IN modern world Franchise-based business relationships are increasingly occupying space. For some, this word still remains unclear, but most entrepreneurs are already actively using it in their activities.
Royalty is a monetary contribution that no franchise can do without, because, as everyone knows, free cheese only comes in a mousetrap. Therefore, after concluding the contract, every month you will need to pay a certain amount.
We’ll look at everything you need to know about royalties, their design features and nuances in this article.
What is royalty?
Many active and temperamental people, in order to improve their own well-being, dream of opening their own business. In this case, there are three ways.
- Open your own business from scratch. But! In this case, you will need to go through the entire story from the very beginning. In most cases, this will take more than one year. However, all beginning businessmen want to receive profit from their own business almost immediately, from the first day. Therefore, this option is suitable only for very aspiring people.
- Buy a business that is already fully functioning throughout the country. In this way, you will save yourself from additional expenses and difficulties that arise at the initial stage.
- . This is the most famous and correct path, since it contains the minimum number of risks and dangers. All you need to do is follow the company’s rules and pay your royalties on time. In return, you will receive invaluable business experience, which can be successfully used after the end of the contract with the main company.
To understand what royalties are in a franchise, you need to know the essence of this concept itself. So, a franchise is the name of a deal concluded between a main company, which is well known on the positive side in the world, and a smaller company that is just starting its work.
According to the documents, the aspiring businessman receives:
- Right to use software which may be needed to conduct business.
- Ongoing legal advice relating to any field of work.
- Continuous training of staff, improving the quality of work with clients.
- A complete base of suppliers, be it food, equipment or services. But, you can only use the companies provided for your work.
Royalties are payments that a franchisee makes regularly (usually monthly) to a company for the benefit of its brand, expertise, goodwill and technology.
So, the franchisee (buyer of the franchise) makes periodic payments to his franchisor (seller of the franchise) for the use of his intellectual property (once again to the question of what royalties are in a franchise).
Companies decide for themselves exactly how to determine the royalty amount. As a rule, the franchisor sets a certain percentage of turnover or margin, or its income is directly generated through the supply of its products to the franchisee. Also, the franchise seller can set a progressive or regressive scale of deductions.
*Margin is the difference between cost and price.
The amount of payments charged to the franchisee is established based on the cost of those services that the company provides to him and those services that are purchased for the entire franchise network. If the company chooses the “percentage of turnover” format (for example, 10% monthly), it means that the partner must pay a royalty in the amount of 10% of sales for the past month.
"Our company is interested in the development of partners, since the more they earn, the more we receive. And it is very important for us to give everything effective tools to its franchisees for successful business development. In fact, we play the role of investors. Initially, the company gives more than it receives from the franchisee partner. We start making money on a franchise only when its buyer reaches a turnover of 2 million rubles, and we receive 80 thousand rubles from him in the form of royalties.
Choosing a percentage not from turnover, but from margin is usually typical for the franchisor, who clearly regulates the pricing policy on the network and, in fact, he sets a certain percentage from the markup on the product. As a rule, these are those companies that can influence wholesale and retail prices. And if the markup level for a particular product is different, then this form of royalty calculation is the most optimal.
Some companies make a profit from the sale of a franchise only due to the fact that franchisees purchase products from them. More orders - more profit. And no payments.
What are lump sum fees and royalties? What is the difference? A royalty, just like a lump sum fee, is a payment for granting the right to use the franchisor’s intellectual property. The lump sum fee is one-time and fixed amount, which the franchisee pays upon concluding a concession agreement. For more information about what a lump sum contribution is, read the article . In turn, royalty payments are regular. It can represent a fixed amount, but is more often in the form of an interest rate.
So, you can choose a franchise without royalties at all or with payments in the form of a percentage of turnover or margin. However, no matter what type of payment the franchisor sets, the main thing is to know what you are paying for and whether the assistance provided is really worth it.
Azgaldov G. G., professor;
Karpova N. N., professor
When using the income approach when valuing certain types of property, the category of “royalties” is widely used. At the same time, appraisers often face two main difficulties associated with operating with this concept:
- not entirely correct understanding of the essence of this category;
- ignorance of the methods by which it is possible to clarify the numerical values of royalties (in comparison with the rougher, averaged values given in the reference tables).
The purpose of this article is to provide in-depth information about royalties (and other types of remuneration for intellectual property licensed) so that information on this issue, at the current level of knowledge, for readers of the magazine can be considered largely exhausted. Moreover, the main attention will be paid to compensation payments for those intangible assets that are intellectual property.
In world practice, remuneration for the use of IP is carried out under a license (from the Latin “licentia” - permission, right) in one of three main forms, which have the following names.
When the amount of remuneration to the IP copyright holder (licensor) from the results of use of the IP by the recipient (licensee):
==> completely depends - the reward is called royalty;
==> completely independent - the remuneration is called a lump sum payment;
==> partly depends - the remuneration is called combined (royalty + lump-sum payment).
The form of remuneration is specified in the license agreement (between the licensor and the licensee). In the following, these 3 types of remuneration are considered in descending order of the relative frequency of their use in practice.
FORM OF REWARD IN THE FORM OF ROYALTY
ORIGIN AND MEANING OF THE TERM
The term "royalty" comes from the English (and French) term royal - royal, from which the term royalty is derived - a fee levied by the royal power in England for granting its subject the right to land ownership or development of subsoil. In the latter case, it could act as a rent for subsoil development. The term began to be widely used in the 16th century, when an industrialist who received from the king the right to develop coal mines had to annually deduct part of the profits to the crown - royalties (royal share).
Currently, in relation to intangible assets and, in particular, to intellectual property, royalty most often means a periodically agreed upon in a license agreement payment by the licensee (buyer, transferee) to the licensor (seller, copyright holder) of monetary amounts in amounts depending on the results obtained when using IP by a licensee.
The term "royalty" is also used for:
- designation of payment for the right to develop subsoil;
- rent;
- duties;
- fees for a license of some kind;
- a share of a product or profit reserved for himself by the owner of some property for granting the right to use this property to another person.
The lack of consideration of the importance of royalties can be illustrated by the following famous example. Dan Bricklin invented the paper drawer for personal computers in the late 70s. But he did not patent the corresponding technology and, naturally, did not receive any royalties from many companies that used his invention. As a result, he lost potentially several hundred million dollars.
Royalties are used for settlements with the licensor in 80 - 90% of cases when licensing agreements are concluded.
STANDARD ROYALTY RATES
Royalties are usually represented by a rate P (in foreign literature the letter R is usually used), expressed as a percentage of the base - the effect (result) of the licensee (buyer). The following can be used as a base:
- gross income (effective gross income, sales amount, sales volume);
- net income;
- additional profit (arising from the enterprise that purchased and uses the IP);
- price of a unit (batch) of products;
- cost;
- unit capacity of the workshop (production);
- cost of the main processed raw materials, etc.
Most often, such a base is taken as the price of a unit of production or the amount of sales (effective gross income - EIG). Experience shows that with such a basis, there is the smallest number of conflicts regarding the payment of license fees between the parties to a licensing transaction. The fact is that the initial data necessary to calculate the amount of royalty payments in this case can be easily found in the licensee’s accounting documents.
Table 1 shows standard (approximate) royalty rates used by specialized large foreign trade organizations in relation to such a base based on an analysis of global practice in concluding licensing transactions in various industries. This table allows you to pre-determine the approximate royalty rate for each specific property.
