Recording contracts are extremely complex and it’s almost impossible to explain all possible provisions a contract might contain in simple terms. If an artist finds his or her self presented with a recording contract the absolutely most important thing to do is to find an attorney with experience in the music business (not a cousin’s friend who closes real estate contracts for a living) to review the agreement and negotiate on their behalf with the record company’s legal department or outside attorney. Recording contracts are written by the record labels and their attorneys and can be structured as less than advantageous for the artist.

The standard agreement works like this: In exchange for the exclusive rights to the artist’s sound recordings the record label will pay the artist royalties from sales , usually a percentage (10% for example) of either the retail price of the record or the price the record company gets from it’s distribution partner (wholesale price). Even though this sounds pretty straight forward there are several negotiated points in the recording contract that affect how the royalties from sales are actually paid to the artist.

The record company also typically provides an upfront fee (known as an advance) to the artist to cover the costs of recording, producing, mixing and mastering the record. Money leftover from the advance after all the costs of recording are paid for can end up in the artist’s pocket. Artists typically get an advance for each new record they make. It’s in the artist’s best financial interest to negotiate the largest advance possible and keep recording costs low since it is very common (as you’ll see in a moment) for them to never see any royalties from sales unless the record is a very big seller.

Recording contracts are usually structured so that almost all the expenses the record label incurs related to the record are charged against any royalties the artist might earn. Artists are not actually paid any royalties from sales until the record label has covered or recouped their expenses from making the record.  Recoupable expenses can include: the artist’s advance, recording & producing costs, the costs of promoting, marketing and advertising the record, tour support, video production, packaging, manufacturing, shipping, warehousing expenses and mechanical royalties paid to songwriters.

The advance and recoupable expenses are not the only items that affect royalties from sales payments. Some other deductions (money withheld) that negatively impact royalties from sales include:

Packaging – It is common for recording contracts to include a deduction for packaging costs of the CD. This deduction can be quite high, 25% is common.

Free goods – Record companies and their distributors will often time include free copies of the CD as an incentive to place an order instead of discounting the price retailers have to pay on a per CD basis. Retailers will be able to sell these free copies without having to pay for them. If the retailers and distributors don’t pay the record company for these free copies the recording contract will often stipulate that the artist don’t get paid on free goods.

Promotional copies – To help promote the CD release with radio stations, retailers, online outlets, magazines and newspapers the record label will send out free promotional copies of the CD to help build interest in the release. The promotional copies of the CD usually are not part of the artist’s royalty calculation.

Return reserve – A record is not considered sold once it’s shipped from the distributor to the retailer. Retailers have the right to return any and all unsold copies back to the distributor without paying for them. Since it takes some time to determine what has actually sold at the retail level record companies will hold back a percentage of the sales (35% for example) from royalty payments.

A few additional deal points:

Options – Options are the number of records the record company can release by the artist (5 for example) under the terms of the existing contract. The artists are committed to the option number but the record company can terminate the agreement or not exercise the option for additional records at their discretion after the first record. The more options the record company has the longer the artist is locked into their existing recording contract.

Cross collateralization – If the record label exercises their option for additional records and haven’t fully recouped their expenses from the first record they have the right to apply the deficit from the previous record or records to the recoupable expenses for the next record. In other words if the record label didn’t recoup their expenses from previous records they won’t pay royalties from sales on future releases until they recoup their total expenses from all previous and current records.

Escalations – Escalations or increases in the royalty rate on record sales can be negotiated as part of the recording contract and are typically based on hitting certain levels of record sales. The increase in royalty rate is often tied to a specific number of records sold for example the royalty rate might increase from 10% to 11% once the record sells over 50,000 copies.

Term of contract – The length of time the recording contract between the artist and record label is in effect.

Mechanical royalty rate – Record labels will may try to negotiate the mechanical royalties rate they are required to pay for the rights to the artist’s sound recording down from the statutory mechanical rate, for example 75% of the statutory rate for lesser known artists.

Tour support – Many record labels will include a provision in the recording contract to help cover some of the costs of touring for their artists since playing live shows has proven to be a great way to build up a fan base and has a direct effect on sales. In return for the tour support from the label the artist may have to commit to playing a certain number of shows. Tour support is typically a recoupable expense for the record label and is charged against the artist’s royalties from sales.

Digital Sales – The emergence of selling music in digital forms (including digital downloads, subscription services and ringtones to name a few) as a major growth opportunity for the music industry has caused both record labels and artists to reexamine how they structure recording contracts as the relate to digital sales.

A few examples of how digital music is changing the music industry and the way recording contracts are structured include:

• Record labels are paid far less for a record on a per track basis for a record that is downloaded as part of an online music subscription service than they would from a sale of a physical CD.
• A common trend among music fans now is to only download the two or three songs they want from a record rather than buying an entire CD reducing the overall revenue the distributor, label and artist generate on a per release basis.
• Artists don’t want a return reserve factored into their royalties from sales calculations when there aren’t returns or even physical inventory for digital retailers and service providers.

Many recording agreements now have a whole separate section of the agreement to negotiate terms related to digital sales.

Licensing Agreements

Artists can sometimes sign an exclusive licensing / distribution agreement with a record label that allows them to keep the copyright to the sound recording and masters and simply split the revenues (50/50 in some cases) from the record after all the expenses are paid.