# Understanding Royalties: Payments for Using Assets Like Patents and Music

## What Is a Royalty?

A royalty is a payment made to an individual or company for using their property, like copyrighted music, franchises, or natural resources. Such payments are defined in a licensing agreement, ensuring that both the licensor and licensee benefit from the arrangement. The agreement specifies the terms, outlining how the royalty is calculated, its duration, and any geographic limitations.  

### Key Takeaways

*   Royalties are payments made for the ongoing use of an asset, such as patents or copyrighted works.  
    
*   Different types of royalties exist, including book, performance, patent, franchise, and mineral royalties.  
    
*   Licensing agreements outline the terms of royalty payments, including limitations and revenue shares.  
    
*   Royalty rates can vary based on factors like product innovation, exclusivity, and demand.  
    
*   Royalties are typically taxed as ordinary income for the recipients.

![Royalty](https://www.investopedia.com/thmb/5FfFpHF8BLvU5FQHG_VC1BBC-Zw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Term-Definitions_royalty-resized-9197639065da4641a4e1135e8d0b7ed9.jpg)

*— Investopedia / Jessica Olah*

## Exploring Different Types of Royalties

*   **Book royalties**: Paid to authors by publishers. Typically, the author will receive an agreed amount for every book sold.
*   **Performance royalties**: The owner of copyrighted music receives an amount whenever the music or song is played, used in a movie, or otherwise used by a third party.
*   **Patent royalties**: Innovators or creators patent their products. Third parties typically enter into a licensing agreement requiring them to pay royalties to the patent owner.
*   **Franchise royalties**: A franchisee pays a royalty to the franchisor for the right to open a branch under the company name.
*   **Mineral royalties**: Mineral royalties are paid by mineral extractors to property owners.

## Understanding Licensing Agreements for Royalties

A licensing agreement outlines the terms of royalty payments. The licensing agreement defines the limits and restrictions of the royalties, such as its geographic limitations, the duration of the agreement, and the type of products with particular royalty cuts.

Agreements should benefit both the owner receiving the royalty and the user paying it. For the owner, a royalty agreement can let another company use their product and enter a new market. For the licensee, an agreement may give them access to products they could not access otherwise.

## How Royalty Rates Are Determined

To accurately estimate [royalty rates](https://www.investopedia.com/articles/personal-finance/121614/how-pandora-and-spotify-pay-artists.asp), the transactions between the buying and selling parties must be willingly executed. All royalty transactions must be conducted at arm's length, meaning that both parties act independently and have no prior relationship. Rates may also be a factor of:

*   Innovation of the product
*   Exclusivity of rights
*   Available alternatives
*   Demand
*   Sales margins

> **Important**
>
> In 2024, songwriters and publishers receive a royalty rate of $0.124 per minute on songs with a running time of less than five minutes. According to the Copyright Royalty Board, this royalty applies to physical sales including vinyl, cassettes, CDs, and digital downloads. For songs over five minutes, the rate is $0.239 per minute.

## How Royalty Payments Are Structured

In many licensing agreements, royalty rates are defined as a [percentage of sales](https://www.investopedia.com/terms/1/25-percent-rule.asp), a payment per unit, or a percentage of the gross or net [revenues](https://www.investopedia.com/terms/r/revenue.asp) obtained from the use of property. However, they can be negotiated on a case-by-case basis according to the wishes of both parties.

Payment may be nonrenewable resource royalties, [patent royalties](https://www.investopedia.com/articles/investing/111014/patents-trademarks-and-copyrights-basics.asp), trademark royalties, franchises, copyrighted materials, book publishing royalties, music royalties, and art royalties. Well-known fashion designers can charge royalties to other companies for using their names and designs.

## Practical Examples of Royalty Payments

Authors typically receive a share of the proceeds from the sales of their books. For instance, a writer may receive 15% on net sales of hardbacks and 7.5% on net sales of paperbacks.

Franchises also use royalties. Individuals can buy restaurant franchises like McDonald's. A franchisee of the McDonald's Corporation has a typical initial down payment of 40% of the total for a new restaurant or 25% of the total for an existing one. After purchasing the franchise, the owner must make ongoing royalty payments of 4%–5% of monthly gross sales.

## What Is Intellectual Property?

Intellectual property is an [intangible asset](https://www.investopedia.com/terms/i/intangibleasset.asp) owned by a company or individual and legally protected from outside use or implementation without consent. Examples include copyrights, patents, and trademarks. Royalties are designed to protect the [intellectual property](https://www.investopedia.com/terms/i/intellectualproperty.asp) rights of a company. A company might file a patent on an innovation, so a third party must pay them a fee to use it.

## Who Pays Royalties?

An inventor or original owner may sell their product to a [third party](https://www.investopedia.com/terms/t/third-party.asp) in exchange for royalties from the future revenues the product may generate. Television satellite companies pay royalty payments to air the most viewed stations nationwide. In the oil and gas sectors, companies pay landowners royalties for permission to extract natural resources from their covered property.

## What Are Royalty Interests?

Royalty interest applies to mineral rights agreements. A royalty interest entitles the mineral rights owner to receive a portion of the minerals produced or the [gross revenue](https://www.investopedia.com/ask/answers/102714/what-are-difference-between-gross-revenue-reporting-and-net-revenue-reporting.asp) from sold production.

## Conclusion: The Role Royalties Play in Asset Monetization

Royalties provide a financial avenue for creators, innovators, and property owners to monetize their assets, whether they are books, music, patents, minerals, or franchises. A well-negotiated royalty agreement specifies the terms of usage and ensures that both the licensor and licensee benefit. Royalty payments, structured as a percentage of sales or revenue, contribute to ordinary income for the recipient.

> **Article Sources**
>
> 1.  Billboard. "[Songwriters Earn 2024 Cost of Living Adjustment for Physical and Digital Sales](https://www.billboard.com/business/publishing/songwriter-royalties-cost-of-living-increase-music-sales-2024-1235553498/)."
>     
> 2.  McDonald's. "[The Financials](https://www.mcdonalds.com/ca/en-ca/about-us/franchising/the-financials.html)."
>     
> 3.  Internal Revenue Service. "[What Is Taxable and Nontaxable Income](https://www.irs.gov/businesses/small-businesses-self-employed/what-is-taxable-and-nontaxable-income)?"