Table 1
|
Objects of application of royalty rates |
Royalty R in % |
|
| INDUSTRIES: | ||
|
Aviation |
||
|
Automotive |
||
|
Instrumental |
||
|
Metallurgical |
||
|
Consumer durables |
||
|
Consumer goods of mass demand with a short shelf life |
||
|
Agricultural Engineering |
||
|
Machine tool industry |
||
|
Construction mechanical engineering |
||
|
Textile |
||
|
Pharmaceutical |
||
|
Chemical |
||
|
Electronic |
||
|
Electrotechnical |
||
|
EQUIPMENT FOR: |
||
|
railways |
||
|
office work |
||
|
boiler rooms |
||
|
foundry |
||
|
medicine |
||
|
metalworking |
||
|
metallurgical industry |
||
|
surface treatment |
||
|
general industrial purposes |
||
|
water purification |
||
|
Food Industry |
||
|
handling equipment |
||
|
printing |
||
|
radio communications |
||
|
aircraft manufacturing |
||
|
alarm |
||
|
special purposes |
||
|
vessels (river and sea) |
||
|
transport |
||
|
chemical industry |
||
|
refrigeration units for industry |
||
|
cement factories |
||
|
electrical engineering |
||
|
SPECIFIC TYPES OF PRODUCTS: |
||
|
Aviation technology |
||
|
Car engines and spare parts for them |
||
|
Auto parts |
||
|
Cars |
||
|
Batteries |
||
|
Aromatics |
||
|
Bicycles |
||
|
Air conditioners |
||
|
Armament |
||
|
Rubber products |
||
|
Plastic products |
||
|
Glass products |
||
|
Measuring instruments |
||
|
Tool |
||
|
Compressors |
||
|
Copy paper |
||
|
Livestock feed |
||
|
Dyes |
||
|
Wooden furniture |
||
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Metal furniture |
||
|
Medical devices |
||
|
Mineral oils |
||
|
Industrial motors |
||
|
Heating systems |
||
|
Equipment |
||
|
Perfumery |
||
|
Printed publications |
||
|
Records |
||
|
Semiconductors |
||
|
Semi-finished products |
||
|
Foodstuffs |
||
|
Products organic chemistry |
||
|
Radio tubes |
||
|
Relay equipment |
||
|
Aircraft |
||
|
Agricultural machines |
||
|
Hardware |
||
|
Sporting goods |
||
|
Metalworking machines |
||
|
Construction materials |
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|
Textile fibers |
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|
TV equipment |
||
|
Fabrics for tailoring |
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|
Fabrics for industrial purposes |
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|
Products for the film industry |
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|
Knitwear |
||
|
Fertilizers |
||
|
Paper and cardboard packaging |
||
|
Pharmaceutical products |
||
|
Photo products |
||
|
Chemicals for Agriculture |
||
|
Chemicals |
||
|
Electrical instrumentation |
||
|
Electrical cables |
||
|
Electronic computers |
||
It is advisable to clarify the approximate royalty rate P (taken from Table 1) taking into account the following factors that influence its value in the specific conditions of a transaction with intellectual property (IP).
FACTORS REFLECTING THE LEGAL ASPECTS OF THE TRANSACTION
1. Scope of transferred rights. The highest royalty rates will be for full licenses - that is, when the licensee receives the exclusive right to use the IP. Somewhat lower (but also quite high) royalty rates occur with exclusive licenses (when the licensor retains the right to use the IP). The lowest royalty rates occur in the case of non-exclusive (simple) licenses, since in this case mutual competition and competition between other licensees is not excluded.
2. Territory of the license agreement. The royalty rate depends monotonically on the size of the territory.
3. Scope of legal protection. Royalties are higher for a patent license than for a non-patent license.
FACTORS REFLECTING THE COMMITMENTAL ASPECTS OF THE TRANSACTION
4. Terms of the license agreement on the mutual exchange of improvements. The royalty rate usually depends monotonically on the volume of interchange of improvements (both enforced and unenforceable).
5. Dependence of the licensee on the licensor. This refers to the dependence in raw materials, materials, equipment, parts and components necessary to organize production using the transferred technology. The greater the dependence, the higher the royalty rate.
6. Availability of competitive offers. This refers to competitive offers for the sale of technologies comparable in economic efficiency to the purchased one. If there is competition, the royalty rate will decrease.
FACTORS REFLECTING THE ECONOMIC ASPECTS OF THE TRANSACTION
7. Amount of required capital investment. They are necessary to organize production of products under license. How larger size investment, the lower the royalty rate.
8. Volume transmitted technical documentation. With the full volume of transferred technical documentation (design, technological and operational), the royalty rate will be higher than with an incomplete volume (for example, only design documentation).
9. Estimated costs of the licensee for its own alternative R&D. These R&D activities are aimed at developing IP that is comparable in economic efficiency to the purchased one. The lower these opportunity costs, the lower the value of the IP and, accordingly, the lower the royalty rate.
10. The licensee’s technological capabilities to make a profit from the intellectual property. These possibilities depend on the degree of technological development of the subject of the license. That is, the subject of the license can be an idea, a technical solution, semi-industrial or industrial use. The lowest royalty rate is in cases where the subject of the license is an idea, the highest is for industrial use.
11. The reputational ability of the licensee to profit from the IP. If the licensor has good goodwill and (or) a trademark and the licensee can directly or indirectly use this information when advertising licensed products, then the royalty rate in this case may be increased.
12. Volume of licensed products produced by the licensee. In connection with the goals pursued by the licensor, the dependence of the royalty rate on the volume of product output can be direct and inverse. Often this relationship is direct (“more output - higher royalty rate”).
13. Share (DD) of the transferred IP in the creation of income (D) for the licensee. The greater the share of income in the licensee's total income that comes from the transferred IP, the higher the royalty rate.
Unfortunately, there is still no data in the literature on the quantitative dependence of the royalty rate on most of these factors. And for those factors for which such an influence is known and depends on the specifics different types IP, relevant information is given below.
SELECTION OF ROYALTY RATES FOR INDUSTRIAL PROPERTIES The absence of a patent, as a rule, reduces the royalty rate by 10 - 30% compared to a similar object transferred under a patent license.
Based on the fact that the cost of design documentation usually amounts to up to 30% of the cost of the entire package of technical documentation, when transferring only design documentation under a license agreement, it is advisable to reduce the royalty amount to 30% of the standard (tabular) rates.
The standard royalty rates P shown in Table 1 usually apply to types of industrial property such as inventions.
SELECTION OF ROYALTY RATES FOR KNOW-HOW OBJECTS If the license is for the transfer of know-how, the P value is usually reduced by 20 - 60% (compared to the table), depending on a number of factors. For example, it decreases by:
- 20-40% if the intellectual property is transferred under a simple (non-exclusive) license;
- 20-40%, if the development of intellectual property requires significant capital investments (for example, for additional research);
- 40-60%, if the know-how is transferred to IP, known on the market, but still of interest to the licensee;
- 70-80%, if not the entire package of technical documentation is transferred, but only design documentation,
SELECTION OF ROYALTY RATES FOR INDUSTRIAL PROPERTIES AND KNOW-HOW There is a tendency to increase the importance of OIP in the creation of new technologies, products, services, and therefore in practice there are increasingly cases where the P rate is taken equal to 20% and even 50% of the additional profit (or NPV - adjusted net income), the source of which is an assessed knowledge-intensive OIS.
