50% of the Profits? Sounds Great. But What Does “Profit” Mean?

Every music contract contains a few key provisions that can have a big impact on your career. In this series, we break down one concept at a time, in simple terms, so you can understand why it matters.

We’ve talked about how many artists are opting out of the traditional record deal in favor of deals with more flexibility and control. Those deals can come in many forms. You can get an investor. You can sign with a niche label. You can go into a production deal with a producer. The list goes on.

One common feature of more collaborative deals is a net profit split, instead of a royalty. Everyone involved wants the deal to feel more like partnership, so the idea is that everyone will share in the net.

That sounds great, most of the time. Someone else puts in the money, you put in your music, everyone works, everyone gets an equal share.

But…

Before you get excited about receiving 50% of the profits, there's a much more important question:

How, exactly, is “profit” being defined?

Revenue and Profit Are Not the Same Thing

We’ve touched on this before, but the context was a little different, so I wanted to explore net profits in a different light. Profit splits share some of the same problems as paying team members a percentage of net. The difference is that a profit split makes the problem more stealthy.

Here’s an example. Suppose a recording generates $100,000. If you own 50% of the profits, you don't necessarily receive $50,000. Why? Because $100,000 is revenue. Profit is what's left after expenses are deducted.

So let’s look at those numbers again. If the project has $60,000 in deductible expenses, the profit might be only $40,000—your 50% is now $20,000. And if there are $100,000 in deductible expenses? There may be no profit at all.

That's why a percentage by itself tells you surprisingly little.

50% Is Not the Only Important Number

Artists naturally negotiate percentages. Imagine this is a production deal we’re talking about. The producer is putting up work, money, and maybe some co-writes, so they want 60%. The artist is putting up work and music, so they want 50%. They talk it through, and they settle on a 55/45 split.

That’s only part of the picture. Look at it through these two filters.

Deal One

You receive 45% of Net Profits, with only direct third-party recording and distribution expenses deducted. That means any money the producer spent doesn’t get deducted before profits are distributed.

Deal Two

You receive the 50% you wanted, but that producer gets to deduct all of his overhead, travel, and a fee for his services before the money is split.

Which deal is better? You can't tell from the percentages. However, to illustrate, take the $100,000 in revenue from the previous examples. Let’s say there are third party costs of $20,000, so that means the net to the two of you is $80,000. If the producer gets to deduct his personal costs first (let’s say those are $15,000), that means the producer takes their $15,000 off the $80,000, leaving $65,000 for you and the producer to split evenly.

But is it really even? That means you get $32,500, while the producer gets $47,500 (that is, his $32,500 share and his $15,000 in expenses). You both put in time and money, but producer is getting their expenses back from both of your shares, not just their own. It’s not necessarily unfair; but it does change the math. Meanwhile, under the first deal, you simply split $80,000 on a 45/55 basis. You get $36,000.

A smaller percentage of a larger pool can be worth more than a larger percentage of a smaller one. It depends on how the pool is defined.

The Definition Does the Real Work

Somewhere in the agreement there should be a definition that says something like "Net Profits means Gross Receipts less..."

Everything after the word "less" is what you should pay attention to. It could be third party costs, like recording costs, marketing, and artwork. Or it could be fees and overhead for your partner. None of those deductions is automatically improper. Someone has to pay the costs of doing business, and expecting someone else to invest in your career comes with a price.

The question is, which costs make sense in any particular deal for you to allow to be deducted before your percentage is calculated?

Watch the Word "Overhead"

Direct expenses are relatively easy to understand. You pay a recording studio for time. You pay a graphic artist for album art. Those are people outside of your partnership that trade a specific service for a specific amount of money.

Overhead is different. If your business partner has a staff, overhead means the cost of him paying those employees. If they have an office, it means rent for their office space. It could mean software subscriptions. Telephones. Whatever else it takes to run a business.

Those expenses are probably very real. But if someone can allocate general business expenses against your project before calculating your participation, your "net profits" can shrink quickly. Further, you can’t tie those directly to your project or control how much they are.

That's why you should understand whether overhead is deductible and, if so, how it's calculated.

Who Controls the Spending?

This is another extremely important concept to bear in mind. It’s one thing to agree to a deduction of costs you have control over. It’s another to write someone a blank check. Even if every dollar is spent legitimately trying to make the project successful, since your money is being spent, you need to have some awareness of how it is going to be spent before it happens. If one party controls the expenses and both parties share what's left, one side’s spending decisions can determine whether there's anything left to share.

"Net Profits" Isn't One Universal Formula

This is another common mistake. People sometimes talk about "net profits" as though the term has one standard meaning.

Trust me, it doesn't.

I’ve read hundreds, maybe even thousands, of entertainment contracts over the course of my career. Each agreement defines the economics for the project it covers. Two contracts can both promise an artist "50% of Net Profits" and produce dramatically different payments because they each define Net Profits differently.

What About Money Paid to Related Companies?

Suppose your partner hires another company to provide marketing services. Sounds good. But what if your partner has some ownership in that company?

Related-party transactions aren't necessarily improper, but you should understand whether they are permitted and how they are valued. Otherwise, your partner can be spending money on themselves, all the while reducing the pool in which you participate. If that’s going to happen, you need to be fully aware of it.

The Reality

There's nothing wrong with a net-profit deal. I’ve seen a ton of them. In many situations, it makes perfect sense—two parties share the risk. They share the expenses, then divide what's left.

But you can’t assume that half the profits is the same thing as half the money. It means you get half of what’s left over. So it is very, very important to know what is coming off the top.

This Week's Takeaway

If you are considering an arrangement that would give you a share of the net profits, the deductions are every bit as important as your ultimate percentage. 50% can be a fantastic deal; but only if it isn’t 50% of nothing. The percentage doesn’t tell you everything. The definition of “net” does.