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Dilemma of the Reasonable Royalty Rate

Written by on Sunday, December 11th, 2005

If you missed the recent blogpost by Stephen Albainy-Jenei, What’s a Reasonable Royalty Rate?, I urge you to check it out. Stephen addressed the question I know that many transactional lawyers like me struggle with: what exactly is a reasonable royalty rate in any particular transaction?

While Stephen acknowledges that Organizations like the Association of University Technology Managers (“AUTM”) and the Licensing Executives Society (“LES”) publish lists and statistical analyses of royalty rates, Stephen says of those publications:

Granted, using an established royalty rate shown in certain guides sounds good since these are derived from prior actual licenses for comparable products. The rates in the guides come from negotiation and paid by a sufficient number of licenses. As with reasonable royalty, an established royalty rate derives from the outcomes of willing parties licensing without the threat of a suit, or resultant from litigation. These rates are reflective of the profitability of industry segments. Correspondingly, what might pass muster for an established royalty depends upon the definition of a market segment. Commodity items tend to garner a relatively low royalty rate, just shy of 3%, consumer goods 5%, while software garners around 7-8%. But generalities don’t tell you anything about your particular deal.

So, if you can’t rely on particular guides to tell you what is reasonable, how do you ever really know what is reasonable? Stephen says to this point:

A reasonable royalty rate is often based on economic sense by utilizing a financial model which relates the investment required to develop a therapeutic technology to the income generated by such technology. What does that mean? It means you have to have a good business plan in place before you can talk turkey on royalty rates. And I don’t mean those wildly inflated fluffy business plans that companies create showing revenue in colorful logarithmic growth charts to impress potential investors. No, I mean a real, down-to-earth, cold shower type of business plan that takes into account all of the pain and suffering that could be encountered along the way.

Stephen shares with us some examples, but in the end, he seems to come back to the fact that the reasonable royalty rate is a somewhat amorphous concept, which is, of course, is basically how most of us have been answering the question when it is posed to us. We give the classic “it depends” answer, which is sure to drive the non-lawyer public nuts everytime they hear it. Still, Stephen has some interesting royalty rate negotiation insights that he shares in his blogpost, which are quite helpful, so even if he provides no definitive answer to the issue, I would definitely urge you to take a look at it.

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