When evaluating IP for licensing purposes, the guidelines for adjusting royalty rates in Table 1 can be used. These guidelines are summarized in Table 2.
table 2
|
Degree of technology value |
License |
Unlicensed know-how |
|||
|
Exceptional |
Non-exclusive |
||||
|
patent |
non-patent |
patent |
non-patent |
||
| Particularly valuable | 1,4 - 1,8 | 1,1 - 1,5 | 0,9 - 1,1 | 0,7 - 0,9 | 1,0 - 1,2 |
| Average value | 1,1 - 1,5 | 0,9 - 1,1 | 0,7 - 0,9 | 0,5 - 0,7 | 0,5 - 1,0 |
| Low value | 0,7 - 0,9 | 0,5 - 0,7 | 0,4 - 0,5 | 0,2 - 0,4 | 0,1-0,5 |
The standard royalty rates shown in Table 1 are N.V. Lynnik (Intellectual Property, 1989, No. 11) recommends using for a turnover not exceeding 1.5 million dollars. With a total turnover of 1.5 to 2.5 million dollars, it is advisable to reduce the royalty rates indicated in the table by 10%; with a turnover of 2.5 to 5 million dollars, a 20% reduction can be accepted, etc.
For example, with a turnover of $5 million, the royalty rate is determined as follows: the first $1.5 million - no reduction compared to the rate indicated in the table; for exceeding 1.5 million dollars to 2.5 million dollars - the rate is reduced by 10°/o; for more than 2.5 million dollars - the rate is reduced by 20%.
That is, if the tabulated royalty rate in this case is determined to be 3%, then the adjusted royalty payments will be equal in dollars:
0.03 x $1.5 million + 0.027 x $1 million + 0.024 x $2.5 million = $132,000
Other, more radical amendments are proposed in the brochure by I. S. Mukhamedshin “How to more effectively protect, sell or buy scientific and technical products.” M.: 1993 The following adjustment factors are proposed for the tabulated standard royalty rates, taking into account the cost of net sales:
R. Khametov (Intellectual Property, 1997, No. 3-4) describes the features of remuneration to the author (copyright holder) in the form of royalties, in relation to objects of copyright (in particular, literary works). And although he does not quantify (does not express quantitatively) these features, it seems useful to give them short description. He highlights the following main modern forms royalty
1) System of linear current payments. According to it, the author receives a certain percentage of the entire turnover, the proceeds of the copyright recipient (licensee), without any changes, depending on how many copies the copyright recipient (licensee) sells. This system is very simple and understandable; it is quite often used in practice.
2) Degressive reward system. According to it, the author receives a certain percentage, which decreases with an increase in sales of copies of the work or with an increase in the income of the recipient. For example, when selling for the first 100 thousand copies. - 10% remuneration, for the next 100 thousand - 9%, etc. With correct calculation interest rates This system satisfies the interests of both the author and the copyright recipient. It is used quite often in Western countries.
3) Progressive reward system. As sales volume increases, the rate of remuneration paid to the author increases. This system may hinder the promotion of sales of the work by copyright recipients. However, if demand for a work grows, such a system may be acceptable to both authors and copyright recipients (licensees).
4) Profit-based system. The basis for calculating the author's remuneration is profit from the sale of copies of the work, and not gross income. This system is often found in copyright agreements concluded by Russian authors. For them, such a condition is extremely unfavorable, since doubts often arise about the correctness of the calculations made by the recipient (licensee). And there may be intractable disputes over the amount of remuneration.
5) A system that minimizes the time to receive rewards. This form is often used if the author (copyright holder) intends to speed up the sale of copies of the work. In this case, the copyright recipient (licensee) provides the author with a lower amount of payments for a certain limited period. This form is used when intensifying the sale of a product that brings high profits, or when targeting a product to identify buyer groups and distribution channels. The disadvantage of this form is that beneficiaries seek to extend the validity of discounts by any means.
6) System of guaranteeing a minimum royalty amount. Recently, the practice of stipulating in the copyright agreement the obligation of the legal recipient to guarantee minimum size royalties, which encourages the recipient (licensee) to intensify the sale of copies of the work.
7) A system for guaranteeing the sale price of a copy of a work. A system that fixes the minimum selling price of a copy of a work, from which royalties will be calculated, has a similar goal to the system of a guaranteed minimum royalty. The fact is that the recipient (licensee) may be able to sell legal copies of the work at reduced prices to subsidiaries of the licensee. This makes it possible to hide significant amounts of income from sales from the author (copyright holder). In this regard, it is considered appropriate to include in the copyright agreement a condition determining the size of the sale price of copies of the work, from which the royalty is calculated.
SEQUENCE OF ACTIONS IN DETERMINING THE ROYALTY RATE
Recommendations for determining the amount of royalties based on standard (tabular) rates were outlined above. However, this is only a special case. And the general case involves carrying out some other actions. Especially when it comes to concluding a licensing agreement for the transfer of IP. Their description (most fully given in the brochure by I. S. Mukhamedshin “How to more effectively protect, sell or buy scientific and technical products” - M.: 1993 and in the article by N. Lynnik and A. Kukushkin, IS, 1993, No. 9-10) is briefly given below in relation specifically to the case of concluding a license agreement.
As for determining the royalty rate by the appraiser in relation to the general case, here he will have to mentally act alternately as a licensor, then as a licensee. Of course, this requires much more labor and time for the appraiser and can only be justified by the special importance and value of the assessed intellectual property object (IPR).
Algorithm general case determining the royalty rate is as follows.
1. DETERMINING AN ACCEPTABLE RANGE OF POSSIBLE RATES
1.1. Considering royalties as the minimum acceptable remuneration for the licensor
Fair (often referred to as reasonable) royalty rates should, at a minimum, firstly, cover the licensor's costs associated with preparing an IP transfer agreement. If the licensor, according to the agreement, must provide the licensee with additional technical information or assistance (further research work at the request of the licensee, training of the licensee’s specialists, participation in the launch of the licensed object, etc.), then the licensor must include these costs in the minimum remuneration.
Secondly, the royalty rate must compensate for the profits lost as a result of the entry of a new competitor into the market in the person of the licensee.
Third, R&D expenditures may be taken into account (albeit controversially). The ambiguity is caused by the following circumstance. If the object of the license agreement has already been mastered in the production of the licensor, then he has the opportunity to reimburse R&D costs through the sale of products manufactured under the license. And the fact that the licensor has mastered the subject of the license increases the value of the license for the buyer, since it reduces its risk and must be taken into account at the second stage of agreeing on the royalty rate. In this case, it is logical not to include R&D costs when determining the amount of the minimum remuneration for the licensor.
If the object of the license agreement has not been mastered by the licensor, then it is advisable to take into account R&D costs when determining the amount of the licensor’s minimum remuneration. When selling a license to several licensees, it is necessary to distribute these costs between buyers in proportion, for example, to the volume of production under the license.
And finally, fourthly, the royalty rate must take into account at least the minimum compensation for transferring the IP to the licensee.
1.2. Consideration of royalties as the most acceptable alternative for the licensee.
The maximum royalty that a licensee can accept is equal to the cost of the best alternative that it could choose to purchase a license.
Such alternative solutions could be:
- carrying out own research and development work in this area;
- acquisition under license of comparable (similar) technology from another source;
- refraining from working with the licensor’s technology;
- free use of the licensor’s technology (albeit associated with the risk of prosecution and subsequent financial sanctions).
Identifying these alternatives gives the licensee a good idea practical value object of the license.
If the licensee finds that few alternative solutions are available at relatively low cost, it will consider the licensor's proposed subject matter to be of limited value and will not accept high royalty rates. Conversely, if the subject of the license is protected by a strong patent (block of patents) covering an important area of knowledge, it makes sense for him to agree to higher royalties.
