Royalties are payments to owners for using their patents for products, creator copyrights in the music, publishing, and franchise industries, or for natural resources such as oil and gas drilling rights or timber rights. Intellectual property owners (licensors) negotiate royalties with third-party licensees through a royalty agreement that includes a precise description of the intangible or tangible asset being licensed, the royalty rate, and how to calculate royalty rate.
Before the parties negotiate the legal document for a royalty licensing agreement, it’s essential to get legal advice, understand how to calculate royalties, and know the current market rates for your type of royalty.
What Are Royalties?
Royalties are compensation paid and received by parties in a negotiated licensing agreement or royalty agreement for using intellectual property, intangible assets, or natural resources related to owned land.
Royalties compensate for inventor patents on licensed products, trademarks, creative copyrights for authors, musicians, and music labels, or land use rights such as drilling or timber rights. The licensing agreement for the royalty determines what is the calculation base and what is a royalty rate in each case.
How to Calculate Royalties
How are royalties calculated? The royalty rate calculation method depends on the type of royalty asset being licensed.
Specific step-by-step instructions for a royalty calculation are:
- Identify the intangible asset or mineral right for which the royalty rate is being calculated.
- Review the royalty agreement.
- Determine the activity and related performance (or mineral rights land area royalty percentage) for which the royalty rate is being measured for the calculation.
- Find the specified royalty rate calculation in the agreement.
- Apply a percentage or royalty rate to the base activity and any tiers used in the calculation.
As an alternative, for certain types of royalties, automated royalty or performance marketing system platforms track, measure, and calculate triggered actions and the amounts payable to royalty recipients or other types of affiliate payees. These performance marketing systems can be integrated with Tipalti’s third-party mass payments software to make global payouts through the PMS software menu.
Factors That Affect Royalty Percentage
Factors that affect royalty percentage as a royalty rate include:
- Exclusivity and uniqueness
- Demand for the intangible asset
- Current market rates in the industry for that type of royalty
- Strength of the intellectual property
- The development stage of a product
- The base upon which the royalty is being applied
- Official royalty rates for an industry, such as the music industry
Industry-Specific Royalty Examples
The music industry streaming rate and two industry-specific royalty examples are highlighted below. These industries, which include applicability to the music industry, are (1) the gig economy for musicians, creators, and producers and (2) media and entertainment, with video and media solutions. We describe Tipalti finance automation software case studies and testimonials in these industries.
Music Industry Royalty Definitions and Performance Rights Organizations
Performance royalties in the music industry are rights paid to songwriters and music publishers to stream, broadcast, or publicly perform copyrighted music. A mechanical royalty is a payment to licensor songwriters and artists when their music is reproduced or distributed in different formats, including streaming, CDs, digital downloads, and vinyl records.
In the USA, BMI and ASCAP are competing performance rights organizations (PROs) that issue music licenses to businesses and collect and distribute music performance fee royalties for their members for US performances and through reciprocal agreements with Copyright Societies in other countries for international performances. Another mission of the PROs is to get fair payments for their members.
Music Industry Royalty Rates from CRB via Settlement
The Copyright Royalty Board (CRB) (with three judges) sets the streaming royalty rates to be paid to songwriters and music publishers every five years. Effective January 1, 2023, through December 31, 2027, the CRB accepted a settlement for the music industry called Phonorecords IV or CRB IV. The settlement rate annually increases the primary streaming royalty rate to a higher royalty rate as a percentage of the US revenues of an interactive streaming service.
The CRB IV streaming royalty rates by year are:
- 2023: 15.1%
- 2024: 15.2%
- 2025: 15.25%
- 2026: 15.3%
- 2027: 15.35%
Instead of applying CRB IV rates, the rate determination document from the settlement includes a Table with streaming royalty rates for publishers and songwriters based on a calculation of “Total Content Costs.”
This settlement applies to almost all of the music industry. Spotify, Pandora, Apple Music, and Amazon Music are examples of major interactive streaming services.
