I’ve negotiated artist investment agreements ranging from $25,000 to $2.5 million. Here’s everything you need to know about them.
The following comes from noted music industry attorney Steve Gordon. Gordon is the author of 11 Contracts That Every Artist, Songwriter and Producer Should Know. The last chapter of the book addresses investment deals.
Early in their careers, many artists face the decision of whether to take the big leap and quit their day jobs. But without the steady income to cover the cost of recording, and other expenses, quitting can be a tough choice to make. This is particularly the case if the artist has no other source of income. So an artist may decide to approach their family members or others to invest money in their career.
This article explains the best way to structure an agreement for that investment.
In essence, an artist investment agreement involves someone who believes an artist will be successful. That person is willing to make a “bet” by giving the artist money to further their career. In return, the investor may seek a percentage of profits (if and when the artist makes money).
This article addresses the deal points of an investment contract. This includes the point of view of both the artist and the investor.
Below is a discussion of the main deal points in a typical artist investment agreement. At the end of this chapter are a pro-artist agreement and a pro-investor agreement. After reviewing this chapter, you will be ready to call that rich uncle and form a fair artist investment agreement.
Then you can quit your job and follow your dream!
Amount of Investment
The amount of money invested varies with the identity of both the investor and the artist. Sometimes an investor is so eager to help an artist’s career that she isn’t very concerned about losing money. In that case she may not even ask for the protections in the “pro-investor” form.
Some agreements provide for installment payments rather than a lump sum up-front. Paying in installments gives the investor greater control. This is so because then she can stop making the installments if the artist does not comply with the contract. For instance, suppose the contract requires expenditure of funds for a specific purpose. If the investor learns or merely suspects the artist is spending the investor’s money for expenses not authorized in the agreement, she may stop paying the installments.
Rate of Return
Most investors are seeking both repayment and profit. Generally, this is handled in the following manner: the investor receives a percentage of monies that the artist earns minus expenses such as recording costs. That percentage, or “rate of return,” varies from case to case. But an important factor in calculating a fair rate of return is the amount of the investment.
If the amount provided is a large sum, the investor is justified in asking for a higher rate of return such as 40 or even 50%. If the investment is smaller, so is the percentage. The reason for this is that the artist retains the opportunity to take on other investors. For instance, if the investment is only $25,000, a fair rate of return would be 10 to 15%.
Repayments can be monthly, quarterly, or semi-annually. An investor will normally have the right to audit the artist’s books.
Cap on Return
The investor’s total possible return is usually limited in one of two ways. First, the return may be limited to an amount that equals a multiple of the investment, typically 100% to 250%. For instance, if an investor puts in $25,000, the cap may be a multiple of 100% (such as $50,000). In this model, the artist is free of the obligation to continue to pay the investor after the investor has made 100% profit.
Another way of capping the investor’s return is to limit the period of time during which an investor is entitled to receive the return. That period of time is subject to negotiation. If the amount invested is very high, such as a million dollars, it may be fairer to apply a long duration such as ten years. This rewards the investor for the significant amount invested. This is because there is no cap on his potential return. The investor’s attorney may also insist that even a long term should be extended until the investor at least makes his money back plus a reasonable profit.
Whether a contract is pro-artist or a pro-investor, the agreement should address decision making and approval. A pro-investor agreement would either state the particular purpose for which the investment can be used. For example, production costs for a set number of masters. Or the contract can at least give the investor the right to approve expenditures of his investment. A pro-artist agreement would state that the artist can use the money in her discretion. This would give the artist the widest latitude to decide how best to use the money as the circumstances of her career change.
Source of Income
An artist may earn income from a variety of sources including record sales, live performances, merchandise, publishing and endorsements. Whether the investor recoups their investment from all these sources or just selected income streams is subject to negotiation. For example, if your rich aunt pays money toward recording masters, in a pro-artist agreement, she would be repaid only from record sales. The reason is that these are sales are directly attributable to her contribution, and not from live performances, merch, or any other income streams.
On the other hand, from an investor’s perspective, the repayment should be from all income sources. This is because investment in one sector assists income generation in another. However, it is to an artist’s benefit to limit the recoupment on the investment to the income streams directly related to the investment.
Affirmation of Risk and Limited Liability
A pro-artist agreement may include a clause stating that the music industry is a highly speculative business. Accordingly, repayment is anything but guaranteed.
Also, it is in an artist’s interest to enter into the agreement not as an individual but via a “furnishing company.” To accomplish this, the artist must create an entity such as a corporation or an LLC. That entity will then conduct business on behalf of the artist. This will protect the artist’s personal assets by creating “limited liability.” A disgruntled investor who sues the artist for breach of the agreement can only try to secure repayment from assets in the artist’s furnishing company.
Liability claims can’t touch personal assets like bank accounts, stocks, houses, and cars. However, an investor may be able to “pierce the corporate veil” if he can prove fraud on the part of the artist. For instance, if the artist moves the furnishing company’s assets into his personal account the investor may be able to go after those funds to recover his money.
Creating a furnishing company can also have tax benefits, while offering proof that the artist is in a legitimate business rather than a hobby. Accordingly, expenses can be legitimately deducted as business expenses.
An artist should consult with a knowledgeable accountant regarding tax issues. Also the artist should strongly consider consulting an attorney regarding formation of the corporate entity.
Third party funding can be a welcome push to an artist’s career. But the agreement between an investor and artist must be well drafted. Both the artist and the investor are well advised to seek knowledgeable counsel to protect their interests and help structure a deal that is fair to both parties.
Exhibit A: Pro-Artist Agreement.
Exhibit B: Pro-Investor Agreement.