What is a royalty payment?

If you are entering into a license agreement – whether as a licensor or a licensee – you need to understand what a royalty payment is. Royalty payments are a basic component of any licensing deal. They provide an incentive for inventors to license out their technology or intellectual property, while giving licensees a cost-effective way of investing in new assets for their business. Read on to learn more about the different types of royalty payments, and the ways they can be structured.

Royalty payment definition

A royalty payment is a regular fee paid by a licensee to a licensor, in exchange for the use of the licensor’s intellectual property. This happens when both parties enter into a licensing deal, which could be as part of a franchising arrangement or as a more standard intellectual property licensing agreement. The fees that the licensee must pay, and the terms of doing so, are specified in the royalty payment agreement. The royalties and licensing deal terms are agreed to by both parties.

For a more in-depth royalty payment definition, see our article on what royalty rates are.

Different types royalty payments

There are various types of licensing agreements that require royalty payments. These include:

• Franchising agreements: If a franchisee enters into a franchising agreement, they will be required to make franchise royalty payments on a regular basis. These payments give them the right to use the franchisor’s intellectual property assets, as per the terms of the franchise licensing agreement. The royalty payments rate is typically set as a percentage for franchise arrangements, as this makes it cost-effective for both parties. In the early days, the franchisee can pay a fair proportion of the franchise revenue, rather than making huge payments. As business picks up and they earn more, their payments increase fairly.
• Intellectual property licensing agreements: A licensor may decide to license the rights to their intellectual property, such as patents, trademarks, copyright, know-how, etc. (many licensing deals include a combination of these). This may be so that another organization can take care of a certain task, such as manufacturing the product or bringing it to market. Or the licensor may wish to license their intellectual property to increase its reach and visibility in a greater number of markets – ones they perhaps could not reach on their own.

Various royalty payment structures

Not all royalty payments are structured in the same way. Here are some of the different options:

• Percentage vs fixed fee: Royalty rates are usually set as a percentage of the revenue generated by the intellectual property. This means that the licensee’s payment obligations and the licensor’s resulting compensation are proportionate to how well the intellectual property is performing. Another option is to structure the royalty payment as a regular fixed fee. This means that the licensee always pays a specified amount, regardless of how well the intellectual property is performing. This is a less common but entirely valid option.
• Weekly, monthly, quarterly or annual payments: Royalties are paid on a regular basis, according to the payment schedule outlined in the royalty payment agreement.
• Fixed or tiered royalties: Some royalty rates are fixed, which means that they remain the same for the duration of the licensing agreement. Others are tiered, which means that they change depending on certain criteria, such as volume or sales thresholds being met.

Struggling to set royalty rates? Get examples here

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