What are royalties? Types and how royalty payments work

Published Tuesday 21 April 2026

Table of contents

• What are business royalties?
• Types of royalty payments
• How to apply the royalty payment cycle
• Factors affecting royalty rates
• Understanding royalty agreements
• FAQs on royalties

Key takeaways

• Recognize that royalties are ongoing payments based on usage or sales, not one-time fees, meaning your income or costs will scale directly with how much an asset is used or how well a product sells.
• Negotiate your royalty agreement carefully by including performance-based termination clauses, clear exclusivity terms, and defined geographic rights, as these factors can significantly affect the rate you pay or receive.
• Track and report royalty-related revenue accurately on the schedule set by your contract, and stay on top of tax obligations such as non-resident withholding tax, to avoid breaching your agreement or missing official deadlines.
• Get legal advice before signing any royalty agreement, as a lawyer can help both licensors and licensees confirm their rights, payment terms, and protections are clearly outlined and legally sound.

What are business royalties?

Royalties are ongoing payments made to asset owners in exchange for the right to use their property. The owner keeps ownership while earning income each time someone uses their asset. This is a highly lucrative model. Intangible assets now account for about 90 per cent of the value of S&P 500 companies.

Here's how royalty payments work:

• Licensor: The asset owner who receives royalty payments
• Licensee: The business that pays for permission to use the asset
• Payment structure: Usually a percentage of revenue or a fixed fee per unit sold

Royalties are common across many industries. Common royalty industries include:

• Technology: Patents, software, and digital products
• Entertainment: Music, films, and creative content
• Publishing: Books, articles, and written works
• Franchising: Brand names and business systems

Types of royalty payments

Royalties come in different forms depending on the asset and business model. The three most common types are franchise royalties, intellectual property royalties, and licensing royalties for creative works.

Franchise royalties

Franchise royalties are ongoing payments franchisees make to use an established business model. They typically range from 4–8% of gross revenue, though some franchisors charge flat monthly fees.

Franchise royalties cover several key areas. Here's what they typically include:

• Brand usage: Rights to the company name and logo
• Operational systems: Proven business processes and training
• Ongoing support: Marketing, technology, and business guidance

Learn what a franchise is and how it works.

Intellectual property royalties

Intellectual property royalties are payments licensees make for the right to use or sell protected assets like patents, trademarks, and copyrighted works.

Tax authorities may allow minimum expense deductions from this income, such as 35% for patents and 25% for trademarks. See the IRD's archived legislative commentary on royalty expense deductions for more detail.

IP royalties are prevalent in several sectors. Common industries for IP royalties include:

• Technology and manufacturing: Patent licensing
• Publishing, music, and film: Copyright royalties

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 payments when businesses use their work in a different context.

Licensing royalties apply in many creative contexts. Common examples include:

• A song licensed for a TV advertisement
• Illustrations licensed for a children's book
• Artwork licensed for product packaging

How to apply the royalty payment cycle

The royalty payment cycle is a six-step process that ensures fair compensation and protects both parties. The steps are: establish an agreement, define payment terms, track usage or sales, calculate payments, make payments, and conduct audits.

1. Establish a royalty agreement

A royalty arrangement starts with the licensor and licensee negotiating a formal licensing agreement. A strong contract outlines the asset being licensed, how it can be used, and the payment structure.

Consider these key negotiation strategies when establishing your agreement:

• Include performance-based termination clauses: Set minimum revenue thresholds to protect yourself from underperforming arrangements
• Specify geographic and usage rights: Define the countries, regions, and domains (such as online or offline) where the rights apply
• Clarify exclusivity terms: Determine whether others can license the same asset, as exclusive rights typically command higher rates
• Define the contract duration: Choose longer deals for stability or shorter ones for earlier renegotiation opportunities

2. Define the payment terms

Payment terms specify how royalties are calculated and when they're paid. Royalty structures usually fall into one of three categories:

• Percentage of revenue: A fast-food franchisee pays the franchisor 5% of net sales
• Fixed fee per unit: An author receives $5 for every ebook sold
• Usage-based: A band earns royalties each time their song is streamed

If you're the licensor, look beyond the payment amount. Consider these additional factors:

• Payment frequency: Monthly, quarterly, or annual payments
• Payment timing: How many days after each period before you receive funds

Both factors directly affect your cash flow. Learn how accounts receivable financing can help manage cash flow.

