license agreement primer: compensation

This post is all about the getting paid part. We know this is the exciting stuff, so without further ado….


Royalties, Flat Fees and "Buy Outs"

Most license agreements compensate the artist by obligating the manufacturer to give a percentage of the money collected from its customers to the artist. This is the royalty. Before we get much further, a word about royalty-based licenses versus flat-fee licenses. There’s nothing inherently wrong with a flat-fee license, though it’s sometimes confused with a “buy-out” where the copyright is sold and transferred, lock, stock and barrel. That you probably don’t want. But if the deal involves a narrowly defined grant of usage rights in exchange for a set sum of money (i.e. a flat fee rather than a royalty), it’s still a license deal and that’s a wonderful thing. For the purposes of this post, we’re going to talk specifically about royalty-based license agreements. Later on, probably when we get into negotiations, we’ll talk a bit more about flat-fee licenses.

While royalties may be calculated against the full amount paid by the ultimate consumer, in most product licenses royalties are measured, as a starting point, against the wholesale price charged by the manufacturer to the retailer. The parties ordinarily negotiate as to which, if any, further deductions may be allowed. For example, a licensee may wish to deduct product returns, volume discounts given, certain advertising expenses, or other “costs.” Royalties are typically paid on the “Net Selling Price” and the NSP is usually wholesale minus any agreed upon deductions. It’s better if you, as the licensor, can limit the scope of deductions. One way of doing this is to request a percentage cap, to ensure that the net selling price does not vary dramatically from the stated wholesale price. The agreement should also state when a sale is “made.” Licensors prefer to have a sale counted as soon as the product is shipped rather than when the customer ultimately pays.

All About Advances

In addition to royalties, you may wish to seek a certain amount of money to be paid right away. This amount can be either in addition to royalties or measured against royalties.  When paid against future royalties it’s called “a recoupable advance against royalties” (sometimes also called a “minimum guarantee”). You’ll receive no further payment until the amount of the advance is earned (“recouped”) from sales. Recoupable advances can be either returnable or nonreturnable. A returnable advance means that if sales of the licensed product aren’t big enough for you to earn out the advance, or if the product is cancelled before even going to market, you could be on the hook for returning all or some portion of the advance. Considering that you may have put a lot of work into preparing the art, or perhaps even turned down other licensing opportunities for the same artwork, you’ll probably want to try to make the advance, when given, nonreturnable. Some licensees will give advances, others won’t. If you haven’t been offered an advance, it may be totally reasonable to ask for one, especially for the reasons listed above. Advances are a common bargaining point in a license negotiation. (And we’ll get into negotiation in the near future!)

Royalty Statements

Royalties are usually calculated quarterly, though we’ve seen bi-annual (every six months) and even annual cycles, too. The payments are generally due thirty days after the end of the accounting period. You’ll want your license agreement to require the licensee to issue royalty statements along with the royalty payments. The agreement should specify the required detail in the royalty statement, sufficient to track the type and number of licensed products sold, the unadjusted cost of the licensed products, and any deductions applied, otherwise you won’t really know what’s happening with specific products.

Your Right to Audit

In the event that you, the licensor, ever have good reason to believe there’s a problem with the royalty accounting, a license agreement will ordinarily grant you the right to audit the licensee’s royalty books on pretty short notice (e.g. three business days). If you’re ready to mount an audit, things have gotten pretty bad. It's unlikely you'll have to resort to this, but it's a really good protection to have in place. Many contracts will specify that the artist pays the cost of such an audit unless a discrepancy of a certain percentage (5% is common) is discovered, in which case the cost shifts to the licensee.

In other news, we're taking a week off! Our son, Henry, is visiting next week so we'll be doing a little San Francisco staycation to have some much-needed family time. SO excited about that!

In our next post (on Tuesday June 23rd), we’ll be looking at how you can ensure the licensed products are up to your standards. Until then, happy licensing!

Please remember: The information provided on this blog and throughout our website is intended for general educational purposes only. While some information on this site relates to the law as a topic, it's not intended as a substitute for legal advice. Only a lawyer, selected by you and fully informed of the facts relating to your particular situation, can render legal advice.