When you want to enter into a licensing agreement, it’s rare that royalty terms are nonnegotiable. As a practical matter, just about everything is negotiable if both sides want something from the other in a deal.
Also, don’t take the other party’s word that the royalty calculation method is “standard” so you should accept it. For example, it’s common for some licensees to claim it’s industry practice to determine the amount of royalties based on net profits. That can be a recipe for disaster for the licensor because the licensee is able to drive down net profits by padding out expenses associated with sales.
Generally, it’s better to calculate a percentage royalty based on gross or net revenues (not profits) to prevent such a temptation. And in some cases, it may make sense to receive a fixed dollar amount per sale instead of calculating percentages.
Now if you’re wanting to get paid as the licensor, it’s more effective to structure payments to be made on a monthly basis instead of quarterly. First, you’re more likely to get paid. Second, it’s easier and quicker to spot if something’s wrong.
With each royalty payment, the licensee should provide a sales report used as the basis for determining the amount paid. And, ideally there should be audit rights to reduce the risk of error/fraud.
These are just a few of the issues that should be covered in your licensing agreement. Of course, the terms you’ll want will vary based on whether you’re the licensor or the licensee. If you need help crafting a licensing agreement designed to protect you, it’s probably time to schedule a phone consultation with Business Lawyer Mike Young.
