by : August 2017, Business, Featured Articles

Royalties, Investors, and the New Music Economy

Royalties, Investors, and the New Music Economy

Record labels and publishers for decades served as the music industry’s “bank.” They provided the advances artists lived on while making new music, and also paid for services like recording, shipping, marketing and more. No longer. Just as there are alternative sources for digital distribution, social promotion, and recording, so are there new sources of funding that give artists new options.

Crowdfunding (or fan-funding) platforms like Kickstarter, Artist Share, Patreon, and so on represented the first round of this. Private investors represent the second.

Private investors have far deeper pockets than the average fan. So while fewer in number, they can be far more impactful to artists looking to raise money. Their motivations for getting involved with artists also differ from both fans and traditional labels/publishers.

Royalties: An Asset Class

For both institutional companies and private individuals, music royalties represent an attractive new investment opportunity. Royalties can offer stable earnings, predictable payment dates, and decent yields.

First, royalty income may rise and fall, but it does so slowly, gradually, and predictably. Newly released music typically has a prime retail “shelf life” of just a few months. That’s the window of time after new music is released where it will likely enjoy its most activity in terms of streaming, sales, radio airplay, and more. (For new and emerging acts, their first single is typically “worked” for months, even years, by labels/managers until it catches hold, after which the retail cycle begins). Incoming royalties usually fall to lower levels once this window closes.  But that lower plateau remains fairly stable thereafter.

Second, royalty checks come in a predictable timeline, typically quarterly. A consistency of payments is desirable for investors, who generally don’t witness regular returns outside of real estate. Stock dividends are at the whim of the company. Bonds take years to mature. Although interest earnings on the amount loaned accrue, typically, every six months, the principal will take time to recover if the bond is held to maturity (depending on the state of interest rates, selling the bond before maturity can lead to gains or losses). Moreover, royalties are a cut off the top. Royalty owners get paid first, before stockholders or employees. So, for instance, if you own royalties to a song distributed by Universal Music Group (a subsidiary of Vivendi, a public company), you’ll get paid before Vivendi stockholders do.

Third, even at declining rates, an investment in music royalties deliver returns that far exceed the paltry interest rates of savings accounts or investment grade bonds. Artists with dwindling royalty payments often express surprise that investors would be interested in owning a share of what they consider to be a small revenue stream. But it’s all about context. While $5K a year may seem low to artists who rely on it as their sole source of income, investors can aggregate that sum to other incomes and leverage the bundle at competitive yields.

Finding stability, consistency, and yield in an investment is in fact extremely rare. Moreover, royalties are less affected by the ebbs and flows of the stock market — an added benefit. The stock market is volatile, and when stocks fall, it affects interest rates, housing prices, and much more. People are likely to still play music if the stock market crashes.

Modus Operandi

There are three ways investors participate in music royalty streams: (i) they can buy an existing royalty stream; (ii) invest in an artist’s future royalty streams; and (iii) provide general financing; i.e. loans and advances.

(i) Buying Into Music Royalties

There are many examples of institutional money flowing into the music industry, driven by an interest in participating in music royalties. Imagem Music Group was formed in 2008 by the Dutch state pension fund ABP, specifically to acquire and generate returns from music publishing catalogs worldwide. Ole is another publishing company aggressively acquiring catalog, funded by a Canadian teacher’s union pension fund. Sheryl Crow sold her publishing catalog to a fund affiliated with an Australian bank.  In the U.S., Round Hill Music is actually a private equity firm created exclusively to acquire music assets. And Blackstone Core Equity Partners acquired the majority stake in PRO SESAC, precisely because the latter generates performance royalty collections and is now aggressively moving into mechanical collections after having bought Harry Fox.

And where institutional money goes, private investment is sure to follow. Royalty Exchange, for instance, is an online marketplace where private investors can buy into music royalties on a more accessible scale. The service is open to anyone interested in buying into royalties, not just accredited investors. Artists with a history of earning royalties can sell a portion of their incoming earnings to investors, much like how a company goes public by offering shares to investors –which is interesting, to say the least.

To begin with, it means artists earning less than the elite superstar tier can find an investor at their price level. For years, superstar artists generating massive royalty returns could attract the interest of private investors in deals usually brokered by their business managers or attorneys. But the “working class” artist earning a more modest living didn’t have that kind of access to investor interest. Deals on Royalty Exchange, meanwhile, range from $5K to $900K.

It also allows for more flexible terms. When music companies look to buy into royalties, they tend to prefer all-or-nothing deals. They want to buy an entire catalog, rights and all, rather than just a portion. But private investors are more interested in passive income, and therefore are content to buy into only a share of a royalty stream without acquiring an entire catalog. This gives rights holders the option to raise money and retain control of their copyright and income.

Finally, it brings transparency to royalty valuations. Most royalty transactions are conducted in private. Outside of a few big-name catalog acquisitions, it’s rarely known how much a buyer paid for royalties. Royalty Exchange, again, is an open marketplace, and the details of every sale that takes place on the platform are made public: past 12 months earnings, starting price, closing price, and more.

(ii) Investing In Artists

While Royalty Exchange focuses its efforts on artists with a history of earning royalties, other services allow private investors to make more speculative bets on future royalties.

One such company is LIVAMP. Its platform allows artists to raise money by promising a percentage of any earnings gained in the future in return for cash today. Often, the artists using the platform seek money for touring or album costs. But the percentage of revenue paid back to the investor does not necessarily have to come from the project the investor funded. For instance, an artist can raise money to fund a tour, but promise the investor 10% of any album sales/streams in return. LIVAMP also offers a layer of management-type assistance as well, such as booking support and marketing expertise.

