How Are Periodic Royalties Calculated?
Royalties are commonly used in the mining and drug development industries. There are companies that specialize in developing or finding resources and then license out the distribution and mining to companies that specialize in that. There are a few different types of royalties, with periodic and profit-based royalties the most widely used.
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Definition
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A royalty is a payment made to a third party for the use of something. It can be for the use of such items as an intangible asset, natural resource, or intellectual property. The agreements are usually made for a cut of sales or a cut of profits. For example, a company develops a drug compound that has been approved by the FDA. The company does not have the distribution capabilities of a different company. A company licenses out the drug compound and will receive royalties from the other company that are 20 percent of sales. Twenty percent of every dollar of sales will be paid out to the drug developer.
Periodic Royalty
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There is also a different kind of royalty called periodic royalty. These are also royalty payments, but are based on the passage of time, not on a percentage of sales. Take, for example, a company that's a precious metals explorer. It finds a gold mine that studies show has a significant amount of gold in it. For a periodic royalty payment of $1 million a month for five years, the company gives the right to the land to a gold miner that specializes in taking gold out of the ground.
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Calculation
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The way the periodic royalties are calculated is solely up to the two parties involved in the transaction. The payments can be made on a weekly, monthly, quarterly basis, or according to another time frame based on what the parties' preferences are. The periodic royalty payments can be calculated by comparing the asset to other comparable assets and their associated periodic royalty payments. The two companies can also set up a hybrid royalty with part periodic payment and part payment based on sales or profits.
Other Royalties
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The most common variable royalties are the ones strictly based on the revenue produced, or based on net profits. However, there are also royalties that are in between. For example, there could be a minimum royalty set that a company has to pay even if it is not earning a profit. There are royalties set based on a sliding scale, where the royalty percentage rises and falls depending on the volume. Another kind of royalty is just set on the product costs, and not the overhead or other costs involved.
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References
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