Third party royalties: Overview, definition, and example
What are third party royalties?
Third party royalties refer to payments made to a third party (other than the primary business or individual receiving the benefit) in exchange for the right to use certain intellectual property, such as patents, copyrights, trademarks, or other licensed assets. These royalties are typically paid as a percentage of the revenue generated from the use of the intellectual property or as a fixed fee, depending on the terms of the agreement.
In a business context, third party royalties often come into play when a company licenses its products, services, or intellectual property to another business. The third party royalty is the payment the business makes to the original intellectual property holder, and it serves as compensation for the use of that IP.
Why are third party royalties important?
Third party royalties are important because they provide a way for intellectual property holders to generate revenue by allowing others to use their creations. For companies and individuals holding patents, copyrights, or trademarks, royalties are a key source of income.
For businesses that are licensing intellectual property, paying royalties to third parties ensures that they comply with licensing agreements and respect the intellectual property rights of others. Royalties are also important in industries like music, film, publishing, technology, and pharmaceuticals, where intellectual property plays a central role in generating profits.
For SMB owner-managers, understanding third party royalties is crucial when entering into licensing agreements or using third-party IP to ensure that the terms are clear, fair, and legally binding.
Understanding third party royalties through an example
Imagine a software development company, TechSolutions, creates a unique software program and patents its technology. TechSolutions then licenses its technology to a third-party company, XYZ Corp., which uses the patented technology to develop and sell its own product.
Under the terms of the licensing agreement, XYZ Corp. agrees to pay TechSolutions a third-party royalty of 5% of the sales revenue generated from products that use TechSolutions' patented technology.
As XYZ Corp. sells more products using the patented technology, TechSolutions receives regular royalty payments based on the sales figures. These royalties are considered third-party royalties because they are paid to TechSolutions by a third party (XYZ Corp.) for the use of its intellectual property.
In another example, a music label might pay royalties to the original songwriters (third parties) whenever their songs are used in films, commercials, or streaming platforms. The songwriters receive a percentage of the revenue generated by the use of their music.
An example of a third party royalties clause
Here’s how a third party royalties clause might appear in a licensing agreement:
“The Licensee agrees to pay the Licensor a third-party royalty of 8% on all gross sales revenue derived from the use of the licensed intellectual property. Royalty payments will be due quarterly, with the first payment due 30 days after the end of the first quarter of sales. The Licensee shall provide a detailed report of sales to the Licensor with each payment.”
Conclusion
Third party royalties are a vital mechanism for compensating intellectual property holders when their creations are used by others. Whether it's a patent, trademark, or copyrighted work, these royalties ensure that creators are compensated fairly for their innovations and contributions.
For SMB owner-managers, understanding how third-party royalties work is essential when licensing intellectual property, entering into partnerships, or using others' IP in their products. Properly structuring royalty agreements ensures fairness and legal compliance, while also creating opportunities for revenue generation through the use of valuable intellectual property.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.