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Royalty Definition & Meaning

A royalty is a legally-binding payment made by one party to another for the ongoing use of their originally-created assets, including copyrighted material, patents, and trademarks. Royalties are commonly agreed upon as a percentage of gross or net revenue obtained from the use of an asset or as a fixed price per unit sold. However, they can be negotiated on a case-by-case basis that suits both parties' wishes.

Terms of royalty agreements

Royalties stem from licensing, which is the process of granting a party explicit rights to use intellectual property that someone else has created or owns. A licensing agreement defines the limits and restrictions of the royalties, such as geographic limitations and duration of agreement. Royalties allow others to use an owner's property, giving the owner income from this use. It also protects the buyer of the property from claims by the owner of improper use.

The royalty agreement must indicate when a payment will be made, how records will be kept, and whether an advanced payment is required. Royalty rates depend on a number of factors including exclusivity, market demand, and availability of other similar products that would compete with the product in question.

Types of royalties

  • In the music industry, royalties are paid to owners of copyrighted music, known as performance royalties. This royalty is commonly used by radio stations wanting to include a song in its rotation and filmmakers wanting to use a song in a movie.
  • A landowner with petroleum or mineral rights to their property can license those rights to another party. The owner receives a royalty payment, also known as a resource rent, in exchange for a party to extract the resources.
  • In the publishing industry, book royalties are paid to the author by the publisher for every book they sell. The publisher determines an author's royalty rate.
  • Royalties must be paid for the use of images such as stock images on a website or other medium.
  • Franchises are closely connected with trademarks, an example being McDonald's. The franchise holder pays franchise royalties to the main company for the use of the name and other assets.
  • Patent royalties are paid to the owner of a patented invention who makes and sells the invention by a third party.

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