A royalty is compensation paid in exchange for the use of intellectual property or natural resources. The royalty is typically computed as a percentage of the sales or profit proceeds generated from the use of these assets. The terms of the arrangement are contained within a license agreement, which is entered into by the asset owner and the party wanting to use the asset. The license agreement sets the royalty rate and limits the extent to which the asset can be used. Several examples of royalty situations are:

  • A cell phone manufacturer pays a royalty to the holder of a patent relating to the technology within the phone.

  • A franchisee pays a royalty to a franchisor in exchange for the use of the franchisor’s business model, processes, and trademarks.

  • A publisher pays a royalty to an author in exchange for the right to print and distribute the author's books.

  • An oil & gas firm pays a royalty to a landowner in exchange for the right to drill on his land.