What are royalties? Definition, types, and examples

Published Tuesday 6 October 2026

Table of contents

• What is a royalty?
• Types of royalty payments
• Examples of royalty payments
• Factors affecting royalty rates
• How royalties work in practice
• Track royalty income and payments with Xero
• FAQs on royalties

Key takeaways

• Royalties are recurring payments to an owner for using their asset, such as a patent, song, brand, or natural resource
• Most royalties are a percentage of revenue or a fixed fee per unit, so the cost grows as sales or usage grow
• Agree on scope, exclusivity, duration, and termination terms upfront, then track sales closely so you pay the right amount on time
• Royalties you receive are taxable income and royalties you pay are generally deductible, with Form 1099-MISC due for payments of $10 or more

What is a royalty?

A royalty is a recurring payment a licensee makes to an owner for using their asset, such as a patent, song, brand, or natural resource. It’s usually calculated as a percentage of revenue or a fixed amount per unit sold.

Think of it like rent. A tenant pays a landlord to keep using a building, and a licensee pays the owner to keep using a brand name or patented invention. If the payments stop, so does the right to use the asset.

Royalties are usually calculated in one of two ways:

• a percentage of revenue, where the owner receives a share of sales made using the asset
• a fixed fee per unit, where the owner receives a set amount for each item sold

Every royalty arrangement has two parties:

• the licensor, who owns the asset and collects the payments, often as passive income
• the licensee, who pays for permission to use the asset to earn a profit

Royalties are most common where an asset drives sales, including franchising, music and film, publishing, technology, and oil and gas.

Types of royalty payments

Royalties take different forms depending on the asset and the business model. Here are three common types.

Franchise royalties

Franchise royalties are payments franchisees make to franchisors for the right to use their brand, recipes, business model, and operating systems.

Most franchisees pay a percentage of gross sales, though some agreements use a flat fee. Because the royalty comes off sales, you owe it even in months when your net profit is low.

Franchising is especially common in fast food. According to McDonald’s 2025 annual report, approximately 95% of its 45,356 restaurants were franchised at year-end. Wendy’s standard franchise agreement sets a royalty of 4% of gross sales.

Intellectual property royalties

Intellectual property royalties are payments for the right to use or sell protected assets like patents, trademarks, and copyrighted works. They’re common in tech, manufacturing, publishing, music, and film.

Common examples include:

• a tech company licensing patented software from an inventor
• an author licensing their work to a publisher for a share of each sale

Licensing royalties for creative works

Licensing royalties for creative works apply to music, films, artwork, writing, and other creative media. Instead of selling the work outright, creators earn fees when businesses use it in advertising, entertainment, or product design.

For example, a brand might license a song for a TV ad, or a publisher might license illustrations for a children’s book.

Examples of royalty payments

Each example below shows who pays whom and how the royalty is calculated. The figures are round numbers for illustration only.

Retail and franchise examples

In retail and franchising, royalties usually track your sales, so they rise and fall with revenue. Some franchisors charge a flat monthly amount instead.

• A restaurant franchisee pays the franchisor 6% of monthly gross sales for the brand and recipes. For example, 6% of $40,000 in sales is $2,400.
• A cleaning franchisee pays the franchisor a flat $500 a month, whatever its sales. That adds up to $6,000 a year.
• A gift store pays a character’s owner $1.50 for each licensed T-shirt it sells. Selling 400 shirts means a $600 royalty.
• A kitchenware store pays an inventor 5% of sales of a patented gadget. For example, $20,000 in gadget sales means a $1,000 royalty.

Creative and media examples

Creative and media royalties often use per-use or annual fees. They suit businesses that use music, images, or writing as part of their service.

• A fitness studio pays a music licensing organization an annual fee for background music in classes. A $1,200 fee works out to $100 a month.
• A marketing agency pays a photographer $50 per image used in client campaigns. Using 20 images means a $1,000 royalty.
• A website pays a national publication $5 per 1,000 views of republished articles. For example, 200,000 views means a $1,000 royalty.
• A greeting card company pays an illustrator $0.25 for each card sold with their artwork. Selling 8,000 cards means a $2,000 royalty.

Technology and manufacturing examples

Technology and manufacturing royalties usually apply per device made or as a share of product sales. The licensee builds the royalty into its cost of each product.

