Key Takeaways:

  • Patent royalties provide financial compensation to inventors for licensing their inventions.
  • Average royalty rates for patents typically range between 3% to 6% of gross sales, but this varies based on industry, exclusivity, and negotiations.
  • Flat-fee vs. percentage-based royalties: Inventors can choose between a one-time payment or a percentage of revenue from sales.
  • Standard-essential patents have legally mandated fair, reasonable, and non-discriminatory (FRAND) royalty rates.
  • Factors influencing royalty rates include industry norms, the patent's market potential, the licensing agreement structure, and the patent's technological uniqueness.
  • Best negotiation strategies involve understanding market rates, considering upfront payments, and structuring milestone-based royalties.
  • Tax implications of patent royalties depend on whether they are classified as passive income or business income.
  • Alternative ways to monetize patents include selling patents outright, forming joint ventures, or licensing through patent pools.
  • Legal assistance is crucial to drafting a strong patent licensing agreement to maximize royalty earnings.

Royalties on Patents

Royalties on patents allow the person paying the royalty to use the invention of the patent owner. A patent owner has the right to prevent other people from using their invention, and they also have the ability to license their invention for a fee known as a royalty. Patents granted in the United States apply only to the country and its territories and will last for a period of 20 years after the filing of the patent application.

The Bayh-Dole Act, which was passed in 1980, provides universities the ability to profit from research performed by geniuses on campus. In 2013, the top five universities in terms of patents submitted were:

  • The University of California
  • MIT
  • The University of Tsinghua
  • Stanford University
  • The University of Texas

The top five patent submitting companies of 2013 were:

  • IBM
  • Samsung
  • Cannon
  • Sony
  • Microsoft

Three Types of Patents

The most common patent is known as a utility patent, which is used to protect articles of manufacture, matter compositions, machines, and processes.

A design patent is used to protect designs for articles of manufacture that are ornamental, original, and new.

You would use a plant patent to protect the discovery of a new type of plant.

How to License a Patent & Royalties?

A patent is one of the most valuable forms of intellectual property rights. Thanks to federal patent laws, having a patent provides you with the sole rights to produce, use, and sell your invention. Federal patent laws also give patent owners the ability to license the production and use of their invention for a royalty.

You can use a licensing agreement to give an investor certain rights to your invention in exchange for their investment. Patent licenses can be used to resolve a patent dispute after you've already manufactured and marketed your invention. If you want to determine your ability to license your patent, it's best to consult with an experienced business professional that understands the complexity of licensing agreements.

It's important to establish how negotiations will proceed before you begin negotiating a licensing agreement for your patent. When licensing a patent, you should consider whether you should use nondisclosure and confidentiality agreements. Having these agreements in place will discourage the potential licensee from violating your patent rights.

Essentially, when you license your patent, you are promising not to sue the licensee for using your invention in exchange for royalty payment. Other than promising not to bring litigation, the most important part of negotiating your licensing agreement is determining the amount of royalties you will charge. It's best to consult an attorney when calculating this figure.

Typically, you would use the gross sales of the whatever product is made from your patent to calculate your royalty payments. While licensing agreements and royalties on patents should be evaluated on a case-to-case basis, most royalties are 3 to 6 percent of gross sales. The amount of certain patent royalties is mandated by law. For example, with standard-essential patents, the rate for royalty payments must be fair and should not discriminate based on the licensee.

Understanding Flat-Fee vs. Percentage-Based Royalties

Patent royalties can be structured in two main ways:

  1. Flat-Fee Royalty: A one-time or periodic lump sum payment made to the inventor.
  2. Percentage-Based Royalty: A percentage of revenue or profit generated from the patented invention.

Each structure has advantages:

  • Flat-Fee Royalties provide upfront certainty but may result in lower overall earnings.
  • Percentage-Based Royalties can be more lucrative in the long run if the product is successful.

How Big Are Royalties From Inventions?

When someone turns an idea into an invention, they usually dream of receiving royalty payments. To receive these payments, an inventor can enter into a licensing agreement with a company. With a licensing agreement in place, the company has the right to sell the patented invention, and the inventor will receive a percentage of the sale of each product.

The following factors can determine the percentage of sale the inventor will receive:

  • Novelty of the invention.
  • How fully their patent protects their invention.
  • The profitability of the product resulting from their invention.

The average royalty for licensing an invention is 3 to 6 percent of the product's wholesale price, which is the price the company charges the consumer. If you have a profitable product and choose the right manufacturer, a licensing agreement can be a great way to make money from your invention.

Factors That Influence Patent Royalty Rates

Several factors determine how much royalty an inventor receives for a patent. These include:

  • Industry Standards: Different industries have varying royalty benchmarks. For example, biotech patents often command higher royalties than mechanical patents.
  • Exclusivity: Exclusive licenses tend to yield higher royalty rates compared to non-exclusive agreements.
  • Market Potential: A high-demand invention with significant revenue potential can command better royalties.
  • Patent Strength & Breadth: Stronger patents with broad claims tend to secure better royalty agreements.
  • Manufacturing Costs: If production costs are high, royalty rates may be adjusted to maintain affordability.
  • Negotiation Power: A well-prepared inventor who understands market rates can negotiate more favorable terms.
  • Competitive Landscape: If there are alternative solutions available, it may lower the royalty rate.

Should You License Or Produce Your Invention?

The majority of inventors follow a three-step process:

  1. Develop their invention.
  2. Decide if their invention is marketable.
  3. Apply for a patent for their invention.

Most inventors are known as “inventors-for-royalties,” which means they want to invent something solely for the ability to collect royalties. However, if you have a competitive mindset, you may want to produce your invention yourself. While this will be more difficult, it may end up being more financially rewarding.

Tax and Legal Considerations for Patent Royalties

Understanding the tax implications of patent royalties is crucial for inventors:

  • Tax Classification: Royalties are generally considered passive income but may be treated as business income if the patent is actively managed.
  • Withholding Taxes: If licensing internationally, some countries impose withholding taxes on royalty payments.
  • Patent Ownership Structure: Holding patents under a business entity can offer tax benefits and liability protection.
  • Contractual Safeguards: Ensuring legal protections, such as termination clauses and infringement indemnifications, is essential.

Consulting an experienced patent attorney can help structure agreements favorably.

FAQs

1. What is the typical royalty rate for a patented invention? Patent royalty rates typically range between 3% and 6% of gross sales, but they can be higher depending on industry norms and negotiation strength.

2. How can an inventor negotiate higher patent royalties? Inventors can secure better rates by demonstrating the market demand for their invention, securing exclusive agreements, and using comparative market analysis.

3. Are patent royalties taxed? Yes, patent royalties are subject to taxation. The classification (passive income vs. business income) affects how they are taxed.

4. Can an inventor sell their patent instead of licensing it? Yes, an inventor can sell their patent outright for a lump sum payment, often a good option for those looking for immediate compensation.

5. What happens if a licensee stops paying royalties? Most licensing agreements have termination clauses allowing the inventor to revoke rights or take legal action if royalties are not paid.

If you need help negotiating royalties on patents, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.