Understanding Royalties

Understanding how record royalties are computed is never as simple as merely applying one’s royalty percentage rate to the gross dollar amount derived from all album sales (less returns). Numerous factors are involved when computing an artist’s royalties, only one of which is the royalty percentage rate.

Language similar to the following is found in many agreements between a royalty earning party, such as a recording artist, and a royalty paying party, such as the production company. This language is also found in agreements between producer and production company, as well as between the record label/distributor and the artist, producer and/or production company:

Subject to your compliance with your obligations hereunder and except as otherwise provided herein, ANYCO will pay to you for the rights granted herein and for the services performed hereunder, the royalties set out below, being percentages of ninety (90%) percent of the Retail Price exclusive of taxes, duties, and the packaging deductions specified below of all records (other than videograms) manufactured, sold and not returned and for which ANYCO is paid, reproducing exclusively Masters recorded hereunder

Depending upon the variables in the clause above, and others throughout the contract, it is possible for a royalty earner with a ten percent (10%) royalty rate to conceivably have a better deal than one with a fifteen percent (15%) rate. For instance, the royalty percentage rate can be computed on either the wholesale price or on the suggested retail list price (SRLP). A royalty rate based on SRLP will generally be lower than the rate based on wholesale because of the substantial dollar difference between wholesale and retail price. This very basic royalty rate as described above, and prior to any deduction, is commonly referred to on the street as “points”.

Royalty paying companies use a variety of techniques in order to reduce their royalty payment obligations. In the sample clause above, the royalty rate is based upon ninety percent (90%) of the SRLP of net sales. Generally, this percentage basis may vary from as low as eighty five percent (85%) of SRLP to as high as one hundred percent (100%) depending upon the company. These decreases in percentages of sales are based upon outmoded deductions for “breakables”, left over from the time when many lacquer records were broken in transit.

Other deductions from royalties include packaging expenses allowances for free goods and cash reserves held over for anticipated product returns. Packaging deductions offset the costs of the box, sleeve, printing, liner, shrink wrap, and other aspects of packaging the product. The deductions may range from ten percent (10%) of the base price for long playing albums to twenty-five percent (25%) for compact discs and other newer formats. These deductions rarely, if ever, have any relation to the actual costs of packaging.

Recording and distribution companies will generally have the right to forego paying royalties on an amount of product which is given away for promotional or other free purposes. This “free goods” deduction can range between fifteen and thirty (15%-30%) percent, or even more, of all distributed product. The royalty earning party may try to limit the percentage of records that can be declared “free” (in order to sell more product and possibly earn some royalties), although this must be balanced by the need for free goods in order to promote the recording.

Reserves against returns are not really a deduction; it only seems that way. It is an accounting concept which seriously impacts the timetable of when to expect royalty payments. Record companies and/or their distributors typically withhold royalties to account for the probability of some returns of released product. The company paying royalties will generally seek complete discretion over the amount withheld. The company or artist receiving royalties may try to limit the amount to a percentage of all sales. The amount withheld is not truly a deduction because if returns are not substantial the reserved amount should eventually be distributed. The royalty earner should ensure that the paying company does not hold onto these funds for an unreasonably long time and that the percentage of funds withheld is not unreasonably large. In holding these reserve funds, the paying company will almost always keep the accumulated interest.

The royalty rate is further decreased through other means. Many recording agreements are still based upon the long playing album rate even though compact discs (CDs) predominate in the marketplace. Recordings sold as singles, cassettes, new recording formats such as Digital Audio Tape (DAT), budget product or through record clubs, will generally yield a lower royalty rate. Even compact discs are often discounted. Indeed, there are many agreements in which payments for CDs are still based upon the SRLP of long playing records.

Royalty earners will also generally receive a reduced royalty rate for foreign sales, typically between 50%-75% of the regular rate depending upon the territory. The rate will be on the lower end for countries with smaller markets, such as those in South America of Eastern Europe. Higher rates are often available for sales in Western European as well as Canada.

If you are a royalty earner, it is not really as bleak as it seems. Although royalties are significantly discounted, an earning party may qualify for increases as well. Substantial record sales may entitle a party to an increase in the royalty rate based on specific plateaus of record sales, such as Recording Industry Association of America (R.I.A.A.) certification for gold and/or platinum sales. Even if a contract does not call for these increases, it may be possible to renegotiate if the sales are seriously notable.

Remember, as we have pointed out in past articles, royalties will generally not be paid to a party until after a company has paid itself back, from royalties otherwise payable, for any advances and expenses for that party. This could take years. Even after recoupment, however, the company may continue to hold money in reserve accounts in anticipation of returns.
By: Bruce E. Colfin and Jeffrey E. Jacobson
© 2007 Jacobson & Colfin, P.C.

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