Licensing Advice from Chris Muggleton

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Deductions from the Royalty Base(Posted: 05-02-2009)

By Chris Muggleton

Hello!

Like me you are probably looking around wondering what happened to January and are also getting ready for the numerous s trade fairs that are coming up.

For those who got in touch following last month’s article, many thanks for your comments and questions. I hope to incorporate responses to the questions in my forthcoming articles.

As promised this month I am going to discuss “Deductions from the Royalty Base”. Without doubt this is the most important clause in any License Agreement and it is essential to define clearly and accurately, how royalties are to be calculated.

Of course specific terms in License Agreements vary from contract to contract. For that reason our discussions will be limited to a Standard Merchandise License Agreement (if there exists one!) i.e. for every unit sold of product bearing the intellectual property of the Licensor, a percentage of that sale price must be paid as a royalty.

In the type of Agreement specified above, the “royalty” clause will define the percentage i.e. 10% of the Licensee’s net sales value which must be paid as a royalty. Net sales value being the gross sales value of the goods less permitted deductions. This is usually referred to “Net Invoice Billings”.

Now we are clear on the mechanics of the royalty basis, some commentary on the most common “Deductions”, using our “standard” merchandise agreement as an example.  

Obviously arguments as to what deductions are to be permitted or not, vary between a Licensor and a Licensee.  However there must be a common ground and both parties have to be able to operate and enjoy financial success.

·          Volume Discounts – these are the most commonly accepted deductions, as they are based on volume of sales. Some Licensors stipulate that these must be indentified on the invoice itself. However, a Licensee should be able to provide documentation as to their rational and application.

·          Credit for Returns– the majority of Agreements permit the deduction for Credit for Returns, providing there can be documented proof of such returns. However, it is becoming increasing common for the level of returns to be capped to a certain percentage of sales.

·          Cash & Early Payment – such deductions are not normally permitted, with many Licensors being weary of cash sales.

·          Transportation Costs– If clearly and separately indentified, some Licensors permit such charges to be deducted from the Royalty calculation.

·          Advertising & Promotion Costs - these deductions are very rarely permitted, as they are seen to be the costs of doing business by most Licensors.

·          Manufacture, Selling and Importing Costs - like some charges above, such deductions would be seen in the majority of instances as a cost of doing business and therefore not deductable from the royalty base. That said, value added and sales taxes are always deducted from the royalty basis.

The best piece of advice that I can offer any Licensee is to talk to the Licensor, clarify the terms of the agreement if certain clauses are not clear keep all relevant documentation relating to any deductions applied to the royalty base.

Obviously there is a lot to understand and near on impossible to give full commentary in this small space. However do feel free to get in touch should you require any further explanation.

Next month I will discuss Royalty Submissions and Payments.

Chris

chris@licensingadvice.com