A Simple Method For Calculating A “Fair” Royalty Rate

Introduction uring a licensing deal (i.e. license of a patent protecting a product), several methods are commonly used to determine what is intended to be a “fair” royalty rate. It is even recommended to combine several methods in order to cross-check that there is no discrepancy between one method and another. These methods fall into three typical groups [1-4]: (i) comparison with previous similar deals done by others, (ii) alignment with industry or internal practice, and (iii) calculation. In light of a common experience, it appears that comparison with previous similar deals is always questionable because, even if data are extracted from a reliable database, negotiators have the feeling that no deal is really similar to the deal they are currently discussing. Alignment with industry or internal practice is generally frustrating when one of the parties does not belong to the industry (i.e. an academic institution), or when one of the parties has limited bargaining power. Therefore, sentences such as “we have always done it like that,” or “there is no way that the rate should be out of this usual range,” are very unlikely to create a “win-win” feeling. Calculation is often felt to be more rational. However, calculation may rapidly become complex, especially if one takes into account probabilities and wishes to introduce options, and relies heavily on the assumptions that are introduced [4]. In addition, calculation-based methods usually do not take into account the amount of money to be invested by the licensee to license and its subsequent associated risk. At Institut Curie, which is an academic research institution, we have introduced a relatively simple calculation-based method which allows sharing the “benefit” made by the licensee and which very important takes into account both the amount of money to be invested by the licensee further to license, and its subsequent associated risk. This method is so far satisfactorily used, in the sense that its outcome is felt by parties to be both rational and fair. This method is applicable to any kind of business, although Institut Curie is primarily involved in life sciences (it is a Paris-based Comprehensive Cancer Center created one century ago by Marie Curie when she received her second Nobel Prize). Parameters to be Taken Into Consideration At this stage, let’s consider a pure royalty-based calculation (there is no upfront payment, no milestone payments, and royalties are a percentage of the sales of the product protected by the patent). Let’s also consider that the license is an exclusive license, and let’s exclude sublicense issues. The typical case is that of the license of a patent (considered as granted), that protects a product which is still in the development stage ( i .e. several years are still needed prior to marketing, and significant investment is still needed to be made, at a certain level of risk). In fact, royalty is nothing else than a share of the “benefit” made by the licensee, which is paid to the licensor. Therefore, three questions arise at this stage: (i) how to define the “benefit”? (ii) how to take into account the investments to be made prior to marketing stage, the required time to develop the product, and the associated risk? and (iii) how to share the “benefit”? There is no universal definition of “benefit.” Depending on the country (many deals are concluded between parties coming from different countries where accounting principles and/or habits are different), depending on the perspective (i.e. operating, accounting, financing, ...), “benefit” covers different notions. For example, “accounting benefit” which is the easiest to access since it is included in the profit and loss statement of every company, neither reflects the level of investment of a company for developing a product, nor the financial risk taken by the licensee. Its format in many countries is set-up for tax reasons, and is therefore not easy to handle for the purpose of royalty rate determination. Let’s, therefore, introduce a “for the purpose of royalty rate calculation benefit” called “B.” B is calculated after establishment of a “simplified provisional profit and loss statement” (SPPLS) related to the product protected by the patent (see Table 1 D