The methods described above make it possible to determine extreme (extreme) values of royalty rates: method 1.1 - the minimum acceptable for the licensor; method 1.2. - the maximum acceptable for the licensee. In contrast, the two methods outlined below make it possible to determine intermediate (from extreme) values of royalty rates.
2. DETERMINATION OF INTERMEDIATE VALUES OF ROYALTY RATES
2.1. Determination of royalty rates by analogy with previously applied rates
In domestic practice, for many enterprises and organizations, for the sake of efficiency, acceptable methods for determining the royalty rate may be:
- a method based on the use of standard royalty rates (discussed above),
- a method based on the analysis of analogues taken in relation to licensing transactions previously concluded by the licensor,
- a method based on the application of royalty rates taken from previously concluded licensing agreements for similar products for a given industry.
Thus, method 1.1 will make it possible to reach the minimum royalty rates that the licensor can agree to, and method 1.2 will determine the maximum royalty rates that the licensee could agree to. The values obtained from methods 2.1 and 2.2 (see below) make it possible to determine intermediate royalty rates. By using a combination of these four methods that is appropriate for a given situation, contracting parties can effectively determine the range of possible royalty rates and focus their attention on them during negotiations.
2.2. Determining the royalty rate using calculation methods that take into account the economic effect received by the licensee from using the IP The royalty rate can be calculated using the following main accounting based methods:
- the amount of additional profit of the licensee;
- the licensor’s share in the licensee’s gross profit
- profitability of production by the licensee.
The methods classified in group 2.2 due to their importance will be discussed in detail later.
3. AGREEMENT OF ROYALTY RATES OBTAINED BY DIFFERENT METHODS
Such approval is carried out by agreement of the parties involved in the licensing transaction, taking into account the royalty rates determined by methods 1.1; 1.2; 2.1; 2.2.
If we are not talking about concluding a license agreement, but about evaluating IP using the income method, then the approval is carried out by the appraiser himself. At the same time, it is advisable for him to use a technology similar to that which is recommended to be used when reconciling estimates of IP obtained by three different approaches - cost, market, income (see, for example, article by G. G. Azgaldov “The problem of reconciling estimates and its Possible Solution"/Evaluation Issues, 1999, No. 4).
DETERMINATION OF ROYALTY RATES BY CALCULATION METHODS
METHOD FOR CALCULATING THE AMOUNT OF ADDITIONAL PROFIT OF THE LICENSEE (THE "CRIMINAL ROYALTY" METHOD)
This method is most fully described in the book: Mukhamedshin I. S. “How to more effectively protect, sell or buy scientific and technical products.” M.: 1993. The material below is mainly based on this work.
Advantages of the method. High accuracy calculation results.
Disadvantages of the method. Sufficiently accurate and reliable data is required on:
- performance indicators of the licensed enterprise;
- performance indicators of enterprises taken as a basis for comparison;
- market conditions for licensed products;
- technology market in the relevant field of production.
Scope of application of the method. Applicable only in cases where the economic effect of introducing a license or know-how is expressed in additional profit for the licensee.
The royalty rate P is determined by the formula:
Р = Dлр Рп (1)
where: P - royalty rate as a percentage of net sales,
Dlr - the licensor’s share of the licensee’s additional profit agreed upon by the partners under the licensing agreement,
Рп - marginal royalty rate i.e. the royalty rate due to the licensor, provided that all additional profits from the licensee's DP go to the licensor. Calculated by the formula:
Рп = DПсд/Сп *100, (2)
where: DPsd is the average annual additional profit of the licensee from the implementation of the license for the period of royalty payment (usually in hard currency), calculated using formulas (3)-(7);
Sp - the average annual cost of sales of licensed products for the period of royalty payment; determined from accounting documents.
The royalty rate R is calculated in three stages.
STEP 1. The additional profit of the licensee DP and the marginal royalty rate Рп are calculated (using the methods outlined below).
STAGE 2. Possible deviations of the values of additional profit DП and the marginal royalty rate Рп from the calculated values are taken into account.
STAGE 3. The licensor's share in the licensee's additional profit is calculated and the estimated royalty rate R is finally determined.
The sequence of actions in all these three stages is discussed below.
STAGE 1
Calculation of the values of additional profit DP and the marginal royalty rate RP is carried out using one of the methods indicated below by the letters “a”, “b”, “c”. These methods are:
a) Method for determining DPezbur - savings on current and capital costs without taking into account the distribution of costs and income over time (the letter “a” will be added to the numbers of the calculation formulas);
b) Method for determining DPazur - savings in current and capital costs, taking into account the distribution of costs and income over time (the letter “b” will be added to the numbers of the calculation formulas);
c) Method for determining DPvts - the amount of additional profit from a higher price for licensed products in comparison with the base one (the letter “c” will be added to the numbers of the calculation formulas).
METHOD "a" (distribution of costs and income - not taken into account)
This method is used when selling individual and related licenses, as well as unlicensed know-how if:
- the additional profit of the licensee DPezbur is caused by savings on the costs of producing licensed products (but compared with industry average costs);
- flow distribution Money(PDS) by year for the licensee’s enterprise does not affect the amount of additional profit of the licensee DPezbur, due to the fact that:
- it coincides with the industry average distribution of PDS or
- there is no data on such distribution.
The term comparison base is introduced - an enterprise whose production and economic indicators simultaneously have the following characteristics:
- manufactured products are similar to licensed ones;
- the capacity is close to the capacity of the licensee’s enterprise;
- it uses the usual, most common technology.
In this case, all indicators used are taken per unit of capacity of the licensee’s enterprise or per unit of output. If there is no data on the activity of the enterprise, you can use the corresponding industry average data.
Then the calculation of additional profit and the marginal royalty rate (without taking into account the distribution of cash flows) is made using the formulas:
DPezbur = DTZbur + DKZbur, (3-a)
DPbur = DPezbur * 100 / Ssn, (4-a)
where: DPezbur is the average annual additional profit of the licensee from the implementation of the license (due to savings in current and capital costs) without taking into account the distribution of costs and income over time;
DTZbur - the average annual value of the licensee's savings on current costs compared with the current costs of the base enterprise during the period of royalty payment (calculated using formula 5-a);
DKZbur - the licensee's average annual savings on depreciation of capital costs compared with the costs of the base enterprise during the period of royalty payment (calculated using formula 6-a);
Рп - marginal royalty rate;
Ссн - the average annual cost of sales of licensed products for the period of royalty payment (determined from accounting documents).
DTZbur = TZ/100 (SiТЗiDTЗi - SPPjDTЗj), (5-a)
where: TZ - the amount of average annual current costs at the base enterprise, recalculated to the capacity of the licensee's enterprise (determined according to the accounting documents of the base enterprise);
ТЗi - the percentage of savings of the i-th element of the licensee's current costs compared to the costs of the base enterprise (determined by the accounting documents of the licensee's enterprise and the base enterprise);
DTZi, DTZj - the share of the i-th (j-th) cost element in the total average annual current costs of the base enterprise (determined by calculation based on the accounting documents of the base enterprise);
PPj is the percentage increase in the costs of the j-th element compared with the costs of the base enterprise (if this occurs), determined by calculation in the accounting documents of the enterprise.
DKZbur = VK/100 (SiКЗiDКЗi/ti - SjPPjbDКЗj/tj), (6-a)
КЗi - percentage of savings according to i-th group capital costs of the licensee compared to costs at the base enterprise;
DКЗi, DKЗj - i-th share(j-th) group of capital costs in gross capital investments at the base enterprise
ti, tj - payback period of the 1st (j-th) group of capital costs at the base enterprise (in years);
PPjb - percentage of increase costs j-th groups at the licensee, compared to costs at the base enterprise.
