Celebrity bonds: An innovative securitization financial debt instrument

Introduction

Intellectual property, including patents, copyrights, and trademarks, is a key source of wealth in the knowledge economy. Previously, ownership of tangible assets such as land or real estate was frequently required to provide security for large transactions; today, ownership of intangible assets such as intellectual property can unlock wealth. The most spectacular demonstration of this occurred in January 1997, when David Bowie, always one of rock music's most forward-thinking contributors, broke financial ground by raising $55 million in a bond issue backed by his future music royalties. The benefits of bonds for a creative artist include the ability to fund other business activities more easily.

Theoretical Background

Securitization is the process of pooling rights to the cash flows generated by a group of assets and selling those rights to investors in the form of securities backed by those assets, thereby raising capital and spreading the risk. Similar to mortgage-backed securities, asset-backed securities are typically backed by other relatively illiquid financial assets, such as auto loans or leases, credit card debt, student loans, or a company's accounts receivable. Nowadays, almost any debt held by an institution has been securitized, but it turns out that almost anything that can generate future cash flow, including music royalties, can be securitized.

A celebrity bond is a debt instrument that is linked to the financial success of specific celebrities. Investors in the celebrity bond market lend money to fund concerts, albums, movies, or other products associated with a celebrity. Investors receive the right to a portion of the royalties in exchange for their investment. The performance of intellectual property sales determines whether or not investors earn celebrity bond returns. Although celebrity bonds have the potential for high returns, they are a high-risk investment because they are based on the performance of an individual or group of individuals and are thus subject to a variety of risks. A band, for example, may dissolve, or a celebrity may die or become paralyzed. Social and technological trends can also have an impact on future rights. As a result, everyone should be aware of the risks associated with rights. Because these bonds are mostly self-liquidating, with principal and interest (coupons) paid by future cash flows generated by the underlying assets that secure the bond, they are volatile and have a high level of uncertainty.

Bowie Bonds

While there is no doubt about David Bowie's impact on music, fashion, and the entertainment industry in general, the "artistic chameleon" led a quieter but equally significant revolution in the financial markets. He shook up Wall Street by creating a new financial product, thanks to his entrepreneurial spirit and love of innovation and risk.

David Pullman, an investment banker, negotiated a deal with David Bowie's manager, William Zysblat, in late 1996 to issue a bond to finance the artist. So, in January 1997, they issued a 10-year bond with a 7.9% yield, which was 150 basis points higher than the 6.4% yield on the 10-year US Treasury bond. Through this issue, David Bowie innovated and made history in the financial markets two decades ago, after he managed to raise $55 million in financing by issuing a ten-year bond. The securities were created by securitizing future royalties from all of the songs he had released prior to 1990, with the assistance of banker David Pullman. The 287 songs from David Bowie's 25 albums prior to 1990 were used as collateral. The Prudential Insurance Company of America purchased the Bowie bonds in 1997, and Prudential sold them along with Prudential Securities to Wachovia Securities in 2003, which merged with Wells Fargo on December 31, 2008.

Securitization, the process of bundling illiquid assets into marketable securities, was already common in the mortgage and automobile industries, but Bowie was the first to apply the same logic to song rights. Bowie benefited from a large upfront payment offset by the gradual collection of royalties over the next few years. The deal netted Bowie $55 million, a portion of which he used to purchase ownership rights to some of his songs from his former manager, Tony Defries. Until the bonds matured, Bowie was in the unusual position of owning the rights to the majority of his songs outright. As a result, it was most likely a good deal for everyone involved.

Bowie found his own solution to the financial difficulties he faced at the end of the twentieth century with the help of Wall Street. In the 1980s, he moved to Berlin due to the high cost of living in New York. But he needed money fast, and Berlin was no longer an option. The Bowie Bonds were asset-backed securities, similar to government bonds, which are backed and guaranteed by government assets. However, the asset was the current and future rights to Bowie's records recorded before 1990. In essence, the Bowie Bonds validated the notion that an artist's worth can be measured in terms of future income streams from intellectual property, which has a monetary value today.

When Bowie's bonds were first issued, they had a fairly high credit rating as an investment. In this case, the Bowie bonds received the highest possible bond rating from Moody's, AAA. The economy, like the music industry, was booming, and this type of financial instrument appealed to investors, many of whom were looking to diversify their holdings. However, they drew criticism when credit rating agency Moody's downgraded the bonds from A3 to Baa3, just one notch above the "junk bonds" category, in 2004. This was due to declining sales of recorded music, as the music industry was changing, CDs were being replaced by MP3s, and people were buying less music and turning to streaming and other options to listen to their favorite artists. The Pullman Group, which arranged the sale of the Bowie bonds on the New York bond market, insisted that no one would lose money as a result of the downgrade. The bonds had not defaulted and would not default in the future. The value of David Bowie's catalog, publisher, and record label assets far outweighs the bond's outstanding balance. Nonetheless, when Bowie regained sole ownership of his music and rights in 2007, his original ten-year bond was fully repaid. Fortunately for Bowie, this occurred just before the 2008 financial crisis, which nearly brought the celebrity bond market to a halt.

