What are royalties? How they work for your business

Published Monday 20 April 2026

Table of contents

• What are royalties?
• Types of royalty payments
• Real-world royalty examples
• How royalties are calculated
• How royalty payments work
• Factors affecting royalty rates
• Understanding royalty agreements
• How to apply the royalty payment cycle
• FAQs on royalties

Key takeaways

• Recognize that royalties can work in two directions for your business: you can earn them by letting others use your intellectual property, or pay them to access someone else's protected assets, such as a franchise model or patented technology.
• Set fair royalty rates by researching industry standards for your asset type, since rates vary widely across sectors (for example, music typically falls between 8–15% and books between 5–15%), and factor in exclusivity, market demand, and your negotiating position.
• Put a clear, legally reviewed royalty agreement in place before any licensing arrangement begins, making sure it defines the asset, payment structure, geographic scope, and what happens if either party does not meet their obligations.
• Track all usage, sales, and payments accurately throughout the royalty cycle, and keep detailed records of every statement and transaction to stay compliant with your contract terms and support any tax reporting or audit requirements.

What are royalties?

Royalties are ongoing payments made to the owner of an asset in exchange for the right to use it. The OECD Model Double Taxation Agreement defines them as consideration for the use of copyrights, patents, or trademarks.

The asset owner (licensor) grants permission to another party (licensee) to use their intellectual property, creative work, or business model. In return, the licensor receives a share of the revenue or a fixed fee.

For small businesses, royalties can work two ways:

• Earning royalties: You receive payments when others use your patents, trademarks, creative works, or franchise model.
• Paying royalties: You make payments to use someone else's protected assets in your business.

Royalties create predictable income streams for asset owners while giving licensees access to valuable resources without the cost of developing them from scratch.

Types of royalty payments

Royalties come in different forms, depending on the nature of the asset and the business model. Here are three common types.

Franchise royalties

Franchise royalties are ongoing payments franchisees make to use a proven business model, including branding, operational systems, and intellectual property.

Franchising is a common way to grow a business. For example, 93% of McDonald's restaurants operate as franchises.

Payment structure: Most franchise royalties are calculated as a percentage of gross or net revenue. Some agreements use flat monthly fees instead.

Learn more about franchises

Intellectual property royalties

Intellectual property royalties are payments for using protected assets like patents, trademarks, and copyrighted works.

Common applications:

• Technology: Software patents, manufacturing processes.
• Publishing: Book rights, article licensing.
• Entertainment: Music rights, film distribution.
• Manufacturing: Patented components, production methods.

Real-world examples: A tech company pays royalties to license patented software. An author earns royalties when a publisher uses their work.

UK tax note: For UK tax purposes, the term 'copyright' is broad. It includes copyright in any literary work such as computer programs, dramatic works, musical works, and registered designs. Recent changes to the UK's original patent box regime mean that claimants must now track this income in greater detail.

Licensing royalties for creative works

These royalties apply to music, films, artwork, writing, and other creative mediums. Instead of selling the work directly, businesses pay licensing fees to use these works in a different context. This often includes advertising, entertainment, or product design.

For example, a song might be licensed for a TV ad, or a publisher might license illustrations for a children's book.

Real-world royalty examples

Royalties work differently depending on the industry and asset type. Here are three common scenarios small businesses encounter.

Franchise example: A coffee shop owner pays 6% of monthly revenue to the franchisor for using their brand, recipes, and operational systems. If the shop generates £20,000 in sales, the royalty payment is £1,200.

Creative works example: A musician licenses their song for a TV advertisement. The production company pays £500 upfront plus 2% of the ad campaign's media spend as ongoing royalties.

Technology example: A manufacturing business pays quarterly royalties to use patented machinery components. The agreement specifies £2 per unit produced, generating predictable costs the business can factor into pricing. Under the Patent Box regime, companies can apply a 10% corporation tax to profits attributable to qualifying patents.

How royalties are calculated

Royalties are calculated based on the terms in your licensing contract. There are typically three methods: percentage of revenue, fixed fee per unit, or tiered rates.

• Percentage of revenue: The licensee pays a percentage of revenue generated from the asset. For example, if a book generates £10,000 in sales and the author's royalty rate is 10%, they receive £1,000.
• Fixed fee per unit: The licensee pays a set amount for each unit sold. A musician might earn £0.50 for every physical album sold.
• Tiered rates: The royalty rate changes after hitting certain milestones. A software developer might earn 5% on the first 10,000 units sold, then 7% on all sales after that.

Your royalty agreement should clearly define how payments are calculated, including any deductions for returns or marketing costs.

How royalty payments work

Royalty payments follow a reporting cycle where the licensee tracks usage, calculates amounts owed, and pays the licensor on an agreed schedule.

The process typically works like this:

1. Track: The licensee records sales or usage during a set period (monthly or quarterly).
2. Report: The licensee prepares a royalty statement showing total usage and the calculated payment.
3. Pay: The licensee sends the statement and payment by the agreed date.

Accurate records are essential for both parties to maintain transparency and a strong working relationship. The end of grandfathering rules means claimants must now track income and expenditure in more detail to claim patent box benefits.