Gig Economy
In the gig economy industry for music creators and producers, Splice, which is headquartered in New York City, presents a playground for hearing and selecting sounds as royalty-free samples, loops, and presets. Its product library includes both audio and video. Splice must pay over 900 musician/artist royalties each quarter and make many time-consuming monthly label payments.
Splice has been a Tipalti mass payments and AP automation customer since 2019. Splice uses NetSuite ERP as its accounting and business management system to integrate with Tipalti. The following testimonial from the Splice-TIpalti customer case study highlights the benefits of using Tipalti finance automation software for making global royalty payments in large batch payouts.
For the 900+ royalty payments alone, it would take me two weeks. That’s all I would be doing at the end of a quarter close. I knew that we needed a new automated platform. What once took us eight weeks a year to process is now down to less than an hour. AP invoice processing is also automated, which eliminates another 36 days a year of workload.
Nas Yaqoobi, Accountant at Splice
Media and Entertainment
In the media and entertainment industry, GoDigital Media Group is a multi-entity company operating in different business segments through subsidiaries. GoDigital Media buys music rights and music licenses to monetize the assets.
As a mission, the entire business strives to help music and entertainment content owners manage, market, and monetize their products. GoDigital operates in 16 countries and makes many global, cross-border payments.
GoDigital Media subsidiaries include:
- Cinq Music, a music label and distributor
- Vida Primo, a music television network
- AdShare, a social media monetization service
We were doing a lot of international bank transactions, and those foreign-transaction fees were hitting us hard in the pocketbook. Since we are a Latin music label, when Bill.com informed us that they no longer could service Puerto Rican banks, we needed a better payment solution.
Hunter Paletsas, CFO of GoDigital Media Group
GoDigital switched to Tipalti in 2018. GoDigital uses Tipalti mass payments software to make efficient global royalty payments. GoDigital Media also uses Tipalti AP automation software in one unified platform for managing suppliers and paying accounts payable invoices. The Tipalti finance automation software integrates and syncs with its ERP system.
I’m getting 20 days a year back from not having to process AP manually. Everything is always available in the Tipalti system; it’s the one source of truth, finally, for our payments. I’m spending more time structuring deals and really focusing on all the strategic aspects of helping the business. I’m freed from the administrative operative burden I had before.
Hunter Paletsas, CFO of GoDigital Media Group
Tipalti Mass Payments Software Features
Tipalti mass payments software is designed to make payouts to creators like musicians, influencers, publishers, streamers, and independent contractors like freelancers.
Mass Payments simplifies and makes mass global payout batches in a volume up to the thousands, using AI-driven automation. Tipalti mass payments integrates and syncs with your ERP or accounting software and some performance marketing system platforms.
The Tipalti automation software for mass payments:
- Provides self-service payee onboarding through a hub portal
- Validates payees to prevent fraud at onboarding and before each payment
- Securely collects each payee’s W-9 or W-8 form (before the first payment), their payment method choice, and required payment details
- Applies 26,000+ payment rules to flag errors
- Tracks calendar-year payouts with a report for your company’s tax compliance reporting needs
- Guides payout approvals with communications to approvers
- Lets you schedule large payment batches with cash flow requirements shown before paying
- Makes global payments to 196 countries in 120 currencies, using a choice of 50 payment methods
- Automatically provides payment status and history to payees
- Prepares real-time payment batch reconciliation
- Works as multi-entity software if your ERP or accounting software is multi-entity
- Gives spend visibility by entity and combined for control and business intelligence
- Allows your business to also integrate optional Tipalti advanced FX software products for cross-border payments
With Tipalti’s simple tax compliance preparation reports, your company can easily prepare its Form 1099-MISC, which includes royalties (and 1099-NEC for nonemployee compensation excluding royalties) filings at tax time. If your company has 12 calendar months of payment data, optionally, it can buy a SaaS subscription to Zenwork’s Tax1099 software with native Tipalti payments integration (through a partnership agreement) for automatic eFiling of your company’s 1099-MISC and 1099-NEC forms. Tax1099 software also distributes a copy of the IRS form to each payee recipient.
