UNDERSTANDING PATENT ROYALTIES

A patent royalty agreement is a contract which establishes the payment terms through which a licensee can use a licensor’s patented product. Such patent royalty agreements generate periodic revenues for inventors, and those royalties are often paid out either monthly, quarterly, or annually. The primary goal of a royalty is to generate a periodic revenue stream for an inventor through, what is often known as, “mailbox” money.  There are several methods for an inventor to profit from licensing an invention:

• A periodic royalty payment calculated on sale 

• A royalty payment based on units sold

• A royalty payment based on the use of a patented process

• Fluctuating patent royalties tied to an outcome

• A lump sum one-time patent royalty
  

Royalties are the most common method of compensation for inventors, and although they can be calculated in different ways, royalties are generally based on net products sales of the patented invention. In other words, royalties are a direct cost that can be added to the price of the patented portion of a good (or service). It is a predictable expense associated with the overall cost of that good (or service). Paying a royalty from the sale of a good (or service) benefits both the patent holder and the person (or licensor) making the product containing the patented invention. For instance, the licensor does not have to pay the patent holder any money when a good (or service) does not sell. This means that if the goods (or services) associated with the patented invention fails to achieve market success, the licensor has not paid any advanced royalties on unearned monies. Despite that risk, most patent owners prefer to be paid a royalty because, conceivable, the amount of money paid over the life of the patent could be significant if the product achieves market success. An inventor will also find a royalty lucrative when the product (or service) price is not variable, relatively inelastic, and not subject to price erosion.

In specific cases, such as computer hardware units which are known to often drop in price due to market demand, a patent holder may prefer not to utilize a royalty system dependent upon net sales, but rather base such royalty on a percentage of units sold. For example, a fixed payment amount of a sum certain (let’s say $5 per unit sold) may be much more lucrative than a percentage of net sales which suffer from demand elasticity and/or price erosion. It is true that licensees generally don’t want to pay “guaranteed” money when prices fluctuate but, the more necessary your invention is, the more leverage you may have in determining how a patent licensee must pay. Sometimes a hybrid fix sum-royalty and net sales royalty relationship can be arranged. For instance, if sales exceed a designated revenue amount (let’s say $500,000), then it could be agreed between a licensor and licensee that a royalty is paid on net revenue and not per unit; however, if sales are less than the designated revenue amount (less than $500,000), then licensee pays a per unit fix fee royalty payment. Royalties can get very creative, and each licensor-licensee relationship is different. Our Dallas patent lawyers can help you negotiate and contract for the best patent royalty possible.

 In the event an inventor creates or invents something that is designed to be used rather than sold, such as a business method patent or process of coating computer chips used in a manufacturing operation, it becomes difficult to quantify the royalty to be paid for that method or process used. A “per use” licensing royalty pays the inventor for the number of times that such method or process is used rather than a derivative of total net sales given consumers never actually utilize the method or processed invention alone. Most inventors of a “per use” patent will have little choice but to accept a royalty based on the number of times the method is “used or performed” given the general public never sees or can use the patented process itself.