Factors affecting royalty rates

Royalty rates vary based on industry norms, asset value, and negotiating leverage. Understanding these factors helps you set fair rates or evaluate offers.

• Industry standards: Each sector has recognised rate ranges (music typically 8–15%, books 5–15%).
• Asset value: High-value intellectual property commands premium rates.
• Negotiating power: Established creators and strong distributors secure better terms.
• Exclusivity: Exclusive licensing rights cost 20–50% more than non-exclusive deals.
• Market demand: Popular or trending assets command significantly higher rates.

Learn more about real-world royalty rates

Understanding royalty agreements

A royalty agreement is a legally binding contract that governs the licensing relationship between licensor and licensee. Clear, enforceable terms protect both parties and prevent disputes.

Essential requirements for effective agreements:

• Define obligations clearly: Ensure both parties understand their responsibilities.
• Specify consequences: Outline what happens if terms aren't met.
• Document thoroughly: Invest time upfront to create comprehensive agreements.

Get legal advice

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

• For licensees (typically drafting the agreement): Ensure the contract is legally compliant and accurately reflects the specific arrangement.
• For licensors (reviewing the agreement): Verify that your rights, payments, and protections are clearly outlined.

Learn the specific rules in the UK.

How to apply the royalty payment cycle

Setting up a royalty arrangement involves six key steps, from establishing the agreement to ongoing compliance. Follow this process to manage royalties effectively whether you're paying or receiving them.

1. Establish a royalty agreement

Establishing a royalty agreement creates the legal framework for your licensing relationship. A comprehensive contract protects both parties and ensures clear payment terms.

Core contract elements:

• Define the asset: Specify exactly what's being licensed.
• Set usage parameters: Outline how the asset can be used.
• Detail payment structure: Include royalty rates and payment schedules.

Negotiation strategies:

• Include performance clauses: Tie contract terms to revenue thresholds.
• Define geographic scope: Specify countries and regions where rights apply.
• Set exclusivity terms: Clarify whether others can license the same asset.
• Establish duration: Balance stability with flexibility for future negotiations.

Learn more about negotiation strategies.

2. Define the payment terms

Set out exactly how royalty payments will work. Royalty structures usually fall into one of three categories:

• Percentage of revenue: A fast-food licensee might pay the franchisor 5% of net sales.
• Fixed fee per unit: A manufacturer pays £1 for each product sold using licensed technology.
• Tiered rates: Rates increase as sales volumes grow, rewarding successful products.

Include payment frequency (monthly, quarterly, or annually) and due dates in your agreement.

3. Track usage and sales

Accurate tracking ensures correct royalty calculations. The licensee should maintain detailed records of all relevant activities.

Set up systems to record:

• Units sold or produced
• Revenue generated
• Returns and refunds
• Geographic location of sales

Most businesses use accounting software to automate tracking and generate reports.

4. Calculate payments

Calculate royalty payments based on your agreement terms. Apply the specified rate to the tracked usage or sales data.

For example, if your agreement specifies 8% of net revenue and you generated £50,000 in net sales, the royalty payment is £4,000.

Review calculations carefully before submitting payment to avoid disputes.

5. Report and pay

Submit royalty statements and payments according to your agreed schedule. Include detailed breakdowns showing how you calculated the amount.

Your royalty statement should include:

• Reporting period
• Total units sold or revenue generated
• Applicable royalty rate
• Deductions (if any)
• Total payment due

Send statements and payments by the agreed deadline to maintain a strong relationship with the licensor.

6. Maintain compliance

Review your royalty agreement regularly to ensure ongoing compliance. Keep detailed records for audit purposes and tax reporting.

Best practices for compliance:

• Store all royalty statements and payment records
• Track contract milestones and renewal dates
• Update your tracking systems when agreement terms change
• Communicate proactively with the other party about any issues

Strong compliance practices protect both parties and support a long-term partnership.

FAQs on royalties

Here are answers to common questions about royalty payments and agreements.

What's the difference between royalties and licensing fees?

Royalties are ongoing payments based on usage or sales. Licensing fees are typically one-time upfront payments for the right to use an asset. Many agreements combine both, requiring an initial licensing fee plus ongoing royalties.

How do I determine a fair royalty rate?

Research industry standards for your asset type. Consider the asset's value, market demand, and your negotiating position. Consult with professionals who understand your industry's typical royalty ranges.

Are royalty payments tax deductible?

For licensees, royalty payments are typically tax-deductible business expenses. For licensors, royalty income is taxable. Consult a tax professional to understand how royalties affect your specific tax situation.

Can I negotiate royalty rates?

Yes, royalty rates are negotiable. Both parties should seek terms that reflect the asset's value and market conditions. Consider factors like exclusivity, geographic scope, and contract duration when negotiating.

How long do royalty agreements typically last?

Royalty agreement durations vary widely. Some last for the life of the intellectual property, while others have fixed terms of 1–10 years. Include renewal options and termination clauses in your agreement.

What happens if someone doesn't pay royalties?

Your royalty agreement should specify remedies for non-payment. These may include late fees, contract termination, or legal action. Keep detailed records to support any claims for unpaid royalties.