What is royalty income?
Royalty income is income received from allowing someone to use your property. Royalty payments for the use of patents, copyrighted works, natural resources, or franchises are most common. Many times, the person using the property does so to generate revenue. Royalties are usually legally binding.
While royalty contracts can be established in various ways to meet the needs of the parties, the payments are often paid as a percentage of the revenues earned from using the property. Inventors often sell their inventions to third parties in exchange for future royalties the invention may generate. Celebrities sometimes charge royalties to companies to use their name in fashion designs. Oil and gas companies pay landowners royalties to extract natural resources from the landowners’ properties.
The license agreement specifies the length of the contract, clarifies what product is being provided in exchange for the royalty, and outlines any limitations regarding geographic territory.
The royalty rate specifies how much the borrower is being charged. Multiple factors impact the royalty rate, including the exclusivity of rights, the availability of alternatives, and the market demand.
Royalty-income trusts hold investments in operating companies. These trusts buy the rights to royalties for the production and sale of natural resources. The income is passed on to investors. Compared with stocks and bonds, royalty trusts offer higher yields.
Royalty income example
Software giant Microsoft earns royalties from computer manufacturers, such as Hewlett-Packard and Dell, as well as smartphone manufacturers like Samsung. These manufacturers use Microsoft’s software products, including the Windows operating system. In 2013 alone, Samsung paid Microsoft over $1 billion in royalty payments.
A Texas oil company wants to sell some of its oil wells. It sells the wells to a royalty-income trust company. The royalty-income trust company pays the oil company a fee to continue to operate the wells but earns the profits from the oil.