Another company investing directly in artists is Alignment Artist Capital, formed in part by Blackrock, the same entity that recently acquired a majority stake in SESAC. Alignment Artist seeks to make “structured investments” in artists. These investments go far beyond the standard album or tour financing, but into things like branding, celebrity endorsements, and more. This differs from LIVAMP in two ways. First, the company puts its own money into play rather than connecting artists to individual investors. Second, and as a result of the first, it focuses on more established artists.

(iii) New ‘Capital’

Advances on future royalties are a familiar theme in the music industry. It’s how labels and publishers have paid and attracted artists for years. These advances are generally interest-free loans that the artist or songwriter takes to pay for current expenses, to be paid off by “recouping” the loan against future earnings. But labels and publishers are far less open with their pocketbooks today. Advances are fewer, and for lower amounts. From this void, a host of “private advance” companies have emerged, offering new variations on the theme.

While the structure of the advance they offer seems familiar, the terms behind them are not. These are not traditional loans, with clearly stated interest rates and adherence to truth in lending regulations. Nor are they the “interest free” model employed by the label/publisher ecosystem. Most advance companies employ a model called factoring – where the lender expects to earn a multiple on the amount tendered. It works like this: in return for a lump sum payment, the artist agrees to pay back another larger sum over a set period of time; for instance an artist takes a $5K advance and agrees to pay back $6K over the next five years, a multiple of 1.2, after which the royalties revert back to the artist.

In such deals there is no mention of an interest rate. That’s because the effective interest rate to pay is far greater than carried by traditional loans. It can range from the low 20% to over 30%, likely violating usury laws in every state in the country. But such contracts avoid complying with lending regulations because they are not structured as typical loans. They conform to a sale of money and a consideration by the artist of the cash to return. Of course, if the artist’s royalty earnings fall below the agreed-upon payback schedule, the length of the payback term will extend and more fees and fees/penalties will accrue.

Artists and Securitization

As the current juncture is more open than ever to private investment in music royalties, it begs a question. How and why should artists exploit this incipient interest in music rights by investors?

The first thing to know is that selling royalties is not an act of desperation, contrary to popular belief. Most of the artists who work with Royalty Exchange, for example, have a financial plan and specific goals in mind, including (i) raising money to finance a new project (tour/album) or a major purchase (house/studio); (ii) getting out of one-sided record/publishing deals or bad advances; (iii) seeking financial security to make room for artistic freedom; and (iv) relying less on managers, lawyers, and others that control their career

One of the biggest advantages of working with private investors is that it reduces risk. The fact is that any royalty stream will almost certainly decline as time goes by. A U.S. Bureau of Economic Analysis study found that music royalties decline at a 28% annual rate on average, compared to 9% for movies. That’s an average that takes into account the total flop to the one-hit-wonder. Many catalogs are far more stable. Clearly it’s impossible to predict future earnings, but inviting an investor to buy a share of a royalty stream allows artists to spread that risk around. They can raise a lump sum of money in the present to protect against potential future downfalls.

Using that lump sum to diversify income is another way to protect against risk. Rather than relying on the royalties from one song or catalog to live on, the money earned from selling a share of those royalties can be applied to new revenue streams. These might come from a new album that will generate new royalties without any claim from others on those future earnings, from investing in revenue opportunities not contingent on music royalties, such as in a side business, and from paying off liabilities like a mortgage or other loan.

The Deal

Timing is of the essence. For those with a history of earning royalties, a good time to seek investors is well after the initial retail spike, after a new release. The longer a history of earnings takes to review, the safer investors feel. Remember investors are looking for stability and consistency.

Investors value any asset using a formula called price-to-earnings ratio, often called a ‘P/E’, to compare one investment with others. It works like this:

If a song generated $10K in the last year and those royalties are offered to investors for $30K, the price to earnings ratio, or multiple, would be three. On average, in this author’s experience, commercial music is selling for a multiple of six, but it can go well over ten for music with a long history of earnings. The trick is not to wait too long before selling. While a multi-year analysis is best, it’s better to sell while the royalty value is still relatively high, because it allows this multiple to be applied to a higher amount.

For artists offering more speculative earnings, such as on services like LIVAMP, the best time to sell is as early as possible. Investors seeking speculative gains will want to participate in the royalty spike that occurs immediately after a new release (that prime “retail window” mentioned earlier). Now of course not every new release enjoys such a spike, hence the speculative nature of the investment. But the opportunity to participate in that spike is a selling point with investors.

In addition to timing, presentation is an important consideration when seeking private investment.

First among equals in any pitch to investors is the pricing of the royalty asset. In an auction setting like Royalty Exchange, setting an attractive price to attract the most participation and engagement among potential bidders is essential. That’s because the value of an auction is based on the number of participating bidders. Higher prices take longer to attract opening bids, and the longer a listing sits with no bids, the lower its perceived value becomes among investors. Also, higher prices bring in fewer interested bidders, meaning less competition and “action” during the course of the auction.

Second in importance is the description of what it is being sold. Just as every song tells a unique story, so does the royalty snapshot it provides. Potential investors want to know things like the details of notable artists who have recorded or performed the song or the bundle of songs in question. The also appreciate the information about its charting history, award nominations/wins, and other notable achievements, as well as any personal awards or achievements relevant to songwriting or performing such songs.  Although income is the overarching draw, investors seeking music royalties want to own compelling assets they can talk about at cocktail parties too.

Finally there’s the issue of getting out there and actually promoting the sale of the royalty assets. The more potential investors that are aware of the opportunity to acquire a royalty stream, the better chance it has of selling. That is how platforms like Royalty Exchange and LIVAMP, that aggregate investors, help. Such platforms host the offer and market it to an audience of interested investors who have already signed up to discover royalty-purchasing opportunities.

 

Antony Bruno works with Royalty Exchange, a company mentioned in the piece.

 

By Antony Bruno

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