A royalty is a fee paid to the legal owner for the use of their patents, copyrighted materials, property, natural resources or franchises to generate revenue. A royalty payment is a legally binding way of compensating the original owner or creator of the assets other people want to use for financial gain.
The parties define the limits, terms, and restrictions on the royalty fees clearly in a contract for the license. The limitations may include the following:
- Geographic territory
- Duration of the agreement
- Kinds of products with royalty cuts
If you are asking how to calculate fees – a service provided by firms such as MetaComet® Systems, Inc. – there are several ways to go about it.
The exact amount of the royalty costs per service or product mostly will depend on the kind of fees for royalty your license agreement is based on.
Fixed percentage of gross sales. Considered the simplest royalty fee structure to manage, where the royalty is calculated based on a fixed percentage applied to the total sales after certain approved adjustments. These modifications include taxes, bad debts, returns, and so on.
Decreasing percentage of gross sales. As the monthly total sales increase, the royalty rate decreases. They base the royalty fee calculation on the monthly sales, adjusted for cumulative annual sales.
Increasing percentage of gross sales. In this royalty fee structure, the royalty rate increases as the sales increase. Of course, some factors affect this type of agreement like franchise location.
Minimum royalty. Under this kind of royalty agreement, a franchisee must pay a minimum amount on a monthly basis even if they are not required to pay that much based on their sales under the percentage royalty agreement.
Fixed Royalty. A fixed royalty fee structure requires the franchisee to pay a flat monthly fee regardless of their gross sales. This is most beneficial to franchisors, as they do not need to worry about fluctuating monthly royalty payments to them.
Calculating royalty fee is a very complicated task that requires much expertise, experience, and knowledge. Fortunately, there are software and tools now available that automate this strenuous task, which makes life easier for both the franchisor and franchisee.