How Recording Contracts Work

Normally, a recording contract will have something like a one-year term to allow the first album to be recorded and released. The first contract period, in other words, lasts a year. Then the contract will have a number of options that the label can exercise to activate the second contract period, the third contract period and so on. For example, a contract might have five options. If the label likes the initial album, it can exercise its first option so that a second album can be produced.

During each option, the label is requesting a new album. The band usually gets another advance and goes into the studio to record the next album. This is definitely a one-way affair. The label can choose not to exercise its option, and in that case, the contract terminates. Or the label can exercise an option, but the band has no way to get out of the contract if things are uncomfortable. For example, if the band's first album is very successful and the band would like a higher royalty rate, there is no way to renegotiate that. The royalty rate applies across all of the contract periods in the contract. Or, if the band's first album was a bad experience and the band would rather not do another one, there is no way that the band can avoid additional albums. If the record company exercises an option, the band is obligated to produce the album.

The options have the effect of locking a band in for six or seven albums (or more if the label rejects an album). If a band is doing well, the options in the contract guarantee that the band will produce a large collection of albums according to the terms of the contract. For most bands that sign their first contract as unknowns, this arrangement is very advantageous to the label. The band produces six or seven albums at a low royalty rate. If the band is not doing well, the label simply terminates the contract, but the lock-out clause prevents the band from re-recording the material. Even if the label has no interest in the band, the label owns all the recordings. There is no way for the band to re-release an album on its own.

Contracts will sometimes specify that recordings of live performances do not count toward the total number of albums stipulated in the contract. So if the label wants to release a live album, it can, and it does not shorten the contract.

Finally, there is a concept called cross-collateralization. Let's say a band's first album does well, but not well enough to recover all the recoupable costs, charge-backs, etc. For example:

So the band "makes" $300,000, but that money doesn't cover all the recoupable expenses. So the band is now $200,000 in the hole. The band does not get a check, but the label probably cleared $2 million from the album. So the record company exercises the first option. The band creates a new album. The income from the second album will have to cover all the remaining costs from the first album ($200,000) and then all of the new costs for the second album before the band sees any money. In this way, a band may need to produce several albums before it gets paid anything. It is not a pretty picture for a band that "almost succeeds." The contract locks the band in, but the band makes no money from the contract outside of the advances.

This is why you would like the advances to be as large as possible. Since the advance money may be the only money you ever see, and is therefore the money that you and the band members will be living off of, you definitely want to try to negotiate an advance that allows the band members to live a decent life and cover things like health insurance.