If the magnitude of the net savings on costs differs between the years of the royalty payment period, the net savings can be calculated for each year, and then its average annual value is calculated.
METHOD "b" (distribution of costs and income - taken into account)
This method is used when selling separate and associated licenses, as well as unlicensed know-how, if;
- the license or know-how is related to the construction of a new enterprise and its commissioning or the modernization of an existing enterprise;
- the object of the license or know-how includes an innovation that leads to a reduction in the time of construction or depreciation of enterprises, commissioning and bringing to design capacity and/or optimization of the distribution of capital investments;
- there is data that allows you to compare these indicators with the indicators of the base enterprise or with industry average indicators.
Method "b" is based on bringing the amount of capital investments and the licensee's expected income during the period of royalty payment to the current period of time and comparing them with similar indicators of the base enterprise. Therefore, the additional profit received by the licensee from using the IP is called “discounted additional profit”. Its value is determined by formula 7-b:
where: DPezur is the amount of the licensee's reduced additional profit from savings on current costs (taking into account the distribution of cash flows);
n is the year of completion of construction of the licensee’s enterprise;
m is the year of completion of construction of the base enterprise;
T - royalty payment period (in years);
Pvt - gross profit in year t at the base enterprise (including depreciation), determined by accounting documents;
DТЗt - savings on current costs in year t at the licensee’s enterprise, compared with the base enterprise (determined by formula 8-b);
SD - discount rate determined in the manner adopted when valuing any property;
KZtb - capital costs in the construction of the base enterprise in year t (determined from the accounting documents of the base enterprise);
DKZtb - savings on capital costs (compared to the base enterprise) in year t during the construction of a licensed enterprise.
Savings on current costs, taking into account the distribution of costs and income over time DТЗр; is determined by a formula largely similar to formula 5-a:
DTZur = Osl (SDTZiNPcibTsrzi - SPPzj NPcjb Tsrzj), (8-b)
where: Osl is the average annual output of licensed products (in physical terms), determined by accounting documents;
TZi - the percentage of savings of the i-th element of the licensee's current costs compared to the costs of the base enterprise (determined from the accounting documents of the licensee's enterprise and the base enterprise);
NPcib, NPcjb - average consumption rate of the i-th (j-th) cost element per unit of production at the base enterprise (in physical terms);
Tsrzi, Tsrzj - market price units of the i-th (j-th) cost element;
PPzj is the percentage increase in the costs of the j-th element compared to the costs of the base enterprise (if this occurs).
Savings on capital costs are determined by formula 9-b, which is largely similar to formula 6-a:
DKZur = VK / 100 (SiКЗiDКЗi - DjPPjbDКЗj), (9-b)
where: VC - gross capital investment in the base enterprise, in terms of the capacity of the licensee's enterprise;
KZi. - percentage of savings in the i-th group of capital costs of the licensee compared to costs at the base enterprise;
DКЗi, DK3j - share of the i-th (j-th) group of capital costs in gross capital investments at the base enterprise
PPjb is the percentage increase in the costs of the j-th group of the licensee, but compared with the costs at the base enterprise.
If the net cost savings differ between the years of the royalty payment period, the net savings can be calculated for each year, and then its average annual value is calculated.
The marginal royalty rate Rpur is determined by formula 10-b, similar in structure to formula 4-a (but taking into account the distribution of cash flows over time):
Rpur = DPazur / Cppr, (10-b)
where: DPezur is the average annual additional profit of the licensee from the implementation of the license (due to savings in current and capital costs), taking into account the distribution of costs and income over time, determined by formula 11-b (similar to formula 3-a):
DPezur = DTZur + DKZur, (11-b)
where: DТЗр is the average annual value of the licensee's savings on current costs compared to the current costs of the base enterprise during the period of royalty payment, taking into account the distribution of costs and income over time (calculated using formula 8-b);
DKZur - the licensee's average annual savings on depreciation of capital costs compared to the costs of the base enterprise during the royalty payment period (calculated using formula 9-b);
SPR is the present value of net sales of licensed products for the period of royalty payment, determined by formula 11-b:
Sppr = SCp / (1 + SD)t, (11-b)
where: Cpt is the cost of net sales of licensed products in year t,
t = (n + l), (n), (n - 1),..., (n + T), where:
n - year of completion of construction of the licensee’s enterprise:
T - royalty payment period (in years).
METHOD "c" (additional profit from a higher price for licensed products)
Additional profit Dpl, as noted above, can also be obtained due to a higher price for licensed products compared to the base (analogue price) and is calculated using the formula:
Dpl = VOL (Tso - Tsa), (12-v)
where: VOL - average gross volume of licensed products for the year during the period of royalty payment (in natural units);
Tso - unit price of licensed products;
Price is the price of a unit of product taken as the basic analogue.
The marginal royalty rate Rp is calculated using the formula:
Rp = VOL (Tso - Tsa) / Spr, (13-v)
where: Spr is the average annual cost of sales of licensed products during the royalty payment period.
If additional profit is obtained by the licensee both from an increase in the price of licensed products and from savings on current and capital costs, it can be calculated using the following formula:
DPL = DPL + DPLc, (14-in)
where: Dpl - additional profit of the licensee;
DPle - additional profit (with a plus sign) or additional costs (with a minus sign) of the licensee due to savings (or increase) in current and capital costs;
DPlc - additional profit from increasing the price of licensed products.
The marginal royalty rate is determined by the formula:
Rp = (DPle + DPlc / Spr), (15-v)
The result of the first stage is the receipt of estimated amounts of additional profit and the marginal royalty rate.
STAGE 2
At this stage, accounting is carried out possible deviations additional profit and marginal royalty rate from the calculated one under the influence of production and commercial risks.
a) Production risk is determined by the fact that the licensee's enterprise may not achieve design production parameters.
This depends on the degree of development and implementation of the licensed technology. And therefore, the additional profit may be less than the calculated value. In this regard, an amendment is made to the calculated additional profit DПлп and the marginal royalty rate Рп depending on the degree of production risk. The amendment is made in accordance with the most likely percentage of the technology achieving the specified parameters. The following formulas are used for this:
Dplp = Dpl * b / 100, (16)
where: DПлп - additional profit of the licensee adjusted for production risk;
DПл - estimated additional profit of the licensee;
b is the probability that the licensee’s enterprise will achieve the specified production parameters (in %).
Rpp - Rp * b / 100, (17)
where: Rpp - marginal royalty rate, adjusted for production risk;
Рп - estimated marginal royalty rate.
As a guide, the probability b values recommended by I. S. Mukhamedshin can be used, depending on the level of implementation of the licensed technology (see Table 3):
Table 3
b) Commercial risk is associated with the fact that there is an opportunity
- incomplete use of enterprise capacity
- incomplete sales of licensed products due to insufficient market demand and competition from manufacturers of similar products.
An adjustment to the estimated additional profit DPlk and the marginal royalty rate Rpk, depending on the degree of commercial risk, is made in accordance with the most probable percentage reduction in the cost of average annual net sales, compared to the calculated one, using the formulas:
DPlc = DPl (100 - h) / 100, (18) and
Rpk = Rp (100 - h) / 100, (19)
where: h is the most probable percentage decrease in the average annual cost of net sales compared to the calculated one.
The most probable percentage reduction in the cost of sales (h) is determined (in the case of a symmetric probability distribution) as the weighted arithmetic average of a series of possible percentage reductions in the cost of sales, weighted by the probabilities of each member of this series.
However, we have to admit that in the theory of property valuation there are still no practically applicable and sufficiently theoretically justified methods with the help of which practicing appraisers could calculate the values of b. For example, using the arithmetic mean in this case is not the best solution.
