|Net Profit Deals:
A Recent Alternative to the Traditional Record Deal
by Bart Day - Entertainment Attorney, October 2009
Back to The
Part One (of Three Parts)
In recent years there has been a rapidly increasing use of so-called "Net Profit Deals," as an alternative to the traditional type of record deal. This has been the particularly true with indie label record deals.
The basic idea is that any net profits will be split - usually 50-50 - between the artist and the record label, after ALL expenses connected with the artist's records have been deducted by (and reimbursed to) the label from record sales income.
Compare this with the traditional record deal, where the artist is paid on a royalty basis, with a typical artist royalty in the range of 12 to 15% (of the retail price) but sometimes higher (especially for more established artists).
Ten years ago, out of every ten indie record deals I negotiated, only one or two were Net Profit Deals. Today it's more like six or seven out of every ten, at least.
In this article, I will first compare the basic aspects of Net Profit Deals and traditional record deals, and the advantages and disadvantages of each, both for labels and for artists. Then I will show some sample royalty calculations for both. Finally, I will provide some detail about typical clauses in Net Profit Deal contracts, and how those clauses compare with traditional record deals.
The Basics of Net Profit Deals
To compute the net profits in a Net Profit Deal, the record company deducts off the top its actual out-of-pocket costs for recording, manufacturing, promotion, marketing, etc. Some labels also deduct a so-called "Overhead Fee" of 10 to 15% of the gross record sales income. After the record company deducts all of these expenses and reimburses itself, the label then pays the artist whatever percentage of the profits their contract requires (usually 50%).
Though this percentage is obviously much larger than the 12 to 15% royalty range mentioned above for traditional record deals, the artist in a Net Profit Deal is getting 50% of the income from records sold, but only what's left after ALL expenses are paid.
In traditional record deals, on the other hand, the artist starts getting their artist royalties after the record company has recouped the recording costs (and any cash advances to the artist) from the artist's royalties. The record company absorbs most other costs out of its own pocket - such as duplication, shipping and staff costs - and those costs don't factor into the calculations of what is to be paid to the artist.
A Brief Word About "360 Deals"
Net Profit Deals are also different from so-called "360 Deals," which so much has been written about lately.
A "360 Deal" is usually with a major label and has two components: (1) The first part of the 360 Deal contract pertains to record sales and contains basically the same terms as a traditional record deal, usually with the artist being paid on a "royalty" basis as described above; (2) The second part of the 360 Deal contract gives the label a right to receive a percentage of certain other income streams
which labels have not historically shared in, such as artists' touring and merchandising income.
There is no standard 360 Deal. The terms vary substantially from deal to deal, and from label to label. A lot depends on the track record and negotiating leverage of the artist, plus how much of an advance is being paid.
A "full" 360 Deal allows the label to share in all entertainment industry income, including touring, music publishing, merchandising, product endorsements, book publishing income (if the artist writes a book), and on and on. However, there are numerous 360 Deals that are not "full" 360 Deals; instead, the label shares in only certain types of income, such as touring and merchandising.
Usually the label's share of those non-record kinds of income is in the range of 10 to 20 percent, but for new artists it can get as high as 50 percent.
360 Deals are a bit complicated and will be dealt with in more depth in a future article.
Advantages/Disadvantages of "Net Profit Deals" for Labels
Advantages (for Labels)
In most Net Profit deals, the label doesn't have to pay the artist anything (including, under many contracts, even mechanical royalties) until the label has recouped all costs fronted by the label. This is, of course, appealing to labels, particularly in the current music business climate, when the foremost concern of labels are the front-end costs and just trying to survive financially.
Disadvantages (for Labels)
The main disadvantage of Net Profit Deals for labels is on the back end - that is, if the records are successful and the costs relatively small in comparison. In that scenario, the deal will be less profitable for the label than would be the case with a traditional record deal.
Advantages/Disadvantages of "Net Profit Deals" for Artists
Advantages (for Artists)
Net Profit deals can be attractive to artists as well, but for completely different reasons.
For one thing, if record sales are quite substantial and if the costs involved are reasonable in comparison to the income from sales, the artist may come out significantly better with a Net Profit Deal than with the traditional record deal.
Also, to many artists the idea of a 50-50 split of net profits seems inherently more fair and understandable than the voodoo economics of the traditional record deal. Plus, some artists prefer the general feel of a profit split situation, which can feel more like a partnering relationship and a more collaborative relationship with the label than is the case with the traditional artist-label relationship.
However, the appeal of a 50-50 relationship is somewhat dampened by the fact that even if the contract states that there is to be a 50-50 income split, in reality the label may be receiving more that 50% of the net income. This is because, as mentioned above, some labels deduct an "Overhead Fee" off the top, along with all other costs (such as recording, duplication, and promotion costs). Then, whatever is left
is divided 50-50. And so, the label is receiving an Overhead Fee off the top, AND 50-50 of whatever the "Net Income" is determined to be. (See the sample calculations below to see exactly how those calculations are done and how the "Overhead Fee" results in the label receiving more that 50% of the net profits.)
This is just one example of some of the subtle financial issues under the surface with Net Profit Deals. As a result, it is not always easy to determine in advance whether a Net Profit Deal will be more or less advantageous than a traditional record deal. Comparing the economics of Net Profit Deals to traditional record deals can be very confusing, and to a large extent, comparing "apples and oranges."
The only way to really analyze the financial ramifications of a Net Profit Deal versus a traditional record deal is to "spreadsheet it," based on a ballpark estimate of what the total expenses will be and what the sales levels will be. It is always crucial to "crunch the numbers." That being said, those projections can be difficult and problematical for an untested new artist with no prior record releases.
On the other hand, for artists with prior record releases, they can use the income and expense history of their prior records as an indicator of the likely income and expenses for their next record and do the necessary projections accordingly.
