With a right of first refusal, the record company protects itself by not allowing the artist to make a great sounding demo and then use that demo to get a deal elsewhere - that is, until the label is certain that it wants nothing to do with the artist. After the artist delivers the finished demos to the label, under the right of first refusal concept the artist has to give the label a period of time ranging from thirty to sixty days in which it has to decide whether it wants to sign the artist. From the artist's perspective, it is best to keep that period short. Moreover, under this same concept, the label will generally provide in the demo deal that if the label wants to sign the artist, the artist must negotiate a recording deal, and, if an agreement cannot be made, the label gets first refusal. This means that the record company gets a chance to match an offer given to the artist from a competing label, and if it matches or betters that offer, the artist must sign with the demo company. The artist should limit the time within which the label which funded the demo can accept or reject the other offer. Ten to fifteen days is a reasonable amount of time, and never give the record company more than thirty days to match the offer.
If the label which funded the demo passes on the artist and does not match an offer under the first refusal provision, the artist is free to record elsewhere. However, the original label will still want to make its money back for the cost of the demos. The only recourse for the demo label is to get the money from a record deal an artist might make in the future. Most labels signing an artist are willing to reimburse the demo company for the cost of the demos as long as the cost is recoupable from the artist's royalties. The artist should include in the demo deal that the company funding the demos can only get its money back if the artist makes a record deal within a specified time limit (i.e., one year).
Since a record deal is not easy to come by, a demo deal can be the entree an artist needs to obtain a record deal. Therefore, it is probably to the artist's advantage to enter into such an agreement with a reputable label so long as the above matters are discussed.
Ben McLane Esq