30 Jan Merchandise Licensing Agreement: Royalties Discussion
Merchandise licensing, whether sports or entertainment licensing is big business. Not only is merchandise licensing lucrative, it is a significant marketing and brand extension tool.
In a merchandise license agreement (“MLA”), the owner (“licensor”) of a work (e.g., a movie, TV show, sports league or player, book, video game) licenses to one or more third parties (each a “licensee”) the right to utilize the work on products or services for a limited time and limited territory.
A major aspect of an MLA is the compensation provisions. Under an MLA, a licensor will receive compensation (referred to as a “royalty”) based either upon a percentage of the revenue from the sale of the licensed products or a per unit amount based on the number of products sold. Often, a licensee must make payments in advance of sales (known as “advances” against royalties) and must pay fixed or “guaranteed minimum royalty” payments (see below) regardless of sales.
Negotiating a good royalty deal is important in maximizing profits for a licensor. Before entering into an MLA, be sure to research all the ins and outs of the licensee’s business and take the time to negotiate royalty provisions that work for you.
Below are definitions of some financial terms which are often used in merchandise license agreements:
Royalties may be based on gross sales or net sales.
“Gross sales” (may also be referred to as “Gross Receipts” or “Gross Revenues”) refers to the total amount of revenue from the sale of licensed products.
“Net sales” (or “Net Receipts” or “Net Revenues”) are calculated by deducting certain agreed costs from gross sales and, if the parties agreed to a royalty based on net sales, the resulting net sales number is used to calculate the royalty amount due. It is generally acceptable to deduct from gross sales any amounts paid for taxes, credits, freight and shipping, returns and discounts made at the time of sale. A percentage of net sales (the licensed product royalty) is the most common form of licensing payment. Net sales royalty payments are computed by multiplying the royalty rate against net sales. For example, a royalty rate of 10% multiplied by sales of $10,000 equals a net sales royalty of $1,000.
Licensors often seek to place caps on deductions from gross sales, which typically range from 5 to 10% of licensee’s selling price. But are caps a good thing? If a licensor is attempting to protect some interest other than how royalties are calculated, then a licensor must understand the licensee’s business and where a cap is appropriate. One must determine if returns, credits and discounts are reasonable and verifiable for your licensee’s business, in which case it may be appropriate to share the risk with the licensee.
An advance against royalties is an up-front payment to the licensor, usually made at the time the merchandise license agreement is signed. An advance is almost always credited or “recouped” against future royalties, unless the agreement provides otherwise. It’s as if the licensee is saying, “I expect you will earn at least $X in royalties, so I am going to advance you that sum at the time I sign the agreement.” When sales commence, the licensee keeps the first royalties which would otherwise be due, to recoup the advance. Advances and guarantees are typically non-refundable. If sales don’t generate the amount of the guarantee, the licensee takes a loss.
Unlike a percentage royalty, a per unit royalty is a fixed amount which is tied to the number of units sold or manufactured, not to the total money earned by sales. For example, under a per unit royalty you might receive $.50 for each licensed product sold or manufactured.
A guaranteed minimum royalty payment (GMR) is when the licensee promises to pay a licensor specific royalty payments under the agreement, regardless of how well the merchandise sells. The licensee pays the GMR either at the end of the license term or in installments over the license term, regardless of how well the merchandise sells. At the end of the license term or at an installment due date, if the earned royalties are less than the amount of the GMR due, the licensor pays the difference. If the GMR exceeds the earned royalties, the licensee takes a loss.
Another issue to consider is when royalties accrue – when goods are sold or when payments are received? From the licensor’s perspective, the obligation to pay royalties should occur on shipment by licensee; on the other hand, the licensee will argue that payment of royalties should not occur until receipt of payment from the customer. Which one is best? If a licensor is already receiving a guarantee or an advance, is it fair to manufacturers who want to protect against returns to pay royalties before the item has sold through?
Every merchandise license agreement should contain an audit provision. If a licensor suspects that the licensee has failed to properly account for royalties, the licensor will want the right to perform an audit to detect and quantify any shortfall. The audit provision describes when a licensor (or its representative) can access licensee records. If the audit uncovers an error of a certain magnitude—usually a sum between 5% and 10%— in addition to paying the shortfall, the licensee will also have to pay the costs of the audit; otherwise the licensor pays the cost of the audit.
This update has been prepared by Rosenbaum Law Group for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Rosenbaum Law Group expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.