Incidentally, if you are an artist, you need to discuss a pending Net Profit Deal with your publisher (if you have been signed to a publishing deal), and with any co-writers, since these mechanical royalty provisions in Net Profit Deals may seriously affect their income. Also, you need to clear the royalty provisions with any producers whom you have hired directly (as opposed to a situation in which the record company has
hired the producer and has agreed to pay the producer separately from any monies owed to you as an artist). Otherwise, the situation is fraught with potential legal and relationship problems.
Disadvantages (for Artists)
Net Profit Deals also present certain disadvantages for artists, including the following:
1) Mechanical Royalty Issues: In a traditional record deal situation, artists who write songs for their own records are entitled to receive mechanical royalties ("mechanicals") on all record sales on a quarterly or semi-annual basis. These mechanical royalties are paid by the label in addition to the 12-15% artist royalties mentioned above and are a crucial source of cash flow for most artists.
In the case of Net Profit Deals, though, mechanical royalties are handled differently, usually in one of two ways:
(A) Either the mechanical royalties will be paid similarly to how they are paid in a Traditional Record Deal context, but the amount of mechanical royalties paid to the artist will be treated as an advance to the artist and later deducted from the artist's share of the net profits (if any); OR
(B) No separate mechanical royalties will be paid to the artist for their original material. Instead, the artist will receive only a share of net profits, and no separate mechanical royalty payments. The contract will usually say something like; "All monies payable to Artist hereunder shall be inclusive of any mechanical royalties which would otherwise be payable to Artist."
In this latter instance, the artist does not have the benefit of the cash flow from mechanical royalties that would be paid in the case of a traditional recording agreement.
The problems caused by this lack of cash flow are compounded by the fact that usually the label is spending money faster than it comes in. Therefore, even if there are eventually net profits from the record, it will likely take quite some time before the artist receives a share of the net profits, since in the case of a successful record the label is usually spending money faster than it is coming in. And in the worst case
scenario - i.e., situations where no net profits ever materialize - the artist will receive ZERO money from the deal (i.e., no ARTIST royalties and no MECHANICAL royalties).
2) Audit Issues: Another potential disadvantage of Net Profit Deals is that it is much more difficult and cumbersome for artists to do a royalty audit with Net Profit Deals than with traditional record deals, all other things being equal. This is because, in the case of Net Profit Deals, the only way that an artist can know whether they have been paid the proper amount is by verifying ALL income and ALL expenses
that the label incurred. On the other hand, in the case of the traditional record deal, the artist needs to verify only the income received and certain limited kinds of expenses (primarily just recording costs and independent marketing and promotion costs), and not all expenses. Remember too that audits can be very expensive, easily costing around $15,000 to $20,000 dollars (and often much more, particularly in the case of major label artists having substantial sales).
In any event, it is still wise for artists to make sure that their Net Profit Deal contract provides strong audit rights and provides that if the label's accounting statements are off by a certain percentage, the label will then be obligated to reimburse the artist for any audit costs incurred.
3) Merchandising: Frequently in Net Profit Deals the label will have the right, for example, to create and sell a new T-shirt for each record released during the term of the deal. Those T-shirts are then sold from the label's website and the other usual channels. The band then shares in the net profits from those sales.
However, the label's sale of such T-shirts tends to reduce/cannibalize the artist's sale of its own T-shirts. And since merchandise income is such a big part of surviving on the road, any band entering into a Net Profit Deal needs to either try to avoid giving the label the right to sell such T-shirts and similar merchandise, or at the very least, negotiate the best possible contractual rights and protections in regards to
future label-created merchandise.
4) "Overhead Fees" (aka "Administration Fees" and "Marketing Fees"): From an artist's point of view, these "Overhead Fees" are questionable, since the label is already entitled to receive 50% of any net profits. Sometimes these fees can either be removed entirely from the contract, or the percentage reduced, when the deal is being negotiated.
Continues in Part Two: Some Sample Royalty Calculations
Editor's Note: Bart Day is a veteran entertainment attorney and represents numerous national recording artists, publishers, labels, managers, producers, and others active in the music industry. He has a Portland, Oregon-based entertainment law practice and presently divides his time between Portland and Los Angeles.
From 2002-2008, Bart was the Vice-President of Legal and Business Affairs for Media Creature Music, a prominent Los Angeles music publisher and catalog administration company specializing in the licensing of music for film and television productions. He has also been outside music counsel for a number of major entertainment companies, including Vivendi Universal Games, the computer games unit of Universal Studios, and counsel
for a major concert promotion company.
From 2000 to 2004, Bart served two terms as an elected member of the Governing Board of the Recording Academy, Pacific NW Chapter, presenter of the Grammy Awards.
Bart co-authored a chapter ("Contracts and Relationships between Major Labels and Independent Labels") in "The Musician's Business and Legal Guide," a book compiled by the Beverly Hills Bar Association and published internationally by Prentice-Hall Publishing (New York). He also recently co-authored with Chris Knab (founder of 415/Columbia Records) the book "Music
Is Your Business: The Musician's FourFront Strategy for Success," published in late 2007. It is available for purchase at musicbizacademy.com
Bart can be reached at 503-224-4900 and by email at firstname.lastname@example.org.
More information about Bart can be obtained at: http://www.avvo.com/attorneys/97204-or-bartley-day-1490758.html.
DISCLAIMER: The reader is cautioned to seek the advice of the reader's own attorney concerning the applicability of the general principles discussed in this article to the reader's own activities. This article does not constitute legal advice, and should not be relied on, since each state has different laws, each situation is fact specific, and it is impossible to adequately evaluate a contract or legal problem without
comprehensive consultation and a thorough review of all the facts and documents at issue.
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