Venture Deals and the Music Business
Illustration by The Ringer/36 States
The one constant in the business of music is the negotiation of contracts between artists and record labels. Record labels commit a specified amount of capital to artists, while the newly signed artists work on delivering an album that recoups the initial investment by the record label and provides residual income for the artist well into the future.
The terms of the contracts will spell out the expectations for the artist, which includes but is not limited to delivering a certain number of albums usually greater than one. The artist works to accelerate the maturity of the contract through chart topping singles and albums to continue being placed on the priority list for the record label until they are able to renegotiate better terms. The relationship ended with the artist delivering the albums, while the road shows, merchandise and hosting duties were off limits to the record label.
In the late 90s when the streaming platforms such as Napster and Kazaa came into the market, consumers stopped purchasing albums and resorted to piracy. A group of executives sort to alleviate the dying market for the purchasing of albums by developing a plan to tie their capital to the diverse sources of income generated by the artist, and separate from the album sales, resulting in the contract known as the 360 deal.
You may wonder why artists commit themselves to a 360 given that the other sources of income while derived from the released album is usually created and managed by the artist and his or her team.. The problem with many artists is that they place more thought into their upside on a contract rather than their downside, according to Alex Danco, venture capitalist working with Social Capital venture firm in San Francisco. Veteran artists realize their failure after their first contract and renegotiate, however, the new artists continue to fail at protecting their downsides. While we have moved away from the days where consumers visit record stores such as HMV, streaming platforms such as Spotify, Apple Music and Tidal are the new profit oriented Napsters of this decade, and without the knowledge of what exactly they are signing, artists may find themselves negotiating away their future cash flows from their initial contracts.
I have written in the past about the similarities between venture capital deals and Blum Production Company. And in that piece I discussed the methods used by the production house, which is to invest in many projects and hope that a few of those films turns into a hit that more than covers the losses of the failures in the film portfolio.
To compare venture capital deals to the music business contracts, you come to find out the similarities in the two different worlds. . In a music contract an artist is offered a deal by the record label for example, $100,000 and a 10% royalty fee – the advance will cover the cost of making the album and the royalty payment from record sales will be used to recover the advance before the artists sniffs any more proceeds from the album. Usually, the artist who has committed their own money to producing the album will push back on the label and ask for a bigger advance, say $200,000. The label rightfully may agree, but will ask for a lower royalty fee at 8%. What the artist has now done is protect their upside, which is the advance but the downside is unprotected and will have to sell a lot more records to recover the advance.
The interesting thing about venture capital deals is that a founder of a startup would never agree to such a deal. For example, if the valuation of a startup before the investment is $4 million and $5 million after the investment, the founder would likely agree to a 1x liquidation upon the exit of the startup either through an IPO or strategic sale. However, what a founder would never do is ask for more upfront investment at $5 million valuation for $2.5 million and a 2x liquidation preference. This means the venture firm will receive $5 million first upon liquidation before the founders of the company make any money from the sale. If you can imagine a scenario where the company sells for less than $5 million, say $4 million, the founder essentially pocket zero dollars. This is what artists are negotiating, which means the downside is not protected upon signing a contract.
If you pay attention to albums and dissect what is happening with new releases, you should realize that artists are providing a lot more songs on each of their releases. In the 90s and early 2000s, if an artist has more than 14 songs on an album, I would conclude that the album is probably thrash, however today that is more of a pragmatic business move than trying to dump records on an album. Artists, I believe, have signed contracts that has tied them to ridiculous streaming numbers in order to recoup their album advances.
There are nine different sources that will be paid before the artists is able to obtain any proceeds from one stream of a record. The following players in the system all get paid before the artist – they include Spotify and administration, record labels, PROs (Performing Rights Obligations), publishing company, producer, songwriter and then the artist. The allocation of the revenue usually is 60% up to and before the publishing company and 40% from the publishing company down to the artist. In a great case scenario where the artist retains rights to their masters, composition and publishing, they might be able to retain 10%-15% of each dollar made on a streamed record. To recover $100,000, the artist needs to have at least ten million listens on the record before they claim any residuals from streaming. This simply sucks for most artist, and results in the dumping of tracks on albums just to meet the required streaming figures to recoup their debt to the label.
When contracts are not open to public scrutiny nor do we get a detailed breakdown of costs of producing an album, artists are promoting to fans without a proper context. I am particularly concerned for the new Afrobeat artists who are looking to get on quickly without truly understanding what is in their contracts. American labels are looking at investing into the Afrobeats genre, which is clear through some of the collaborations that artists such as Drake and Chris Brown have featured or lead on. Afrobeats artists need to educate themselves on the terms of contracts and stay up to date on the changing landscape of the business of music, especially because of the implication of streaming. Is it a good idea to release twenty-five songs on an album, which is effectively two albums just because of an inappropriate downside negotiation by the artist and his legal team? Or should artist forgo the big advance to reduce their risk of not only making more music to satisfy a portion of their contract, while losing on the streaming, merchandising and hosting revenue because of a 360 deal? I cannot make a judgment call because each artist is different but I believe the latter is the better approach.
An artist cannot avoid competition in the industry and with the growing popularity of Afrobeats, the competition is not only among African artists, but also Americans who are realizing the untapped market opportunity to attract African fans. Drake is one of the megastars to first do this, but Chris Brown and Wale have also led the charge. How then can young African Afrobeats artists protect themselves from the downside of contract negotiations to ensure that they maximize their earnings during the peak season for the genre.
The industry is small and the group of lawyers that manage many of your favorite artists is also a smaller pool of individuals and firms. The goal for a young Afrobeats artist is to find their own legal representation outside of the entertainment community to at least perform a proper due diligence on the contracts that are negotiated. The independent lawyer can be hired on a contractual basis for specific procedures or permanently as part of the team. This is obviously additional cost to the artist; however, it can help the artist maintain their power in the negotiation and avoid short term gains at the expense of long term earning potential.
Negotiate both upside and downside
I mentioned above that there are similarities between a startup founder and an artist, however, founders have more resources to learn about the negotiation and the terms of their deals with venture capitalists. Musicians and artist are more engaged with their art and let others handle their business. This needs to change, but in the interim artist should ask about the upside and the downside of the deals they are signing.
Artists want to create and this requires that they hand off much of their administrative duties to a team. What this leads to is disbursement of funds that could be kept in-house rather than outsourced. For example, if an artist manages their publishing internally, they can potentially make the higher end of the average per play on Spotify, compared to an artist who outsource their publishing who land in the low end of the average in terms of revenue per play.
The business of music will continue to take advantage of new artists, while the ones that are able to make it past their first contract will renegotiate more fairly to protect their upside and downside. The goal for the next wave of artists whether in Hip Hop or Afrobeat is to temper their excitement of signing a contract with taking control of some of the administrative duties to lower the cash outflow of their revenue from the streaming platforms.