Licensing Royalties: What Every Licensee Needs to Know

If your business has acquired the rights to use another party’s invention, creation, or intellectual property (IP), then congratulations: you are now a licensee! 

Licensees pay licensing royalties to a licensor when they monetize the IP they have acquired. What follows is a guide to licensing royalties, how they work, the benefits and risks they involve, and the systems that can help you manage them.

What are licensing royalties?

Licensing royalties are payments made in exchange for the use of licensed intellectual property (IP), and are tied to the revenue generated as a result of the license. The IP may be a copyright, patent, or trademark, and may exist in a wide variety of mediums or forms: visual, audio, text, code, or an invention or creation of almost any kind.

How do licensing royalties work?

Licensing royalties are calculated based on either a percentage of sales or a fixed amount per unit sold. For example, 10% of net sales or $1 per unit.

Whether it’s a percentage or a fixed amount, the royalty rate is agreed upon by the licensor and licensee and defined in the licensing agreement they sign when they establish their business relationship.

The agreement will also contain a number of other licensing terms which affect how royalties are calculated and paid, such as:

• Whether the royalty percentages will be applied to gross or net sales, and how those sales totals will be calculated.
• Whether the royalties may be reduced by returns and discounts that the licensee grants to customers.
• Whether the sales are made to a distributor, retailer, or end user. This may affect the price that the customer pays for the end product, return policies, or other obligations that the licensee may have to the customer.
• Certain benchmarks may affect when royalty payments must be made, or may trigger increases or decreases in royalty percentages. The benchmarks may be calendar-based or related to sales levels or various activities undertaken by the licensee: for example, the publication of a book, or FDA approval of a pharmaceutical product.
• The license period and territory, and whether or not the license is granted exclusively to one licensee.
• How often the licensee is responsible for royalty calculation and payment.
• Other payment terms, such as late fees.
• Whether the licensee is responsible for paying advances against royalties or guaranteed minimum royalty payments.
• Guidelines for audits to be performed by the licensor or on the licensor’s behalf.

What are the types of licensing royalties?

Royalty payments come in dozens of different types in our modern, information-based economy. Some common types include:

• Payments to writers, illustrators, and other creators in all kinds of book publishing, including e-books and audio books.
• Royalties in other kinds of media and entertainment, paid to creators of and contributors to a piece of music, a video work, or a video or physical game.
• Merchandise royalties, paid when a manufacturer or marketer licenses IP from a sports team, brand, or content owner. This could include a depiction of a character, a logo, or other artwork.
• Technology royalties, frequently paid in biotech, software, and many other kinds of health care, tech, and manufacturing businesses.
• Royalties paid to creators of curriculum or other online learning resources.
• Franchise royalties, paid by franchisees in exchange for the use of a logo, branding, trademarks, business model, and know-how owned by a franchisor.

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What is the difference between licensing fees and royalties?

 A licensing fee is set at a fixed amount, while royalties are calculated based on usage or sales. A single licensing agreement may involve both licensing fees and royalties.

What are the benefits of licensing royalties?

Licensing royalties allow both parties in the agreement to share in the risk and in the upside of the business venture. The licensor invests in the cost of developing the licensed material, while the licensee invests in marketing it, and both have the opportunity to make a profit when the material is sold or monetized.

What are the risks of licensing royalties?

Royalty agreements involve risks for licensors, particularly around payment accuracy and revenue guarantees. If the licensee intentionally or accidentally underreports sales, they may also end up underpaying their royalties. If sales are lower than expected and there are no guaranteed royalty or advance payments, then the licensor may receive no revenue at all.

Both parties in a licensing agreement give up some level of control over the product, compared to what they would have if the product was conceived and sold by a single company.

The risks of licensing royalty agreements can be mitigated by developing strong, secure partnerships, with clear and detailed agreements, based on a foundation of honesty and trust between the two parties.

What are examples of licensing royalties?

Below are a few sample scenarios illustrating when licensing royalties may be paid.

• When a book publisher licenses the content of a book to a film studio that produces a movie based on the book, the studio may pay royalties to the publisher, which in turn would pay royalties to the book author.
• A sports team may license its logo, mascot, or other imagery to a company that produces branded merchandise in exchange for royalties.
• A biotech company may pay royalties to a university’s technology transfer office in return for the use of a technology developed by the university’s faculty. In turn, the university would distribute revenue shares to the faculty members and perhaps the lab, school, or department where the technology was created.
• A medical device manufacturer may pay royalties to the inventor of some component of the technology that the manufacturer produces and sells.
• A professor may receive royalties for curricula they developed for an online learning program.

What systems help licensees manage their royalty obligations?

MetaComet® Systems helps licensees calculate and pay out licensing royalties quickly and accurately, no matter what industry you’re in. Our Royalty Tracker® makes it easy to input the terms of your licensing agreements, upload sales information, and instantly generate royalty statements, reports, and electronic payment files.

Would you like to see how MetaComet® Systems can help you? Contact us for a no-pressure demo today, and see how easy and stress-free licensing royalties can be.