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What is 'Royalty'

A royalty is a payment to an owner for the ongoing use of their asset or property, such as patents, copyrighted works, franchises, or natural resources. A royalty payment is made to the legal owner of the property, patent, copyrighted work, or franchise by licensees or franchisees who wish to make use of it for the purposes of generating revenue or other such desirable activities. In most cases, royalties are designed to compensate the owner for the asset's use, and they are legally binding.

BREAKING DOWN 'Royalty'

Royalties are often expressed as a percentage of the gross or net revenues obtained using the owner's property, but they can be negotiated to meet the specific needs of an arrangement. The use of royalties is common in situations where an inventor or original owner chooses to sell his product to a third-party in exchange for royalties from the future revenues it may generate.  Royalty interests are the legal rights to collect future streams of royalty payments.  

For example, computer manufacturers pay Microsoft royalties to be able to use the Windows operating system for the computers they manufacture. Payment may be non-renewable resource royalties, patent royalties, trademark royalties, franchises, copyrighted materials, book publishing royalties, music royalties, and art royalties. Well-known fashion designers can charge royalties for the use of their names and designs by other companies. Authors, musical artists, and production professionals are paid for the usage of their produced, copyrighted material. Television satellite companies provide royalty payments to air the most viewed stations nationwide. Royalties are also evident in the oil and gas industries, as companies provide royalties for landowners for giving them the permission to extract natural resources from the landowners' covered property.

License Agreement

The terms under which royalties are based on is called a license agreement. The license agreement defines the limits and restrictions of the royalties, such as its limitations pertaining to the geographic territory, how long the agreement will last, and the type of products with particular royalty cuts. License agreements are uniquely regulated if the resource owner is the government or if the license agreement is a private contract.

Royalty Rate

The royalty rate or the amount of royalty charged per product or service depends on the type of royalty fee for which a party is paying. Many factors affect the royalty rate. The most common ones include exclusivity of rights, availability of alternatives, risks involved, market demand structure, sustainability of technologies involved, and the level of innovation the product or service provides.  To accurately estimate royalty rates, there must be willing transacting parties (buyer and seller), the transaction must not be forced, and the transaction must be at arm's length (transacting parties act independently and have no relationship with each other).

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