The Basics of Royalty Accounting: What You Need to Know

Royalty accounting can be somewhat complex, especially depending on the contract terms that are negotiated. However, once you have an understanding of the basic principles you should be able to negotiate a deal that benefits both parties so each of you can focus on selling great products.

Most brands license to extend their brand presence in the marketplace. However, unlike advertising, product sampling, and other initiatives, licensing generates a direct revenue stream for the brand.

Royalties

So how much should a brand expect in royalties? Like most things it depends. It depends on the product category, the royalty rate, retail placement and product sales.

First thing’s first, the royalty rate. The royalty rate is typically a percentage of a licensee’s net sales paid to the brand; alternatively, it can be an amount per unit of licensed product sold. We have seen royalty rates as low as 1% and as high as 10%+. This rate is typically negotiated between the Licensee and Licensor during the contract phase.

We typically recommend that the Licensee pay an advance of royalties when the contract is signed. The advance royalty is a credit against royalties to be earned in the first contract period. Contract periods are typically one calendar year.

Guaranteed Minimum Royalties (GMRs)

The licensee is asked to guarantee a minimum amount they will pay in royalties, a number we call the Guaranteed Minimum Royalties (GMRs). Typically, there is a set amount for each contract period and it is paid quarterly. Industry standard is for the licensee to guarantee 50% of expected royalties. For example, if a licensee is paying a 5% royalty rate and they are projecting $1MM in sales for the first year/contract period, the licensee’s GMR would be $25,000 for the first year/contract period ($1MM * 5% = $50,000 and half of $50,000 will get you to $25,000 GMR). For more detailed explanations of GMRs read here.

You might be asking yourself, “What if the licensee sells more than $1MM in their first year? Do I get paid more?” The answer is “YES”! The licensees pays the higher of the two, the earned royalty or the GMR.

We typically ask licensees to pay and report 30 days after each quarter ends. We have a royalty report template we use, although some licensors may use an online royalty reporting system like Royalty Zone, Brand Comply or Dependable Solutions.

Understanding these two vital components of a licensing deal can help you create an agreement that’s a “win” for all parties.