- The music producer would get 3% of $1,458,333, which is about $43,750. And they would probably also receive a portion of the publishing royalties... also likely shared with a music publisher.
- The record label would get the other 97% of $1,458,333. (Its 85% plus the 12% that would have otherwise gone to the artist.) So the label would receive $1,414,583. Subtracting the $200,000 they previously spent, would leave about $1,214,583. The label's taxes would depend on the performance of its entire business.
So the label could've potentially made a significant profit even if the artist didn't fully recoup. And even if the artist does fully recoup, the label would still own the sound recording copyrights. The advance was likely the artist's primary incentive to give up copyright ownership, but that advance is recoupable from their future royalties.
Since all of the potential albums of the record deal are cross-collateralized, then if Album 1 doesn't fully recoup but the label picks up its option for Album 2, then Album 1's unrecouped balance would also count against Album 2. This artist would receive a minimum advance of $250,000 for Album 2, but if they don't fully recoup the cross-collateralized amounts, then the only master side revenue they may ever receive would be the advances.
Giving advances is a risk for the label, but also, for labels seeking the kinds of deals this post describe, deals where the label owns 100% of the sound recording copyrights and receive the vast majority of the master royalties while also counting the vast majority of the expenses against the artist, such deal would likely be more scrutinized if the label didn't offer an advance. Otherwise many signed artists may give up a lot of rights and do a lot of work to promote albums and yet never fully recoup and receive master royalties under this structure even as the label, in many cases, still made a significant profit. Those kinds of lopsided results could result in a lot of negative PR for a label.
So to make an analogy of a much smaller magnitude, it's kind of like someone wanting to start a lemonade stand and buying lemons, sugar, and cups. Yeah its a risk, but it's also kind of necessary for the type of business they want to run.
(Note: there are other types of record deal royalty structures than the type described in this post. Two examples are net profit (where artist typically receives about 40 to 60 percent of the profit) and net proceeds (essentially Revenue - Expenses - Label Fees = Net Proceeds which the artist would receive all of). Net Proceeds are more common with distribution deals which is a type of record deal that is more common with very popular artists.)
To learn how the publishing royalties and master royalties for music streaming are calculated, check out my ebook, How Interactive Streaming Royalties Are Calculated & Paid (2nd Edition).
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