Financing Artists through Securities

When Bowie's bonds were issued in the mid-1990s, the only way for artists to seek funding for their musical endeavors was to sign a contract with a major label and have the label provide all of the funds. Simply put, record labels paid for the recording costs and royalties for an album, and the artist continued to repay the loan through the album and single sales until the label received the advance and royalties in full, as well as the advertising costs of promoting the artist. Only after the loan was repaid could an artist obtain recording rights. Bowie Bonds overturned that structure.

David Bowie was the first artist to use what later became known as a "celebrity bond" to raise funds. When Bowie issued his bond, asset-backed debt securities were not new, but they had never been used for such purposes. There's little that bankers can't securitize these days, but it came at a high cost, as we saw during the 2008 global financial crisis. At the time, such bonds, known as asset-backed securities, were still in their infancy and were associated with traditional products like credit card debt and mortgages. And, because it was the first bond issue of its kind, it offered a higher interest rate than the next issue from other artists, in order to make the new product appealing to investors.

Of course, this type of arrangement was always reserved for legends with extensive song catalogs. Few artists today appear to provide the kind of guarantees that would entice outside investors like Bowie. Even if the loan guarantees extended beyond publishing and recording revenues to a portion of live music - concert receipts, an investment in a celebrity artist would be risky in a world where the value of that intangible set of rights is less clear as technology changes rapidly. Furthermore, keep in mind that Bowie was willing to hand over and transfer the rights to the assets involved in the deal, to a separate legal entity that was not under his control, because only under this arrangement do the lenders control the risk because if Bowie went bankrupt, the bank of securitized assets was at least under their control. Finally, he was able to do so because, unlike most artists, he owned the rights to his songs, as opposed to others who had their rights held by record labels.

Obstacles to Using Bonds from Celebrities

Anyone introducing a new financial service into the music industry will face backlash. The music industry has long been known for favoring financiers over artists. African American rock and jazz pioneers were frequently killed in poverty or as a result of disputes over exploitative contracts. But in Bowie's case, celebrity bonds don't seem to have failed the artist as much as the investors.

Uncertainty in the music industry makes such bonds more difficult to sell right now. The economics of music rights have changed dramatically as the internet has grown. This makes these types of transactions more difficult. Because music is an intangible asset, there is no good registration system in place to determine who has a claim on the collateral, as there is in real estate. Bonds, on the other hand, are too rigid for music's erratic income streams, which is why purchasing "celebrity bonds" remains an "exotic" option nearly two decades after the "Bowie Bond" was created.

However, the internet and music sharing have dashed artists' hopes of raising funds through bond issues. After all, David Bowie stated in an interview with the New York Times in 2002 that copyright will cease to exist in 10 years and that "intellectual property will feel a crushing defeat." As it turns out he was right, as China rises disregarding intellectual property and patent rights, considering them a public good without offering protection. Many times these intangible assets are infringed while many Asian manufacturers choose to produce their products or even replicas of them using patented intellectual property, without the consent of the rights owner. All artists should prepare themselves for extensive concert touring, as this is the only situation that will persist. This helps to explain Bowie's desire to collect royalties from his song catalog upfront via bonds. This was confirmed in 2012 when Goldman Sachs withdrew from a $300 million bond loan backed by rights to Bob Dylan and other artists' songs.

Conclusion

The preceding analysis reveals the presence of a new trend in the financing of artists. Among them is David Bowie, one of the most consistently talented singers who have chosen to title his intellectual work in order to increase his financial power. Bowie changed the way top artists thought about raising capital to develop new projects or get out of financial ruts. He walked away from the music industry's routine, seeking financial independence elsewhere, and he was successful. This was before the internet, before digital music, and before crowdfunding was considered a viable financing option. His lead is being followed by other artists who want to evolve and improve financial products by incorporating a future factor. As a result, we see financial practices constantly evolving, providing solutions to all sectors and increasingly taking the lead in people's business lives.

Acknowledgments

I would like to express my deepest appreciation to my friend Stelios who I met in college, where we came up with that project and conducted research regarding intellectual property securitization, part of which is published here in this article, during the last year of our studies together at the business school.