• An electronics maker pays a software developer $3 per device for embedded software. Shipping 5,000 devices means a $15,000 royalty.
• A device maker pays a patent holder 3% of product sales to use a patented component. For example, $200,000 in sales means a $6,000 royalty.
• A regional store pays a national brand 2% of revenue to trade under its trademarked name. On $250,000 in revenue, that’s a $5,000 royalty.
• A food producer pays a patent holder $0.10 per jar to use a patented sealing process. Sealing 30,000 jars means a $3,000 royalty.

Factors affecting royalty rates

Royalty rates vary widely by industry and asset. The rate you pay or charge depends on:

• industry norms, which differ between sectors such as music, publishing, and franchising
• the asset’s value, since high-value patents and popular brands command higher rates
• negotiating power, as established brands and proven licensees secure better terms
• exclusivity, since exclusive rights usually cost more than non-exclusive deals
• market demand, since in-demand assets attract higher rates

How royalties work in practice

Royalties turn an asset into recurring revenue for the owner and a predictable cost for the licensee. Here’s how the process works, step by step.

1. Establish a royalty agreement

A written agreement sets the rules before any money changes hands, and strong negotiation tactics help you get fair terms. Before you sign, check that the agreement:

• includes performance-based termination clauses with specific revenue thresholds
• defines where and on which platforms the rights apply
• sets exclusivity terms, weighing the higher rate for exclusive rights against the licensor’s reduced flexibility
• states the duration, with longer terms for stability or shorter terms to renegotiate rates sooner
• confirms who owns the intellectual property rights, including any improvements

2. Define the payment terms

Payment terms set how much the licensor receives and when. These examples show the most common structures:

• In a percentage-of-revenue deal, a clothing brand pays a designer 8% of quarterly sales. On $25,000 in sales, that’s a $2,000 royalty.
• In a fixed-fee-per-unit deal, a publisher pays an author $2 for every book sold. Selling 1,500 books means a $3,000 royalty.
• In a usage-based deal, a streaming service might pay a musician around $0.004 per stream, though rates vary by platform. At 100,000 streams, that’s about $400.

Payment timing affects cash flow, and late payments can be costly. Wendy’s franchise agreement, for example, adds a $100 late fee to any overdue payment, plus interest at a rate Wendy’s sets, up to the maximum the law allows. Most agreements use one of these schedules:

• monthly, which keeps the licensor’s income steady but adds admin for both sides
• quarterly, which balances cash flow with less paperwork
• annually, which suits stable, high-value agreements

3. Track your usage or sales

Accurate royalty reporting keeps payments correct and builds trust between both parties. As a licensee, you’re responsible for:

• tracking every sale or use of the licensed asset
• providing statements with sales figures, deductions, royalty calculations, and payment dates
• meeting reporting deadlines, whether monthly, quarterly, or as your contract specifies
• keeping receipts and sales records for audits
• filing Form 1099-MISC if you pay $10 or more in royalties during the year

Adding Form 1099-MISC to your list of business tax forms helps you file on time. Good reporting also benefits your business by:

• building trust with licensors through transparency
• reducing disputes over payment calculations
• keeping relationships positive for future negotiations
• supporting accurate tax reporting and deductions

Track royalty income and payments with Xero

Whether you earn royalties or pay them, clear records make statements and tax filings easier. With Xero, bank feeds bring your transactions in automatically and reports show exactly where your business stands.

That means you can check each payment against your agreement and spend less time on admin. Try Xero today and get one month free.

FAQs on royalties

Here are answers to common questions about managing royalties for your small business.

What’s the difference between royalties and license fees?

Royalties are ongoing payments tied to usage or sales, while license fees are usually one-time payments for the right to use an asset. With royalties, licensees pay based on actual performance.

How do I report royalty income on my taxes?

Royalties from an active trade or business, such as self-employed writing, go on Schedule C. Passive royalties are generally reported on Schedule E.

Can I deduct royalty payments as a business expense?

Yes, royalties you pay to use someone else’s intellectual property are generally deductible business expenses. Keep your agreements and payment records to support the deduction.

How long do royalty agreements typically last?

Some last for the life of a patent or copyright, while others run for set terms, such as three to five years with renewal options. McDonald’s, for example, says its franchise agreements generally run for 20 years, so check the term before buying a franchise.

What happens if I stop paying royalties?

Missing royalty payments usually breaches your contract, which can lead to penalty fees, interest charges, loss of license rights, or legal action. Most agreements include termination clauses that set out the remedies for non-payment.