This series addresses the needs the legal community has for licensing technology knowledge by laying out the basic concepts that one should understand, identifies traps for the unwary and offers drafting and negotiating tips. Click here to read parts one and two.

Royalty obligations should provide a clear description of the licensee's activities for which royalties are to be paid and should be carefully coordinated with the license grant provisions. The royalty obligations can take different forms depending on the nature of the intellectual property, such as whether it is a machine, a process or a composition of matter. They also may vary based on the licensee's intended use, e.g., use for manufacturing purposes or sales of patented products.

  1. Royalty Structures

Royalties can be one-time or ongoing. They can include upfront payments, milestone payments or running royalties based on use of the licensed IP.

Running royalties can be based on a percentage of sales revenue (customarily referred to as “net sales”), a percentage of net profits, or a fixed dollar amount per unit. Basing royalties on net profits is difficult, however, and can lead to disputes regarding overhead and other expenses. Also, the licensee may not want to open its books. If the parties do choose net profits, it is essential that the license agreement contain a clear, complete and unambiguous methodology for calculating the net profits.