Subject: Manage for Success: Royalty Accounting (Newsletter #16, August 2002)

A colleague recently suggested that I discuss royalty accounting in one of these newsletters, and specifically who receives royalties. So here goes.

Royalty accounting at many record labels has become a black art, using not only smoke and mirrors but all kinds of arcane methods not unlike those at an especially scary voodoo rite. The object, of course, is not just to thoroughly confuse the artist or whoever is supposed to be receiving royalties, but to pay out as little as possible.

Preparing royalties statements is probably the most complex function of a label’s accounting department. This is due in great part to the convolutions of most recording contracts. Deal are labyrinthine in nature with curlicues of different royalty rates and furbelows of costs that the label considers to be recoupable from the artist. The resulting maze of deal points makes for, at best, a difficult statement to prepare -- even where a label is completely honest and forthright.

Because of the intricacies of most deals, in the case where a label may be less than honest there is room for a lot of chicanery. A statement may not, for example, show the actual quantity of royalty units that it knows were sold, it may take unreasonable reserves against returns (not just the contractual percentage,) it may delay reporting of foreign sales, and may take charges against the royalty account beyond those that may be contractually justified.

And even where a label is honest with its statements, they’re frequently difficult to read and understand because they’re not laid out clearly and rendered graphically understandable.

In fact there’s very little well-written and moderately priced software available that’s been specifically designed to handle royalty accounting. Many labels use a spreadsheet program such as Excel or a relational database such as FileMaker Pro (both programs work on Macs and PCs) to calculate and prepare statements, but no matter which software is used, it’s extremely complicated with much room for honest error, no less for the rendering of dishonest statements.

In a case where not much is involved, some labels assume that a royalty recipient won’t spend the money to send in a qualified auditor, and frankly, there aren’t a lot of CPAs knowledgeable in the intricacies of recording industry accounting. Therefore the label may bury untold "errors" when they prepare their statements.

Where a lot of money may be involved, an artist, or publisher, or publisher's representative, such as the Harry Fox Agency, may suspect they'll find sufficient accounting errors -- whether honest or not -- to justify the cost of an audit. In fact I remember one former major label CFO who purposely placed easy-to-find errors in royalty files so that an auditor would find them and not other better hidden "adjustments."

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Solutions Unlimited has helped quite a few clients set up their royalty payment systems, and has guided others through the deal-making process, suggesting terms that are fair and equable to both parties. Why not have me do the same thing for you.

I've had many decades of experience planning, budgeting, and fixing record industry management problems. Don't hesitate to call me to see how I might be able to solve your particular situation.

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Who customarily receives royalties?

First, there are the artists, who may be an individual, a duo, or a group. The recording agreement, which artists -- or more likely their attorney or manager -- negotiates with a label, will clearly specify circumstances as to how and when the artist will be paid. These negotiations can get quite heated as each party tries to make the best deal possible. Points that are argued the most are royalty percentages, cash advances, recording funds or budgets, escalations, reserves for returns, "free" goods, and what the label may recoup. Such recoupable items are not just the cost of making a recording, but may also include tour support and video costs, if any, as well as independent promotion and/or publicity.

Independent producers may also be royalty participants. In such an event the producer's royalty will be deducted from the artist's share, and will commonly be paid out by the label on behalf of the artist. This protects the producer in the event an artist may have already spent the money, or just hasn’t gotten around to paying the producer.

Labels frequently license a song or track, or sometimes an entire album, from another label for a compilation, a soundtrack, or a reissue. The licensor of this music will then be a royalty participant according to the terms of the negotiated license.

Finally, almost all recordings contain copyrighted works. (A common exception is for classical music written by long-deceased composers.) The publishers (not customarily the writers) are supposed to receive "mechanical" or publisher royalties for each song or copyrighted work. The statutory fee, which is set by Congress, is currently eight cents per song of less than five minutes, or $.0155 per minute (a bit more than one and a half cents.)

Most publishers' mechanical licenses state that royalties must be paid on all units "manufactured and sold." Very few labels follow this, however, and pay for units shipped less a reserve for returns, thereby not paying for inventory that may be in the "pipeline" and which was not in fact sold to consumers.

Some labels use SoundScan sales as the basis for their statements.

Labels customarily render royalty statements to artists, producers, and licensors semi-annually, ninety days after the close of a calendar quarter. Publisher statements, on the other hand, are usually rendered four times a year, forty-five days after the close of a quarter. Where possible you should try to negotiate with your smaller, and possibly more-flexible publishers, that you may render statements semi-annually rather than quarterly, halving the time and cost of preparation for your accounting person or department. This is particularly true in the case of small, artist-owned publishing companies.

In any event, I believe it’s in the best interest of labels that they do whatever is possible to render honest and clearly understandable royalty statements. And if you keep your deals simple, it’ll be easier to calculate, and pay, your royalties.

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Copyright 2002 by Keith Holzman, Solutions Unlimited. All rights reserved.