So we have just looked into profit share agreements. Now we’ll have a closer look at the other common deal type, the royalty style deal.
In a royalty style deal, the label will not simply look at the total profit of the project and share a percentage of this with the artist. Instead, the label assigns designated royalty percentages to the different sales types and designated recoupment percentages to different cost types. It does not have to be complicated, the label could simply assign one royalty rate to all sales types and one cost recoupment rate to all cost types. Though some deals can become very granular, with a plethora of royalty rates being agreed for different sales in different formats and different territories.
So we’ve mentioned that a royalty deal means applying percentages. But applying percentages on what? There are different bases which may be used as the input of our calculations.
Digital royalties are most commonly calculated on the Net Receipts, but some artists may also have negotiated the royalties to be calculated on the Gross Receipts to protect themselves from any intermediates taking a cut in the payment chain. Physical royalties are often calculated as a percentage of the PPD or Retail Price, but just as commonly the agreement may say physical sales are calculated on the Net Receipts or Gross Receipts of the label.
Let’s say we are a label that just released an LP. Imagine a fan bought this LP at the physical store for £10, we set the PPD at £7, the physical store bought this LP from the distributor at a discounted price of £6, and that our distributor took a 20% commission on all earnings meaning we as the label in the end earned £4.8. If we agreed with our artists to report a royalty of 25% on all physical sales, the outcome may be very different depending on which calculation basis we agreed.
Royalty rates are the percentages of earnings that will be shared with the artists. A deal may be as simple as one agreed percentage that is applied on all sales types, but it may be as complex as a different percentage being applied on an excess of different conditions. Common conditions are -
So it may well be that a label pays a lower royalty rate on all physical sales versus digital sales. But more specifically, the agreement may also state a different royalty rate for subscription streaming revenue in the United Kingdom, for example.
It is usual practice for physical distributors to arrange a more than adequate stock to be sent to the physical retailers, as this is better than risking a loss in sales due to an inadequate stock (and some gossips may say because these physical units count towards chart statistics, so overstocking retailers increases your chances of chart success). Physical retailers do reserve the right to return any unsold stock to the distributors and claim a refund. So for the label to combat paying royalties to the artists which they will then have to take back in future periods, the label will hold back a portion of the royalties to pay out in future periods. Returns don’t exist in a digital sales context, so reserves are generally only applied on physical sales.
For example, let’s say we report to our artist half-yearly and that we’ve agreed a royalty rate of 25% for all physical sales and a reserve of 20% to be released in the following half-year. If we have £1,000 worth of sales in 2021H1, then we’d report £250 in royalties to the artist but keep £50 (equivalent to 20% of £250) as a reserve. We’d thus only pay our artist £200 this period and add £50 to our artist’s balance in 2021H2.
The contract may include a clause that lowers the royalty rate under certain conditions. These are known as Deductions. For example, the label may set out a deduction for any foreign physical sales, to cover additional distribution costs that go in hand with shipping units overseas. Another common example are the so-called “packaging deductions”, which are deductions applied to all physical sales to cover for the cost of packaging and breakages in shipping physical products.
For example, let’s imagine we have £1,000 in physical net receipts and that we have agreed with our artist a royalty rate of 25% and a packaging deduction of 15%. After applying the artist’s royalty rate, £250 is left on which a 15% deduction (equal to £37.5) is to be applied. So the final amount that is to be reported to our artist equals £212.50.
Ahead of a release, there are a great deal of unpredictable variables that decide whether a release may be a success or not. So some parties may negotiate a deal which is tied to the future success of the release. A higher royalty rate may be agreed for sales that surpass an agreed number of units or earnings. Or the royalty rate may increase once a certain date in the future has passed.
For example, let’s say our artist agreement dictates a royalty rate of 50% for all sales but that we increase this rate to 60% once the artist has earned over £10,000 in royalties. And let’s say that in our first half-year, our release has earned £50,000 in sales. Applying our agreed royalty rates, it means that our artist reached the threshold once the project earned £20,000 in sales (because applying our royalty rate of 50% to £20,000 matches the £10,000 threshold). On the remaining £30,000 in sales, a royalty rate of 60% is to be applied. All together, the result is a total royalty for our artist of £28,000 (which is equal to £20,000 x 50% + £30,000 x 60%).
As opposed to a Profit Share deal where costs are recouped from the total income, a Royalty style deal is characterised by the costs being recouped from the artist’s share at an agreed percentage. It is common for costs to be fully recouped from the artist’s balance, though it is possible that only a set percentage of some or all costs are recoupable from the artist.
Let’s say our artist agreement dictates a 50% royalty rate, a 50% cost recoupment rate for video costs and a 100% cost recoupment rate for all other cost types. If our project has £10,000 in sales, £1,000 in video costs and £5,000 in other cost types, the artist’s balance can be calculated as per below.
The sum of these amounts equals a balance of -£500 which can be recouped against the artist’s future royalties.
Let’s imagine we enter another agreement with our artist, The Cricket Bats, for their second EP. The details of this agreement are as per below.
Now let’s imagine in the first half of 2022, the below revenues are applicable.
And we have made the below upfront costs:
We now have all the data points we need to complete our royalty calculations. Since this is a brand new agreement, we are starting with an opening balance of 0. On this opening balance, the following transactions will apply.
If we take the sum of these calculations, the total artist balance equals £98.08, with a reserve of £149.52 still to be released in a future statement.
As per our agreement, we need to report an update to our artist by the end of September 2021. Below you can find an example of a statement that could have been reported to The Cricket Bats. To be transparent towards the artist, we would also provide a spreadsheet that outlines the detail of every single physical or digital sale and every single cost that the label has made upfront.