Royalties and Their Relationship to Patents

    Royalties are defined as legally binding payments made to any business or individual for the use of any form of intellectual property. Royalties can be related to just about any form of intellectual property; they exist for copyrights, patents, and trademarks, among others. They often serve as a steady source of income for their recipients.

    Patent owners have maximum control over their invention which has received a patent. This means that they may deny anyone else the right to use the patented invention. Alternatively, by licensing that invention to anyone who is willing to pay the royalty, the licensee who pays it may use the invention according to the terms established by the patent owner.

    Patent Licensing Royalty Rates

    Patent licensing royalty rates are a crucial part of any patent licensing agreement. In such an agreement, the amount which a licensee is required to pay to a licensor to use the patented item is stated. These rates typically take the form of a percentage of the revenue which the patent generates. However, certain licensors may sometimes prefer to require payments to be made in the form of a fixed fee. In either case, these rates ensure the licensor’s proper financial compensation for the use of the patented item.

    Ideally, royalty rates ought to be fair to both the licensor and the licensee. The amount of money received by the licensor should be in line with the value generated by the patent as the licensee develops, manufactures, or markets the associated product. Similarly, the licensee should have to pay an amount which is proportional to the income generated but is not so large as to hinder the use of the invention to improve business activities and outcomes.

    How Royalty Rates Are Determined

    Several different factors determine the appropriate value of patent licensing royalty rates. These factors include the industry in question, the license’s exclusivity, the stage of the patent, and the market potential of the patented invention. Any upfront compensation paid by the licensee also plays a part in setting an appropriate royalty rate.

    Royalty rates, which may be expressed as either a percentage of sales or a payment per unit, are determined through the income, market, or cost approach. The income approach estimates the income to be generated and sets the royalty rate based on that figure. The market approach uses similar patents in the market as the basis for the rate to be used. Royalty rates based on the cost approach use the cost of production of a similar patented item as a basis for the calculation of the rate.

    Patent Royalties and Transfer Pricing

    Sometimes, those who perform transfer pricing analyses do so for transactions which involve patents. When they do so, they can use information derived from patent royalty rates to assist with their calculations. This is possible by assessing the royalty rates which have been established for similar uncontrolled transactions. This way, it can be determined if the transfer pricing in question is fair.

    According to the Organisation for Economic Co-operation and Development (OECD), the comparable uncontrolled price method is the most viable transfer pricing method to be used in the presence of data for comparable items. This method involves an assessment of the amount which would have been earned through the patent if a similar transaction were to be performed by two unrelated parties. Databases of third-party patent royalty rates can often be accessed via the Internet.

    Investing in Patent Royalties

    Some people or businesses might choose to invest in patent royalties. When they do so, they receive a regular payment based on the sales generated by the patent. This payment will usually arrive on either a monthly or quarterly basis. Just like stocks, shares, mutual funds, and other investments, patent royalties can be bought and sold.

    Investing in patent royalties is generally a low-risk venture. Unlike stocks or shares, the value of royalties does not depend on either prevailing interest rates or the condition of the stock market. Investments in patent royalties also serve to diversify an investor’s portfolio. Industries in which investments in these royalties are common include entertainment, venture financing, and oil and gas.

    This article is brought to you by Exy Intellectual Property Malaysia and Singapore.