L52 Royalties

The various means of calculating the value of a license have alrady been described (L38). However though all payment methods can be reduced to a present value using discounted cashflow analysis there are a very wide variety of methods of payment. Among them are:
  • A percentage of gross or net selling price (though competition can erode this)
  • An amount based on some measure of use, input or output relating to the technology
  • Direct Profit sharing or an amount based on the some measure related to the benefit the licensee gains (though measures based solely on profit result in no payment if the licensee makes no profit)
  • A provision for a minimum payment irrespective of the licensees sales or profits
    (this backs up a best endeavours clause)
  • An initial lump sum with a subsequent running royalty of some form
  • A lump sum (this may avoid the need for auditing requirements but both parties are making contrary assumptions about the future fate of the technology which may signal future problems).

Any one or more of the above might be combined and royalty rates might also vary with the level of use, the volume or value of products involved. Minimum payments might also be tied to some guarantee regarding the effectiveness of the technology.

In order to enable royalties to be determined it is usual to require the licensee to keep adequate records and to subject them to audits and reporting requirements.

It may be desirable to provide a clause which removes the obligation to pay royalties in respect of IP which is subsequently found to be invalid. This may mean that in licensing a package of IP it is desirable to identify what royalty applies to what IP so that if one falls the rest remain. In the EC at least confidential know-how related payments can continue even if the patents involved have been found invalid. There may well be tax considerations where such a division is made and again good advice is essential. Royalties can be spread over time as the parties wish so it is possible to have payments relating to the time the agreement was in force being paid after it has expired.

Licence agreements have a considerable degree of flexibility in how royalties are calculated but they should ideally be calulated in a way that gives both parties an incentive to promote the future success of the business. There should also be adequate and clear provision for the mechanics of payment including the time, frequency and currency of payment and provisions regarding taxation.