STAGE 3
The calculation of the additional profit due to the licensor DPlr and the actual royalty rate Rd is carried out using the formula:
DPlr = DPl * a, (20)
where: DПлр - additional profit due to the licensor;
a is the licensor’s share in the licensee’s additional profit;
Dpl - additional profit of the licensee.
Рд = Рп * a, (21)
where: Рп - marginal royalty rate.
It should be noted that the problem of determining the value of a is one of weak points"royalty cap" method. The value of a depends on a large number of factors that are difficult to formalize. Attempts to take into account, if not all, then at least some of them, led to the development of proposals to reduce the subjectivity associated with their use. One of these proposals (used in international economic practice is given below in table form). It allows you to take into account the influence of 4 factors:
- licensee’s market share;
- degree of exclusivity of the license;
- presence of patents in the license;
- degree of severity of market competition (see Table 4).
Table 4
Notes
1. For non-patent licenses, it is advisable to be guided by the minimum values of the limits, for patent licenses - by the maximum.
2. The average share of licensed products in the total volume of products sold of this type on the licensee’s market, estimated for the period of royalty payment.
3. Determined by method expert assessments based on an analysis of the market conditions for licenses and patents in the relevant industry.
The values of a obtained using Table 4 are recommended to be adjusted depending on the expected change (during the royalty payment period) in demand in the licensee’s market for this type products. The correction formula looks like:
a1 = a * Kd, (22)
where the Kd value is determined using Table 5.
Table 5
Notes
1. Adjustment of a when demand decreases is recommended only when a > 0.2.
2. Adjusting a when demand increases is recommended only when a< 0,8.
METHODS FOR CALCULATING ROYALTY RATES BASED ON ACCOUNTING THE LICENSOR'S SHARE IN THE LICENSEE'S GROSS PROFIT
Advantages of the method: very low labor and time required.
Disadvantages of the method: less accuracy compared to the licensee's additional profit method.
Using this method, the royalty rate P is calculated using the following simplified formula:
P = l Pe, (23)
where: l is the share of royalties (in %) in the licensee’s gross profit (determined in accordance with the recommendations set out in Table 6);
Re - profitability of production of licensed products, defined as gross profit per unit of cost of net sales - that is, sales excluding indirect taxes on sales (in %). If information on the profitability of a particular licensee’s enterprise is, for one reason or another, difficult to access for the appraiser, average data on the profitability of the relevant industry can be used.
Table 6
Note: it is advisable to adjust the figures indicated in Table 6, taking into account factors not taken into account in the table.
Advantages and disadvantages of the method: the same as that of the Mukhamedshin method (see above).
This method was proposed by O. Novoseltsev (Intellectual Property, 1998, No. 3; Assessment Issues, 1998, No. 3). It is based on the application of the formula:
P = Re * l / (1 + Pc), (24)
where: Re is the profitability of industrial production and sales of products under a license, defined as the ratio of the licensee’s profit to the cost of production and sales of products under a license;
l - share (part) of the licensor’s profit in the licensee’s total profit from the production and sale of products under the license (in %).
A feature of this technique is the possibility of using the profitability values of a specific enterprise. It can be calculated by submitting the accounting and financial statements of the enterprise (this data, according to the Decree of the President of the Russian Federation, appears as a commercial secret and can be obtained for a set fee from the State Statistics Bodies!). Or according to official statistical data on the profitability of individual industries in a specific period of time, which are regularly published in specialized publications, as well as in statistical and analytical reviews of the state of industrial production in periodical information sources.
For example, in the weekly magazine "Economy and Life" (No. 34 (8675), August 1997) the profitability values of certain industries in Moscow were published, in particular, chemical and pharmaceutical - 44%, electric power - 43%, alcohol - 43% , confectionery - 28%, railway engineering - 26%, brewing - 25%, bakery - 22%, oil refining - 20%.
The Licensor's share in the Licensee's profit from production and sales can be selected depending on the volume of rights transferred, the degree of readiness of the licensed object and the availability of patent protection, which ultimately should reflect the entrepreneurial risks of commercial success in organizing the industrial use of intellectual property, production and sale of products under license.
Analysis of the functional dependence of the royalty value on the profitability of production under a license according to formula (24) explains, according to O. Novoseltsev, the downward trend in royalty values for material-intensive and resource-intensive industries. In them, the increased cost of production and sales of products under license (due to increased costs for materials and other resources) leads to an increase in the cost of production and, accordingly, to a decrease in the profitability value for the same amount of profit.
At the same time, the increase in royalty values for new high-tech technologies also becomes understandable, since advanced high-tech scientific and technical developments contribute (through the use of new material and resource-saving technologies) to reducing the cost of production, which, accordingly, increases the rate of profitability for the same mass arrived.
The use of the royalty rate according to the formula (24) proposed above in practical calculations also explains the increase in the value of royalties with an increase in the Licensor’s share in the Licensee’s profit by reducing the Licensee’s production and commercial risks. This happens by increasing the volume of transferred rights (ensuring a licensed monopoly), the degree of industrial development of the subject of the license (reducing production risks of development new products) and the presence of patent protection (protected state laws patent monopoly). Since all these factors ultimately contribute to increasing the likelihood of the Licensee achieving commercial success and generating additional profits.
It is easy to notice, however, that Novoseltsev’s method is an analogue of Mukhamedshin’s method and differs from it only in the use of the divisor calculation formula (1 + Re) in the denominator.
METHOD FOR CALCULATING ROYALTY RATES BASED ON UNIT COST INDICATORS
The advantage of the method: low labor and time costs.
Disadvantages of the method:
- lower (compared to the additional profit method) calculation accuracy
- the relatively rare existence of situations in which it is possible to find all the information necessary to apply this method. Calculation formula:
P = l * KZu * Pvkl, (25)
where: l is the share of royalties (in %) in the gross profit of the licensee (determined in accordance with the recommendations set out in Table 5);
KZu - specific capital costs per unit of sales (in relative shares);
Pvkl - gross profit per unit of investment (in%).
Both calculated indicators (KZu, Pvkl) are determined based on statistical data related to the relevant industry.
FORM OF REMUNERATION IN THE FORM OF LUMMARY AMOUNTS
The term "lump sum" comes from the German word "pauschal" - taken in bulk.
It is advisable to use this form of remuneration when:
- the basis for calculating remuneration in the form of “royalties” cannot be determined practically;
- control over the accounting and financial reporting of the licensee is difficult;
- the costs of counting and control operations are disproportionately large in comparison with the expected results;
- the method or conditions of use of the subject of the license make it impossible to apply the rule of proportional remuneration;
- the entire range of rights in relation to the subject of the license is transferred to the licensee (similar to the purchase and sale agreement);
- a license agreement is concluded by a little-known independent licensee, when there is no real opportunity to exercise effective control over the licensee’s activities in using the licensed object;
- there is no industrial development of the subject of the license;
Based on the frequency of lump-sum payments, they are divided into:
a) one-time lump sum payment with receipt of money only once;
b) periodic lump sum payments, i.e. payment of strictly defined amounts in several ethanes depending on the use of the IP by the recipient (licensor). For example, annual lump sum payments.
Often the frequency of lump sum payments depends on the stage of implementation of the license agreement. In this regard, the following procedure is used:
- 10 - 15% is paid upon signing the license agreement;
- 15 - 20% is paid after mastering the technology;
- the remaining 65 - 75% is paid at the end of the first year of production of licensed products.
Periodic payments in relation to copyright objects are divided into linear, progressive and degressive (see above).
