Wednesday, November 9, 2011

Lump Sum or Royalties?

Dear Rich: I'm trying to figure out whether to ask for a lump sum payment or royalties for a deal I am making. Is there some formula for figuring out what to ask for in terms of a lump sum? I've heard from someone that you multiply expected revenue for one year times four. Any help would be appreciated. Congratulations on your pending deal. Money in your mailbox -- what a great way to get paid. Except we guess that nowadays everybody has opted for direct deposit instead. And sadly, with everybody doing direct deposit, it's not so easy to simply drop your red state bank and walk over to the credit union and switch accounts as requested by our friends at Occupy Ocean Beach.
Right, you had a question. The Dear Rich Staff would never recommend one method of payment over the other because (1) if we recommended a lump sum and the licensed product was a much bigger success than you expected, you'd hate us, or alternatively (2)  if we recommended ongoing royalties and the sales were disappointing, you'd hate us. By the way, here's an article that explains the various types of royalties (per use, per item, etc.) and compares royalties to lump sums.
Why do some people prefer a lump sum payment? Without establishing a preference, we can tell you why some people prefer the lump sum. First, the licensor doesn’t have to be concerned with accounting or auditing records. Second, some licensors like the lump sum because they're not sure of the viability of the licensee or the long-term prospects for the product. Third, some licensors prefer lump sum payments for foreign licenses because of currency conversion rates. These rates -- which measure the foreign currency against U.S. currency -- may change dramatically, making your foreign royalty payments less valuable.
Why do some people prefer a royalty? The periodic payment of royalties rewards the licensor who has a successful product. So if it's a hit, you can quickly join the 1%. Getting paid royalties also may result in lower taxes, depending on how they're categorized on your tax return.
License or Assignment. A lump sum payment for a license is different from a lump sum payment for an assignment. A license may be limited in time, for example, for two or three years. Under an assignment, however, you lose ownership of your invention. The tax implications for the lump sum payment may be different for an assignment than for a license, as well.
Formulas for Evaluating Products. There are many formulas for evaluating product value although we've never heard of the "4X" system you describe (and we're wary of applying it). Such formulas are beyond the scope of our lowly blog and we recommend perusing a text such as this one.