Are You Confusing the Royalty Rate with the Royalty Calculation?

When it comes to getting paid in a licensing deal, there’s a big difference between the royalty rate and how it’s used to calculate royalty payments. If it’s not clear in your licensing agreement, you wind up losing money on your licensing deal.

The royalty rate determines how much will be paid to you from your licensing partner’s revenues. Royalty rates are often a percentage of sales or revenues, such as 10%. But they can also be a fixed amount, such as one dollar per unit. That’s what most people are familiar with.

But many IP owners wind up losing money on how the royalty is calculated. And that usually happens when your royalty calculation formula is not clear. If your royalty rate is calculated on net sales and you don’t define what net sales are, you wind up receiving a fraction of what you should be paid. Or worse, it leaves it open to the interpretation of what net sales are or how the sales are calculated.

Then your licensing partner starts deducting such costs as advertising, promotion and even manufacturing. These deductions significantly impact your actual royalty payments, depending on what and how much is deducted. For example, an 8% royalty gets reduced to an actual payout of only five to six percent of gross sales.

On the other side, if you don’t define gross sales, the problem you encounter is a licensee who is unhappy because they wind up paying royalties on things like returns, discounts, damaged goods, and products given away to promote sales.

There’s nothing more frustrating than arguing with your licensing partner over how much they owe you in royalty payments. Whether it’s gross or net sales, the best way to avoid this trap is to be very clear on what the royalty rate is and how that number is defined and used to calculate your royalty payments.

Remember, there’s a big difference between calculating the royalty rate on gross and net sales. One pays you the full royalty rate amount, the other results in losing money on your royalty payments.

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