Lump sum payments are usually particularly beneficial to the licensor. Along with the absence of the need to exercise control over the activities of the licensee, it is associated with the one-time receipt of a sufficiently large amount of money. But sometimes this form of payment of license fees turns out to be unprofitable for the licensor. Indeed, in some cases, with a lump sum payment, he is deprived of the opportunity to receive excess profits from a significant expansion by the licensee of the volume of production of licensed products.
At the same time, the need to pay significant amounts before making a profit, as well as more high degree the risk associated with acquiring a license leads to the fact that the licensee does not always agree to pay the license fee in the form of lump sum payments.
Determining the size of a lump sum payment by simple arithmetic addition of the amounts of payments determined on the basis of royalties for the entire period of the license agreement will be inaccurate due to the change in the “value” of cash depending on the period of its receipt, caused by the state of monetary relations.
By general rule, operating in international trade licenses, the licensor seeks to receive such an amount of lump sum payments that, if invested in the bank, would provide him with a profit equal in amount and time of receipt to the payment of the license fee in the form of royalties. In turn, the licensee strives to reduce the price of the license when paying in the form of lump sum payments. The reduction factor is calculated using standard methods of financial mathematics using the compound interest formula.
Using the discounting method, current royalty payments can be reduced to a lump sum payment. And, conversely, reduce the lump sum payment to the average royalty level for the entire period of the license agreement.
COMBINED FORM OF REMUNERATION
It should be borne in mind that in some cases the payment of license fees in the form of lump sum payments or in the form of royalties may be unacceptable for one of the partners or for the licensee and licensor at the same time. And, for example, in this case, the owner of the IP requires payment of a lump sum and subsequent ongoing royalty payments for the provision of a license.
In such cases, combined (mixed) payments can be used. In this case, initial (lump sum) payments are paid during the initial period of validity of the license agreement (usually after signing the license agreement), before the start of commercial use of the licensed object.
The rest of the license fee is paid in the form of royalties in the process of commercial use of the licensed object at the end of each reporting period.
Initial payments in most cases are considered as an advance and serve as a kind of guarantee of the seriousness of the licensee’s intentions, which is very important for the domestic practice of trading licenses. At the same time, they allow you to recoup the costs of preparing and concluding a license agreement, producing and translating technical documentation, other tangible media of information about the transferred technology (samples, special equipment, devices), as well as fulfilling other terms of the agreement. Initial payments in certain cases may also offset the costs of research and development of the subject matter of the license.
It is recommended to set the amount of initial payments within the limits of up to 25% of the license price, determined in the form of royalties. To translate this value into combined payments, it is recommended to set the amount of the initial payments and then reduce the royalty rates accordingly.
In order to encourage the licensee to master the subject of the license, it is advisable in licensing agreements to provide for minimum guaranteed payments when paying license fees in the form of royalties, including in the presence of initial payments. They are recommended to be paid at the end of the reporting period. At the same time, it is not advisable to establish a dependence of payment on the results of mastering the subject of the license, production volumes and sales of licensed products. As already mentioned, it is desirable that the amount of the initial and minimum guaranteed payments does not exceed 25% of the total royalty payments. It is necessary to differentiate this amount depending on the types of license agreements (for a full and exclusive license - up to 75%, for a non-exclusive license - up to 50%). Annual minimum guaranteed payments are fixed in the text of the license agreement.
Opening your own business is always a good idea. To achieve this goal, three scenarios can be considered:
- – you can open your own business from scratch;
- – you can buy a ready-made business;
- – you can buy an already successfully operating franchise.
In order to open your own business from scratch, you will have to put a lot of effort and time into developing an individual plan and program of action, brand advertising, searching for investors, etc. and so on. This option of starting your own business is very problematic and brings a lot of trouble, unlike an already established business.
Buying a franchise includes many nuances and terms that will be difficult for a novice businessman to understand. In this article you will find answers to questions such as the concept of lump sum and royalty, royalty rate and payments, what is the amount of royalty payment and what methods of royalty relief exist.
Concept of lump sum and royalty
Opening your own business by purchasing a franchise is one of the most profitable and popular options for building a business today. Together with a franchise, a businessman receives a well-known brand or type of service that is recognizable to customers, has constant support from partners in all areas of business, trained personnel by highly qualified franchisors, and at the same time a low purchase price for the goods necessary for the business.
To successfully implement a business based on a franchise, you must have a sufficient amount of lump sum and royalties, which are also called “the key to the success of your franchising system.”
When purchasing a franchise, you pay a certain cost for it, a significant part of which is a lump sum fee. In practice, a lump sum fee is the purchase of the right to trade under the licensor's brand. At the same time, the one who bought his franchise receives the licensor’s own developments and goods.
The lump sum fee, in terms of the size of the payment, is the actual price of the license, which is compiled in accordance with the forecast economic effect future project.
The lump sum contribution is made once and can be paid either in one amount or in installments. But, as a rule, licensors require payment as quickly as possible.
The concept of royalty is introduced to determine several other payments that a future entrepreneur who has acquired a franchise must make.
Royalty refers to regular payments that a businessman must pay to the franchise owner. The royalty can be a percentage of the businessman's gross profit, or a fixed amount that is agreed upon in the contract.
Starting your own business with a high-quality online store franchise is the best solution for beginners:
For the effective operation of a new business with a franchise, the optimal royalty amount is selected, which will be beneficial to each of the parties to the agreement. If, when taking into account royalties, its size is overestimated, then the profitability of the franchise may be somewhat underestimated, which is why the meaning of the business may be lost. The same applies to the lump sum payment.
Therefore, when purchasing a franchise to open own business you need to pay attention to indicators such as lump sum and royalties to determine how profitable this franchise is for you and whether it is worth starting a business with it.
Lump sum fees, royalties, and taxation are taken into account when maintaining accounting records and when calculating the economic profitability of an enterprise that uses a license to produce goods or provide services.
The optimal option for concluding an agreement for the purchase of a franchise is an agreement in which a lump sum fee, payments under a royalty agreement and minimum deductions in favor of the franchise owner are applied.
Royalty rate
Royalty waiver method
The royalty relief method is used by the franchisor to determine the value of the patent and license. Typically, a franchise owner grants a potential franchise buyer the right to use their intellectual property for a fee (royalty).
Royalty in this case is expressed as a percentage of the total revenue that the entrepreneur receives as a result of the sale of goods or the provision of services that are produced on the basis of a patent. According to the time-limit method, the price of intellectual property is a certain (usually current, minimum) value of a stream of planned royalty payments over the life of the license or patent.
The royalty free amount is calculated in accordance with market analysis. This method is designed for both income and market approaches to calculating royalties.
INTERESTING VIDEO: Franchise. Collection of royalties from franchisees
The Anglo-French term, which came to us from the 16th century, today denotes internationally recognized technologies for calculating compensation payments for the licensed use of copyrighted objects.
There are different ways to determine the amount of rewards for the use of objects that belong to someone. For the use of objects of various copyrights. For the use of ideas, for the use of tangible and intangible assets. Royalty rate is an interesting term that refers to those products and objects that are measured in value as income-generating objects, that is, as making a profit. Royalty calculations, in practice, are calculations of the cost of patents, licenses and inventions, calculations of the cost of using technologies, materials and equipment that are objects of intellectual property and can generate profit when used.
Certain types of property, according to certain rules and in view of their characteristics and the peculiarities of their application, are valued by applying the “income approach”. When using this approach, in many cases a category called “royalty rate” is used. There are two problems associated with the royalty rate and the concept of royalty, with its use in the Russian Federation. This is the lack of a clear and correct understanding of what it is. And ignorance or insufficient knowledge of technologies to accurately determine the value of royalty rates for different intellectual property items in different cases.