3. Track your usage or sales

The licensee is responsible for tracking and reporting royalty-related revenue. They record how much the asset generates and report to the licensor on a schedule set by the contract, such as monthly or quarterly. They must also ensure they meet official tax deadlines. In New Zealand, NRWT on royalty payments is due annually by 31 May.

Accurate reporting builds trust and strengthens the working relationship between both parties.

4. Calculate your payments

The licensee calculates what's owed based on the payment structure and agreed terms.

Several factors can affect the final amount. Here are the key considerations:

• Minimum guarantees: Ensure the licensor receives a set amount regardless of performance
• Advances: Represent upfront payments recouped from future royalties
• Deductions: Account for returns, refunds, and other adjustments
• Escalators: Increase royalty rates after reaching certain sales or revenue thresholds

5. Make payments

The licensee makes the payment according to the agreed schedule. To document the transaction, the licensee may issue a royalty statement or request that the licensor raise an invoice for the payment amount. If making payments to foreign investors in New Zealand, ensure you withhold any necessary non-resident withholding tax.

Use one of Xero's free invoice templates.

6. Auditing and compliance

Most royalty agreements give the licensor the right to audit the licensee's records on request or at regular intervals. This extra layer of protection ensures licensors receive the payments they agreed to.

Factors affecting royalty rates

Royalty rates vary based on industry norms, asset value, and negotiating leverage.

Several factors influence how royalty rates are determined. Key factors affecting royalty rates include:

• Industry standards: Range from 8–15% for music royalties to 3–5% for software patents
• Asset value: Increases for high-demand intellectual property, as seen with companies like Facebook holding more than US$19.7 billion in intangible assets
• Negotiating power: Strengthens with established brands and proven sales records
• Exclusivity agreements: Add 25–50% to rates compared with non-exclusive deals
• Market demand: Rises for popular or trending assets due to competition

Read research on profitability and royalty rates across industries.

Understanding royalty agreements

Royalty agreements are legally binding contracts that define how royalties are calculated, paid, and enforced. Clear, transparent terms protect both parties and establish what happens if either side doesn't meet their obligations.

Invest time upfront to get the agreement right.

Get legal advice

Both parties should ask a lawyer to review the contract before signing.

• Licensees typically draft the agreement and need to ensure it's legally compliant and accurately reflects the specific terms.
• Licensors need to understand each clause fully and confirm their rights, payments, and protections are clearly outlined.

View New Zealand's royalty regulations.

FAQs on royalties

Here are answers to common questions about royalties.

What's the difference between royalties and licensing fees?

Royalties are ongoing payments based on usage or sales, while licensing fees are often one-time or periodic flat payments. Royalties typically scale with performance, whereas licensing fees remain fixed regardless of how much the asset generates.

How are royalty payments taxed?

Royalty income is generally taxed as ordinary income. In New Zealand, if you're paying royalties to non-residents, you may need to withhold non-resident withholding tax (NRWT). Consult a tax professional to understand your specific obligations.

Can royalty agreements be renegotiated?

Yes, royalty agreements can be renegotiated if both parties agree. Common triggers for renegotiation include changed market conditions, performance milestones, or contract renewal periods built into the original agreement.

What happens if someone doesn't pay royalties on time?

Late or missing royalty payments are contract breaches. Most agreements include provisions for late fees, interest charges, or termination rights. Licensors can also pursue legal action to recover unpaid amounts.

How long do royalty agreements typically last?

Royalty agreement durations vary widely. Some last for the life of the intellectual property rights, while others run for specific periods like three to five years with renewal options. The duration depends on the asset type and negotiated terms.