One thing that often tempts musicians into signing a record deal is the promise of an advance. This is especially true for up-and-coming acts who have been slogging through on their own dime and making many financial sacrifices in the process. "An advance!" they say. "We're going to be rich!"
Well, not so fast. The most important thing to remember is that an advance is just that: an advance. It's a loan against royalties you expect (hope) to earn on future record sales, and the label requires a return of the advance. In fact, they will keep revenues until they recoup the full amount of the advance—and that holds true across multiple albums and advances. That's because record label advances are often cross-collateralized, meaning that a label can pull money from other record sales or even other band revenue streams to recoup its advance.
There's your warning about getting too excited about advanced cash. But now for what you really want to know: How do record labels decide how much of an advance to pay?
Calculating the Advance
For most labels, the process of determining your advance is part art and part science. With your first advance—the advance for the first album you record with a label as part of a multi-album deal or for the only album in a single album deal—the label will consider many different factors. Indie labels, in particular, will consider how much they can afford to pay and still have enough cash left to promote the album release. If working with an indie, opting for a small advance in exchange for a bigger promo spend is the right choice in the long run.
A Record Label's Considerations
Major labels will consider things like how much they plan to spend on promotion in addition to how many copies they think they can sell off your release in order to recoup your advance and make extra money. Of course, indies also consider sales potential, but for many of them, it's a pure cash flow issue. Even if they think you can sell millions, they can't pay you an advance to cover that.
That's where the art comes in. Labels consider your sales potential—often based on what you've accomplished before—as well as plans for touring, feedback received on your music, and more. However, it's still a gamble because they don't know if the advance is going to be too small, too big, or just right. You can count on them to err on the side of caution, though, unless you are the subject of an intense bidding war.
Advances in Multi-Album Deals
The science comes into play particularly with the advance formula associated with multi-album record deals. These formulas aren't included in all record deals, but if you're signing with a major label, a good lawyer will insist that your contract include one. Essentially, a mathematical equation will determine the advance for each album in a multi-album deal. This equation usually sets the advance as a percentage of royalties earned on the previous album. There is also usually a minimum and maximum payout amount stipulated in the formula.
The percentage is computed using sales from within a specified territory during a specified period (e.g., sales in the U.S. for nine months after the album release). Once determined, the formula is applied to each release; so, album two sales will determine album three's advance, album three's royalties will determine album four's advance, and so on. The beauty of this equation is that it rewards good sales and prevents overdoing advances when sales have dropped.
The most important fact about advances bears repeating: this isn't free money. It's more like credit. Take what you need and wait for your sales to come in. It will keep you out of debt to labels, and put you in better control of your music career.