A royalty payment is one of the basic components of any licensing deal. If you’re entering into a licensing agreement – either as the licensee or the licensor – it’s important to understand what royalty payments are and how they’ll affect your relationship with your licensing partner.
In short, royalty payments are the exchange of an agreed upon amount by a third party to an owner of a product, patent, or intellectual property for the ongoing use of that item. The point is for the users of that asset to compensate the actual owners for the allowance of their brand to be used by the third party. Royalty payments incentivize inventors and big brands to license out their technologies or products while simultaneously offering other businesses (the licensees) a way to build new assets for their own companies in a cost-effective manner.
Royalty payments are generally ongoing fees that a licensee has to pay their licensor. They’re often associated with assets like:
- Franchising agreements
- Patents
- Trademarks
- Other forms of intellectual property licensing agreements
Types of Royalty Payments and Structures
There is no one-size-fits-all rule for royalty payments. Some agreements will require weekly payments, while others allow for monthly, quarterly, or annual payments. Some license agreements offer straight fixed royalty structures, while others are set on a more complicated tiered structure. Similarly, payments may be required as part of a fixed fee or percentage fee basis.
With this in mind, let’s dive a little deeper into payment and structure types involved with royalty payments.
Percentage vs. Fixed Fee Royalty Agreements
Often, licensees are required to pay a certain percentage of the revenue they generate from the asset they’re licensing. In other words, the amount of money they pay the licensor is directly proportional to how well that asset is performing. This is generally the most common setup, as it protects the licensee if the asset doesn’t generate revenue as expected.
A less common (but still entirely valid) method of licensing is a fixed-rate structure. In this instance, the licensee pays the licensor a fixed fee, no matter how well or poorly the asset performs.
Payment Frequencies
Royalty fees are required to be paid on a regular basis, as defined by the payment structure that’s set forth in the license agreement. Depending on the contract, payments may be required to be paid weekly, monthly, quarterly, or annually.
Fixed vs. Tiered Royalties
If a royalty agreement outlines a fixed rate, that means the licensee’s rate remains the same for the life of the licensing agreement.
Tiered royalties are a little more complicated and can fluctuate based on certain criteria, such as when specified sales volumes are met.
Types of Royalty Agreements
As noted above, there are a few different types of royalty agreements. These include:
Franchise Agreements
If you’re a franchisee who’s entered into a franchise agreement, the franchisor will require regular payments for use of their intellectual property assets. These are typically set up on a percentage basis, allowing for franchisees to pay a fair portion of their franchise revenue, rather than being forced to make huge payments that may over-extend their cashflow.
Intellectual Property Licensing Agreements
Licensors can decide to license the rights to their assets, such as patents, trademarks, copyright, and knowledge, or any combination of these elements. This often helps manufacturers bring products to market. Licensors may also wish to license their intellectual property as a way of bringing greater reach and visibility to new markets they may not be able to establish credibility in on their own.
Need Help Navigating the Difficult Waters of Royalties and Licensing Agreements?
The MIBAR team can help! With the MIBAR Rights and Royalty Management solution for NetSuite, licensees can now automatically file royalty reports and submit payments to agencies, track financial obligations, and generate licensor-specific statements across an unlimited number of contracts. Touch base with our team today to schedule a demo!
Download our whitepaper Using ERP to Manage the Complexities of IP Licensing, Reporting and Audits to learn how growing and mid-market companies can combine NetSuite with MIBAR’s industry-built functionalities to meet the stringent requirements of the product licensing world.
