There are two main ways inventors are paid for licensing their inventions--either a one-time lump sum payment or continuing payments called royalties. Which is better? It depends.
The most common way method of compensating inventors for licensing their inventions is payment of royalties--these are continuing payments made to the inventor. Royalties can be calculated in many different ways.Royalties based on net sales
A royalty payment based on net sales is the most common method of licensing payment. In business terminology, it is a direct cost that can be charged against the cost of goods. In other words, it is a predictable expense that is figured as part of the cost of selling the product. If the invention is not successful, there will be no royalties. Licensors prefer this system because if the invention is successful, the licensor will be richly rewarded over the life of the invention.
Per Unit Royalties
In some instances, an inventor may not want to use a royalty system based upon net sales. For example, computer hardware prices often drop radically. More units may be sold but the net sales revenue decreases because the price has dropped. If the wholesale price for your product drops, you may be better served with royalties tied to unit sales. A payment of two dollars per unit may be more profitable than 5% of net sales. Unfortunately, licensees generally don’t want to risk committing to unit royalties when the wholesale price can drop dramatically. If you have the bargaining power, look into a per unit royalty system.
Per Use Royalties
It’s possible that you may have invented something that is used, rather than sold. For example, if you patented a method of coating glass for neon light, your process may be used in the manufacturing operation. That is, you are licensing a procedure that is used as part of a production process. Since the process may be used in a variety of ways, a royalty system based on net sales is difficult to justify and hard to audit.
Under these circumstances, inventors choose a use royalty. This is a royalty applied to the number of units produced, or the number of times the method is used in manufacture.
Fluctuating Royalty Rates
A fluctuating royalty rate (sometimes referred to as a sliding royalty) is a rate that changes during the licensing period. The rate may change each year or it may change because of other circumstances, such as sales or inflation. For example, the royalty rate may go up if sales exceed a million units in one year. Similarly, a licensee may seek a decreasing royalty in the event that sales fall below a certain mark.
Lump Sum Payments
Instead of a royalty, an inventor can receive a lump sum payment from the licensee--for example, a manufacturer could agree to pay you $1 million for the right to license your invention. However, lump sum payments are a gamble. If your invention is wildly successful, you may always regret the lump sum choice. If the invention is not successful, you won’t see any royalties. You can attempt, if possible, to estimate potential sales over the period of the license. However, that is a speculative approach and the fact is, there is no proven method for successfully picking the form of payment.There are two reasons that some licensors prefer a lump sum payment. First, the licensor doesn’t have to be concerned with accounting or auditing records. Second, some licensors prefer lump sum payments for foreign licenses because of currency conversion rates. These rates -- which measure the foreign currency against U.S. currency -- may change dramatically, making your foreign royalty payments less valuable. If you are in doubt whether or not to choose a lump sum, you may wish to consult a patent attorney to evaluate your invention’s commercial potential.
Note: A lump sum payment for a license is different from a lump sum payment for an assignment. A license may be limited in time, for example, for two or three years. Under an assignment, however, you lose ownership of your invention.