Multi-FX and FX Hedging for payables are Tipalti’s optional advanced FX software products that work with its mass payments and AP automation software (for goods and services invoices from suppliers and vendors). With Multi-FX, which supports 30 currencies, your business can use one centralized virtual payment account for all subsidiaries’ global payments. With FX Hedging, you lock in foreign exchange rates on accounts payable invoices before payments are due.
Common Royalty Structures
Common royalty structures in royalty agreements are:
- Percentage fee. Royalty percentage fees are calculated and paid, based on performance, as a percentage of revenues or another specified base in the negotiated royalty agreement.
- Tiered royalties. Tiered royalties consist of different royalty rates for each range of usage or performance, such as revenues.
- Fixed fee or lump sum. Fixed fee royalty structures often pay in total for a royalty upfront without considering performance in the calculation.
- Periodic payments. Royalty agreement structures may specify weekly, monthly, or annual royalty payments.
- Ad valorem rate and per-unit rate. The ad valorem rate is a per-unit royalty rate for patents applied to the quantity times the sales price of each licensed product sold.
Your ERP or accounting software doesn’t make royalty payments easy
Automate global royalty payouts to artists, publishers, music labels, and other affiliate payees with Tipalti mass payments software to increase efficiency, cut costs, and make timely payments.
Tips for Negotiating a Fair Royalty Agreement
To negotiate a fair and reasonable royalty agreement, know the strength of your intangible or tangible asset being licensed, objectives, current royalty rates in the industry, and the other negotiating party’s needs. Be willing to compromise to the extent possible to achieve mutual gains.
Through an Internet search, you can find royalty rate data in databases with comparable royalty rates for license negotiation at the right valuation level.
Ensure the royalty calculation formula is correct, and the royalty terms are clearly defined. Have your attorney with royalties know-how review the preliminary royalty agreement and propose any recommended changes before signing a final version.
After the royalty agreement is finalized, the parties must understand what are royalty rates, all terms, and the agreed-upon royalty calculations for making royalty payments to ensure amounts paid and received are accurate.
The (Licensing Executives Society) LES USA and Canada, provides training and resources for its intellectual property (IT) and licensing professionals members.
Common Mistakes to Avoid in Royalty Calculations
Mistakes to avoid in royalty calculations include:
- Ambiguous royalty agreements
- Not identifying types of sales as subject to royalties
- Mistakes in accounting for tiers, such as revenue tiers or activity levels
- Applying the royalty percentage to net revenues instead of gross revenues
- Not considering the allocation of fractional interests for each different licensor’s share of the royalty
- Not understanding how to calculate royalty interest for oil and gas drilling rights
- Miscalculating the contract formula for royalties
- Not applying a reasonableness test to the royalty rate calculation by knowing the average royalty rate for the industry
To calculate a royalty interest for drilling rights as a decimal interest, multiply the royalty payee’s acres in the unit divided by the total number of acres in the unit by the royalty rate specified in the agreement.
Summing It Up
Royalties are negotiated and paid upon negotiation of a royalty agreement that includes a calculation with the royalty rate, payment base or tiers, and the timing of the royalty payouts. Royalties may be paid as a lump sum or periodically using payment calculations for each payout period. The royalty rate for each industry is different and considers factors such as demand and exclusivity.
Royalties are complex and may require making global cross-border payments to recipients. With ERP and performance marketing system-integrated Tipalti automation software, your staff will spend much less time making and recording payouts.
Royalty payees will choose their preferred payment method, receive automated payment status notifications, and be paid on time for greater satisfaction. Tipalti payments automation software reduces payout cost. Learn more about using Tipalti’s mass payments and advanced FX products as your royalty payments automation software.
