Universal Music Group, the world’s largest music company, is no longer accepting letters of direction for the sale of royalty streams, Billboard has learned. That means that — at a time when the market for various kinds of music royalties is exploding — investors who have purchased some or all of an artist, producer, engineer or side performer’s revenue stream on a sound recording owned or controlled by UMG will now need to coordinate that payment directly through the artist with whom the label has a deal. The policy does not apply to publishing deals, where the majority of third-party acquisitions have been taking place.
UMG will continue to honor creators’ letters of direction to pay out any of those royalties due to the producers, engineers and players who have “points” — a percentage of revenue on a recording — but will no longer redirect them to investors, in what some view as an aggressive stance at a time when financial institutions’ interest in these revenue streams is at an all-time high.
UMG had historically “voluntarily accommodated” artists’ request to assign rights, even though most of its agreements prohibit doing so, according to a statement provided to Billboard. “However,” the statement continues, “the acceptance of Letters of Direction for the sale of royalty streams, essentially re-assigning these payments to entities with no legally recognized relationship with the company, potentially posed significant tax and legal liability issues.” UMG did not elaborate on what the potential legal or tax issues might be, but concerns have arisen since labels do not have contractual relationships with these third-party buyers, according to a source familiar with the matter. That has resulted in legal questions regarding audit rights, approval rights and reporting requirements without any defined terms.
“Nothing is more important to us than our relationships with our artists and fulfilling the terms of our recording agreements,” the statement continues.
The company says the policy does not prevent artists from independently transferring UMG royalties to a third party, it just means UMG will now only pay artists and their creative collaborators; and any investors buying the rights to a percentage of that income will need to come to their own arrangements with creators to receive the royalties. It is unclear whether the policy will be enforced retroactively against earlier letters of direction.
Over the past five years, royalty streams have become an increasingly popular investment for private equity firms and other large institutional investors that are outbid for publishing and master recording ownership, who instead turn to songwriter shares of catalogs and artist royalties for master recordings. Investors can choose the royalties of specific tracks, license, or income type or across a creator’s repertoire. They also can invest in the income stream of producers or engineers who are due royalties on songs’ sales, streams and synch placements — all of which are paid from the artist’s share of royalties. These royalties are predictable from year to year based on past earnings and are generally passive investments that require little expertise beyond collecting and accounting for the payments.
With the increase of such sales, the major labels don’t want to deal with the accounting and administration demands of these financial institutions entering the music rights market, says one label source. And some are using letters of direction to leverage a relationship that the majors are more comfortable with. “They may approve the letter of direction under strict conditions,” says attorney Scott Bradford of DLA Piper. These could include restricting audit rights or approval rights for synchs, he says, “so it’s just a revenue participation.”
That’s why it behooves buyers to keep creators involved in their copyrights after an acquisition so that they can ensure audit rights, say finance executives. But what happens after a creator dies? Currently, when a creator retains the income stream, the labels honor those same rights to heirs. But it’s unclear whether they will continue to do so for heirs, if the artist had already sold the income streams to a third party.
UMG’s policy has received criticisms from executives around the industry analyzing its potential effects on an otherwise flourishing aspect of music finance. (On the far end of the spectrum, one executive with a company that has been investing in music assets over the last few years says, “It’s a hostile gambit that appears to be aimed at stopping pure-play financial investors from coming into the market.”) But it appears the other major labels are also being less accommodating to investors buying these royalty streams.
“It’s not just UMG,” says an executive with a company that acquires music assets. Sony Music and Warner Music Group in the last quarter have also been showing hesitancy in responding to letters of direction on acquired music assets, some sources say. Sources acknowledge that whether to honor letters of direction has been a topic of discussion at some music companies but thus far hasn’t yet transformed into action or policy, while others say Sony is refusing to formally acknowledge letters of direction in writing but will still reassign royalty payments when an income stream is sold.
Warner and Sony declined to comment for this story.
If Warner or Sony follow UMG’s lead with similarly hardline approaches against letters of direction for royalties — the majors have a history of adapting their competitor’s policies if they perceive it might benefit them as well — it could put a serious damper on institutional investors coming into the market. One lawyer concedes such a strategy would create an undue complexity to a sale and other music asset investors worry the UMG’s stance could deflate value.
One investor suggests the majors could be trying to “contain value to bring multiples down,” as well as discourage new investors from entering the music rights market. (Labels traditionally have not been in the market for music royalties like those affected by UMG’s letters of direction policy, but are in competition with financial investors for publishing catalogs and catalog recordings.) “It’s probably being done to scare off some financial players,” says another executive who thinks the majors appear aimed at cooling a market perceived to be overheating. But, the executive adds, “If you are a savvy player, you can figure out a work around.”
UMG is not the first music entity to come out with policy limiting letters of direction. SoundExchange only accepts letters of direction only for people involved in the creative process, such as producers and engineers, but not for third parties, a spokesperson tells Billboard. Sources suggest that for years at least one of the U.S. performance rights organization has a similar policy on letters of direction, but it’s unclear if those policies are fully enforced. Nevertheless, so far those policies don’t seem to have stymied the music asset marketplace. And the Music Modernization Act gave artists the ability to provide letters of direction to SoundExchange to directly pay producers, engineers and others who work on their records what those collaborators are due.
Opinions vary on how investors might be able to manage UMG’s new stance. In one scenario, a seller could set up a joint account into which royalties would be paid, a source says. But an institutional investor argues that approach wouldn’t work because if the seller has access to the account, then the buyer couldn’t “perfect” the acquisition. “That’s why deals usually have holdback on payments — to ensure the income stream gets to where it’s supposed to go to,” says that financial executive. (“You may not be able to perfect the acquisition of the income stream, but you can secure it through a contract with the [artist],” counters another financial executive.)
Investor perspective on UMG’s new policy seems to split depending on how long they’ve been in the market. Newer players interpret the company’s stance as more aggressive, while long-term players in music asset market tend to see it as just a new spin. But, they add, it’s just an evolution in the typically contentious wrangling seen in practically every music asset acquisition that require assignment consent — especially when the majors are involved. While in the past the majors were willing to accommodate the occasional letter of direction for the sale of income stream, now that such deals are becoming a frequent occurrence, they’re growing into an incredible accounting hassle — which is one reason why the discussion on this policy even began at the majors, according to some sources.
UMG, meanwhile, might face an optics issue as word of the new policy spreads and the company could have a hard time presenting itself as being artist friendly, says the institutional investor. “If you have an asset that can be traded, that policy will be seen as standing in the way, so they are basically taking money out of the artist pocket.” Adds the financial executive, “I think that policy has the potential to harm an asset’s value.”
It could even get in the way of future deals, says another player in music assets.
“Why would artists or songwriters sign with UMG if they are going to get in the way of eventually realizing the value that they created through the sale of their copyrights and royalty income streams,” wonders that trader, who’s seeing it from the buyers’ side. “If I was a songwriter, producer, and/or artist, I would be asking, ‘Are you telling me I can’t sell my catalog?’”
UPDATE: This story was updated at 12:40 p.m. EST on May 24, 2021. It previously stated that UMG’s new letters of direction policy applies to publishing as well as label deals. The policy does not apply to publishing, according to a UMG spokesperson.