This, of course, hinders the ability to evaluate intellectual property and production, use of technology, and use of intellectual property in Russia. The Royalty rate is a globally recognized method for valuing such assets. Ignorance of this technology and these principles in Russia, where such standards have already been adopted, and where there are so many actual and possible connections with foreign partners, leads to a slowdown in the development of various areas of industry and production.
Approximate royalty statistics, what we will tell our readers about this, and types of compensation for the use of intellectual property
Royalty forecast tables for different manufacturing industries and product areas, which can be found in specialized sources, provide average approximate royalty percentage data, divided into general categories of goods, equipment and types of industry. We will list them below. In various publications we will tell you what royalty rates are, how they work, and why. And by what principles, in general, and more specifically, are calculated in different cases.
In the process of presenting a fairly broad material on the topic of royalty rates, we will focus on issues of intellectual property and intangible assets - or rather, compensation for their use, which is royalty. The basis for our articles will be in-depth materials on this topic authored by professors G. G. Azgaldov and N. N. Karpova.
The main scope of royalties is the use of intellectual property, or “IP”, under a document granting the right to such use, or under a license (licentia - “permission” in Latin). In the practice of using IP by persons to whom it does not belong (or who are not its creators), three main, most common types of compensation for the use of IP objects (intellectual property objects) and licensing objects are accepted in the world:
- royalty – when the amount of remuneration depends on the results of the use of the object by the licensee. Most often used;
- lump-sum payment – when the amount of payments does not depend at all on the results of the use of copyright objects by the licensee. Used less frequently;
- combined remuneration - when compensation payments consist of payments at a royalty rate and a lump sum payment. Used least often.
In terms of licensing the use of various objects and assets, the terms “licensee” and “licensor” refer to different sides of this relationship. On one side is the licensee, already mentioned, who receives the rights to use the objects, that is, a license. On the other side is the licensor, that is, the person who owns the ownership rights (use, copyright) to objects of intellectual or other property.
To formalize the relationship between the parties, a special document is created - a license agreement. Which contains information about the form of payment accepted in this case, information about the details of commission payments and use of facilities by the licensee.
History of origin and meaning of the term Royalty - yesterday and today
Royalty, or royalty in the original, is a translation from English meaning “royal share.” In Britain, subjects paid the crown a share of profits if the government granted them land or the opportunity to develop mineral deposits. Since the 16th century, the term royalty has become commonly known as the payment to royalty of a certain annual percentage of profits for the development of coal deposits.
Today, the term royalty most often refers to the regular payments that the licensee (the person receiving the license) pays to the licensor (the person who owns the copyright) for the use of intellectual property. Royalties are paid under the licensing agreement, which has already been mentioned, depending on what results the licensee receives from using the licensor's copyrighted property.
In addition, the term royalty is still used to denote payments for the right to develop mineral resources, as well as to denote payments for any licenses, to denote various duties, lease payments. Also, “royalty” today can mean an agreement that the owner of property, in particular and possibly intellectual property, reserves for himself some part of it or some part of the profit from its use when it is used by another person under a license.
Royalty works as a standard form of relationship in 80-90% of cases when someone's patented inventions and technologies are used. The problems and issues of royalties are in many ways the same problems and issues of patent law. For example, there is a known case when the inventor of the paper puller for personal computers, Dan Bricklin, due to the fact that he did not patent this technology in time, lost the opportunity to receive huge profits from many companies around the world. This happened in the 70s, but the situation is still relevant today. This is also a question of the application of royalties.
The percentage of profits that the licensor must receive from the licensee as royalties is indicated in calculations, tables and documents by the Russian letter “Р” for the Russian language and the letter “R” for English or for foreign documents. English or Latin notations are used in the formulas for calculating royalties in Russia, for Russian-language documents. Royalty is calculated as a percentage of the “base”; the base means the result (effect) obtained by the licensee from the use of the object or technology. The results of using licensed objects, of course, can be of different types, and can be calculated in different ways. It could be:
- net income from the licensee's work using technology, ideas or material;
- additional profit that arose for the licensee as a result of the use of IP - an object of intellectual property;
- (effective) gross income - sales volume, the amount of sales occurring;
- the cost of the main processed raw materials;
- unit capacity of the workshop (production);
- cost of products manufactured using OIS;
- unit price and price per batch of products produced using OIS;
- other methods of calculating the royalty base.
Royalty bases of different types are calculated using different data, which are “mined” in different ways from different sources. Some are more difficult to obtain and calculate than others; in some types of base calculations there are fewer oversights, difficulties and errors. Much depends on specific situations.
The most common case is to calculate the basis for the royalty rate from the price per unit of products that are produced using this technology, and to calculate the royalty from the EGR, the effective gross income, that is, the amount of sales. As long-term practice shows, this type of calculation of the royalty base causes the least conflicts and ambiguities regarding compensation payments among licensees and licensors. What is the reason? To obtain data and simply and accurately calculate the amount of regular compensation, the data in this case is easily found in the accounting department of the person who has received a license to use the copyrighted property.
Examples of approximate royalty rates for different product and manufacturing areas
There are general, approximate tables of interest rates on royalties for the use of ideas and technologies and objects of licensing and patenting in various fields of industry and production. This information is derived from general averages of licensing practices around the world. Large foreign trade organizations use this data to roughly predict royalty rates in different cases. The bets are then calculated more accurately.
These are approximate standard values are shown as a percentage of the volume of product sales, the amount of sales - or the price for one unit of products produced using OIS. Different percentages are indicated for different areas of production and industry:
- the aviation industry is one of the most profitable areas in terms of royalties - 6-10%;
- automotive industry – 1-3%;
- metallurgical industry – 5-8%;
- machine tool industry – 4.7-7.5%;
- electronics industry – 4-10%;
- consumer durables – 5%;
- consumer goods of mass demand with a short shelf life – 0.2-1.5%;
- textile industry – 3-6%;
- pharmaceutical industry – 2-5%;
- chemical industry – 2-4%;
- electrical industry – 1-5%.
Examples of average royalty rates by product type:
- metal furniture – 3%;
- wooden furniture – 2-3%;
- printed publications – 3-6%;
- semiconductors – 1-2%;
- livestock feed – 2-3%;
- carbon paper – 1-2%;
- metal structures – 2-4%;
- glue – 2-3%;
- games (without copyright) – 3-6%;
- chemicals – 1-3%;
- airplanes – 5-10%;
- electronic computers – 7-5%.
Examples of average royalty rates for licensed equipment for:
- radio communications – 7%;
- welding work – 3.5-5%;
- general purpose refrigeration units – 2-4%;
- railways – 3-5%;
- water purification – 5%;
- general industrial purposes – 5.5%;
- alarm – 1-1.5%.
In many cases, forecasting and calculating the royalty rate begins with such approximate tables, which contain much more columns about the types of industry, products and equipment. Next, the rate begins to be clarified by involving in the calculations factors and parameters that influence the amount of compensation. Next, formulas and different types of royalty calculations are applied for different types of intellectual property, for different areas, different use situations, and different types of royalty calculations.
We will take a closer look at the types of bet calculations and other issues on this topic in other articles. As before, we invite you to contact the ANO “Forensic Expert”. Any problems of licensing and patent law, issues of using licensed objects and intellectual property are resolved here. And other issues related to the expert, evaluation, patent sphere - regardless of the direction of your activity or area of \u200b\u200byour interests. See you in other materials.