Ultimate Guide to Buying Music Royalties: Chapter 1

Chapter 1: Why Music Royalties

Music royalties are unique because they are considered “alternative assets.” They are much different than traditional stocks, bonds, and cash investments. They are also less frequently tracked by retail or institutional investors.

They don’t receive much attention from CNBC, the Wall Street Journal, or the mainstream financial media. You can’t track their performance on Bloomberg Terminals or TD Ameritrade.

But that doesn’t mean that the industry hasn’t seen an increase from new interested buyers, including alternative investment managers in the private equity and hedge fund industries, high-net-worth individuals, and accredited investors.

What you might not know is that intellectual property – sometimes called “Intangible Assets” – are the most valuable asset class in the world today. The value of all combined intellectual property in the United States today is worth at least $5.8 trillion, according to the U.S. Chamber of Commerce.

That is more than the nominal GDP of any other nation.

However, knowing how to exploit these assets remains one of the biggest challenges for investors and businesses without proper guidance or understanding how they generate income. Returns on investment for this alternative asset class are best defined as royalties paid directly to the owners of intellectual property.

Royalties work like this: The owner of a royalty has the right to license the asset – in the case of music, a song or portfolio of songs – to third parties. These third parties then have to pay the royalty owner any time they use it.

In the music business, there are various organizations in charge of collecting royalties who obtain payments from these parties, and distribute them at specific time periods to the intellectual property owners. Royalties can be paid annually, quarterly, or on a monthly basis.

Royalties Offer Direct Access to Industry Revenues

For a long time, few investors were able to get in on the income generated in this industry. There isn’t a New York Stock Exchange for royalties. If someone wanted to buy these assets, they typically needed to take part in backroom deals between insiders and artists.

The only way to profit from the music business outside of this is owning stock in a firm like Sony – the parent of the Sony Music Entertainment – or a rival company that owns and operates a music production division. Unfortunately, these global entertainment giants don’t provide clear access to music industry revenues. They have many different subsidiaries, products, and services that impact the company’s bottom line and stock performance.

That’s what make music royalties such a unique investment. Music royalties offer direct exposure to revenue streams generated by music consumption.

In 2013, the International Confederation of Societies of Authors and Composers (CISAC) collected more than $8.8 billion in royalties on behalf of artists and musicians around the globe, according to to the organization’s 2015 Global Collections Report.

Royalties Are Not Rare Assets

When you own rights or a percentage of a royalty stream tied to a song or catalog of songs, you collect revenue every time they are streamed, played, downloaded, or covered. When a song you own the rights to plays on Spotify, you receive a royalty. When someone downloads that song on Apple Music, the tech giant pays a royalty to you – the owner.

But royalty payments for intellectual property owners are not unique to the music industry. Royalty streams exist in the energy sector, as payments to the rights to oil, gas, and solar energy production. They’re common in the healthcare industry on patents and medical devices. They’re paid to authors and filmmakers when someone buys a book or watches a film on Netflix. Screenwriters receive royalty payments from the Writers Guild of America when someone uses, buys, or downloads their scripts.

This income recurs in high-demand industries with hundreds of millions of customers, if not more. A common theme among these industries is that compensation is paid for the use of another person’s intellectual property.

Understanding Intellectual Property

Intellectual property (IP) refers to creations of the human mind. These assets include underlying rights to inventions; literary and artistic works; computer designs; and trade symbols used in global commerce.

Intellectual property also includes copyrights (also known as an author’s right). ”Copyright” is a legal term that describes specific rights held by artists and other creative types over their works. Copyrights span a broad base of different creative works, including music, literature, artwork, sculpture, and film. They also cover technical drawings, computer programming, personal databases, advertising works, maps, and other business concepts.

In the following chapters, we describe the specific types of copyrights tied to the music industry and how other parties compensate asset owners for use of their IP.

U.S. copyright laws mandate compensation for such use. Copyright laws also ensure that no one can steal another person’s intellectual property. No one can copy intellectual property (without explicit permission). And no one can sell someone else’s intellectual property without serious legal consequences.

Simply put: If they want to use your intellectual property, they must buy it from you or pay you compensation every time they use it.

Within the music industry, copyrights are the basis on which royalty payments are made. And when you own popular intellectual property rights, it can provide several key benefits that are attractive to investors.

The Key Benefits of Owning Intellectual Property

1. Music Royalties Can Provide Strong Income Streams

Music royalties can provide strong income over the duration of the music copyright. This quality is important to investors in times when they are unable to generate much from low-yield savings or bonds investments.

Music royalties are also not impacted by global central banks that subject investors and regular citizens to negative interest rates.

Royalties are subject to the global demand of music fans and businesses that use music for personal and professional purpose. A federal statutory standard ensures that royalty rates are set for IP holders. This framework is critical to ensuring that IP owners receive their royalties at a standard rate for each use.

Depending on how IP owners are paid (a topic of discussion in Chapter 4), royalty payments are typically received on a quarterly or monthly basis.

These payments depend on the number of times that third parties use the intellectual property in previous periods. Naturally, that can create some large spikes in revenue or smaller lump payments depending on demand.

2. Potential Appreciation and Value Upside

In addition to long-term income, the value of intellectual property can rise over time.

You might remember what happened after the passing of Michael Jackson. His net worth surged after his death in 2009. Billboard writes that MJ Inc., the firm that controls his branding, earned at least $1 billion since his passing.

Roughly half if it – $494 million – is tied directly to music sales and royalties. In fact, his royalties have increased by 70% since his passing.

There are other ways that music royalties can appreciate in value. Intellectual property in music typically increases in value when there is an increased demand from others to use, license, or reproduce it over time.

