Deal Making and the Art of Creative Royalty Structures
For example, one of our clients had a prospect interested in licensing a technology that was somewhat unknown in the marketplace. The price point for the technology was uncertain and likely would vary significantly over time and between buyers.
A standard structure would likely have resulted in an unfair deal for both parties at various times. At lower price points, the royalty would cut dramatically into margins, making the deal unprofitable for the licensee. At higher price points, the royalty would yield such high margins for the licensee that it would be unfair to our client.
So what to propose? A savvy prospect would have rejected a traditional royalty structure and possibly terminated negotiations. And even if the deal went through, the prospect would likely want to renegotiate—or, worse, terminate—the deal in the case of the lower price points.
A creative royalty structure was needed to account for price point uncertainties. The structure had to be fair to both parties as well as easy to implement and track.
We worked with the client to develop a creative and viable structure that met everyone’s requirements. Rather than a fixed royalty rate, we proposed a gated matrix of royalty rates based on the average sales price. Variability in the sales price (and therefore margin) was reflected in a variable royalty rate. The higher the average sales price, the higher the royalty rate.
Use of the average sales price (over the quarter, for example), eliminated the need for complex tracking and reporting. The licensee simply would divide total sales for that product for that time period by the number of units sold. The use of averaging would account for both price variability over time and between deals.
Our client’s willingness to build a creative, innovative model enabled them to move forward with this deal.
Do you have a creative royalty structure to share? We’d love to hear about it.
–By Karen Hiser