Licence royalties are paid to the owner of the intellectual property (IP) by the person licensed to commercialise the IP. There are a number of things to consider:
Usually, royalties are expressed as a percentage of the product's sale price. However, many factors influence a royalty rate. These include:
- industry type (as different industries have different rates)
- state of IP development (as the closer the product or service is to market-readiness, the higher the royalty)
- relative bargaining positions of the licensor and the licensee.
There is no standard 'sale price' where a royalty on sales is calculated. The starting point is usually the price at which the product is invoiced. From this, it is common for different types of deductions to be made, such as:
- sales tax
- turnover tax
- import or export tax
- excise duty
- a customs duty.
Freight and insurance costs are sometimes factored into the definition, where these costs are added to the invoice and appear as separate items.
Sometimes royalties may be increased as product sales reach certain milestones. For example:
- sales below $10 million - 5 per cent royalty rate
- sales above $10 million - 6 per cent royalty rate.
Royalties may also be paid on sub-licence fees. These are royalties received by a licensee from a sub-licensee in relation to product sales made by the sub-licensee. As an alternative, a sub-licensee may pay a lump-sum payment.
If a product is manufactured using licensed IP then it is appropriate that a royalty be paid for the use of that process.
The most common way of structuring IP royalty rates for processes is to pay the royalty based on the gross sales price of the product manufactured with that process.
A lump-sum licence fee is often sought at the time of granting a licence. This could be a:
- signing fee
- milestone payment.
Generally a lump-sum fee will recover the expenses of developing the IP to a point where a licence is possible. These include research and development costs, administrative and indirect costs, along with a profit component.
A particular type of lump-sum licence fee is a signing fee. This can reimburse the out-of-pocket commercialisation costs incurred by a licensor up to the date the licence is granted, and can include:
- patent application costs and patent attorney's fees
- legal fees
- accountant's fees
- other consultants' fees.
Milestone payments are made by the licensee as certain, defined milestone events occur during the conduct of the commercialisation process by the licensor. Examples of milestones that may trigger such payments are:
- manufacturing a working prototype
- manufacturing a production model
- a licensee granting a sub-licence to operate in North America
- the patent being granted
- the first sale of a product
- the making of cumulative sales of a stipulated amount.
As the commercialisation process advances through these milestones, the uncertainty of market entry reduces and the IP correspondingly becomes more valuable.