Based on its popularity, the mood the song sets, or the message it conveys, a song or portfolio of songs can generate a lot of demand. Sometimes movies and commercials will use the same song time and time again. Increased use boosts the number of payments that the intellectual property holder receives.

A strong example of music that can increase in value are assets known as “evergreen” songs. These songs are typically always in style. They set a mood and provide listeners with a unique feeling each time they hear it. These songs are immensely popular with advertisers and film producers due to their ability to fit into the narrative of a story or message they are trying to convey.

When more companies and individuals pay to license these songs, the value of these assets typically increase.

For example, Royalty Exchange recently sold the royalty income and master recording copyright for the song “Love.” Not only is it popular with consumers, but companies and advertising agencies also regularly request to license this song in commercials for various products. Firms have paid licensing fees for this song to appear in different movies, including “She’s the Man,” “Something’s Gotta Give,” “Wedding Crashers,” “Hotel for Dogs,” and more.

Here are a few examples:

  • Nissan used it in commercials promoting the Nissan Leaf vehicle in 2014. They paid $200,000 to use the song in their regional dealership ads.

  • Panasonic used it in 2012 to promote their brand. They paid $175,000 to use the song.

  • Microsoft used the song to promote Bing in France, Germany, Spain and Puerto Rico. They paid $125,000 to use the song.

  • Aveeno used the song to promote its Baby Moisture Lotion product. Wow Mom used the song in its Mother’s Day 2014 advertising campaign.

  • Cadillac used the song in an advertisement for its new navigation system in 2011. They paid $50,000 to feature the song on the navigation screen in the commercial.

  • Sandals used the song in 2010/2011 to promote their resorts. They paid $60,000 for the sync license.

3. Longevity of Individual Copyrights

Royalties also provide another key benefit: The continuation of their income streams can be significant depending on the length of the copyright protection.

Some copyrights will outlive many of the companies trading on the stock market today. Depending on the origin of the musical work, a copyright could last up to 70 years after the death of the artist, songwriter, or musician.

That means that intellectual property is an asset that can be owned for decades, providing returns based on the demand for its use long after its creation and passing of its creators.

One of the risks and benefits of music intellectual property is that a song’s popularity can go in cycles.

We’ve seen a large shift in popularity of music over the last decade. In 2015, for the first time, newly released music was outsold by catalog albums, which consist of music released more than 18 months ago. According to Nielsen, catalog albums sold over 4.3 million copies more than their newer counterparts. While this doesn’t include streaming services, it is a significant trend that has increased over the last decade.

In 2005, current music sales outsold catalog music by more than 150 million albums. Music listeners can now control their experience between buying individual songs or a customized streaming experience. The flip of buying behavior suggests that older music can remain or become increasing popular long after its release and still generate income for its IP owners.

Some songs can go through many different cycles over time, renewing income streams. After it fades from the radio, a song can find new life as a classic song or throwback tune to the soundtrack of a film or television show.

For example, “Handbags and Gladrags” was a song written in 1967 by Mike d’Abo, the then-lead singer of the band Manfred Mann. The song peaked at #33 in the United Kingdom that year. It would generate little interest even though Rod Stewart covered the song in 1969. The song didn’t find too much mainstream success, even though it was re-released as a single in 1972. At its U.S. peak, it hit #42 on the Billboard Hot 100.

Twenty years would go by before the song suddenly found renewed interest. In 1993, Stewart recorded a live version of Handbags and Gladrags during his MTV Unplugged session. The song generated income through sales of the Unplugged album. Then, it faded again from the public. But years later, something important would happen for the song and its IP owners

The United Kingdom saw the remarkable rise of a television show called The Office. It starred comedian Ricky Gervais, and the producers chose this song as its theme. The version is performed by singer Big George.

The Office was a smash hit. Its rights have been sold to broadcasters in more than 80 nations. It has appeared on channels like BBC Prime, BBC America, BBC Canada, ABC1 in Australia, The Comedy Network in Canada, and TVNZ in New Zealand. It even appeared on Cartoon Network September 2009 until 2012. And each time that The Office airs, the owner of the IP tied to this song receives a royalty payment.

This series of events offers evidence of how a forgotten song can experience multiple revivals and generate income for the owners of the intellectual property over many years.

4. Diversification

Diversification from the stock market is one of the benefits of music royalty investment. Given that they are largely uncorrelated to the market, they can reduce volatility and even provide greater returns for an investor.

Traditionally, many investors have considered gold, oil, and other commodities to be a hedge against market volatility. But this has proven to be false in recent years.

In a 2011 article by Charles Sizemore, the portfolio manager explains that investments in commodities like gold, oil, and real estate do not provide the type of diversification that they used to offer. The author cites an academic study from Princeton University that shows that such commodities have become more correlated with other asset classes like stocks and bonds.

Now, let’s return to our earlier example of royalties sold on Royalty Exchange. The royalty streams tied to the music used in films like “Dumb and Dumber” generated $22,627 – an initial yield of 18.4% – from the use of songs over 12 months. The use of – and demand for – the songs generated this revenue. This is a key distinction.

It wasn’t stock prices, interest rates, or the Federal Reserve’s monetary policy that allowed the owner to earn more than $22,000 in royalty payments. The songs determined the annual return on investment. They will also determine the future revenues produced by these intellectual property assets.

Keep in mind, periods of volatility are also times when alternative investments like royalties grow more popular. Consumers don’t stop listening to music if the S&P 500 rises or falls.

That doesn’t mean that music is recession proof. During the 2008-2009 financial crisis, the global economy sank and financial problems rippled to every corner of the globe. Every major industry in the world faced financial downturns.

But music’s challenges and risks – which we outline in the next chapter – are more affected by individual industry trends than broader macroeconomic concerns.

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