What are royalties and how are they paid?
Royalties are payments made by someone else, the licensee, to you in return for using your IP rights.
Most commonly, royalties are paid on sales or for use of a process.
Royalties from sales
Royalties from sales are usually based on a percentage of the product's sale price.
However, many factors influence royalty rates, including:
- Distinctives of the product, service, or know-how that's being traded
- Industry type
- Bargaining positions of the licensor and the licensee
- Buyers in the market
- Other competitors in the market.
The starting point for setting royalties is usually the product's invoice price. Then, deductions are usually made, including:
- Sales tax
- Turnover tax
- Import or export tax
- Excise duty
- Customs duty
- Freight and insurance.
Royalties on sub-licence fees
You can arrange to receive royalties from a sub-licensee for sales made from your IP.
Royalties for the use of a process
If a product is manufactured using your licensed IP, the licensee pays a royalty for the use of your process.
These rates are commonly structured by basing the royalty on the gross sales price of the manufactured product.
Lump sum licence fees
Franchising arrangements can include lump sum fees paid at particular points in time, known as milestone payments, in addition to royalty payments.
Sometimes the owner of the IP will negotiate lump sum fees in addition to royalties. This is most likely in cases where no one can be sure that the idea being commercialised will ever reach the market.
A new pharmaceutical that is licensed before clinical trials are completed and the time to market is many years with no guarantee of success.
In these situations the IP owner can negotiate to receive payment up front, or lump sums at particular milestones to offset the risk that there may be no royalties.
Milestone payments could be set for:
- Signing the agreement
- Manufacturing a working prototype
- Manufacturing a production model
- Granting a sub-licence to operate in a particular geographical area
- Granting of a patent
- The first sale of a product
- Cumulative sales reaching a set amount.
How to value IP rights
What makes an IP right valuable is complex, so this can make valuation difficult. Many factors can contribute to the value of an IP right, including:
- The quality of the idea it protects and commercial potential of that idea
- The likelihood of legal disputes concerning the validity of the right or any of its claims
- The amount of follow-on ideas inspired by the idea.
We recommend that you seek advice when it comes to valuation. There are many patent attorneys and specialist advisory services that can value your IP for a fee.