Recurring royalty revenue is a key component behind the success of a wide variety of businesses. They provide a consistent revenue stream to the asset owner for the use of a licensed asset, whether that be intellectual property rights, brand rights, or the right to use other assets.

Copyright royalties frequently come to mind when thinking of recurring royalty revenue. Recording artists and songwriters may receive periodic payments for the streaming, distribution, or reproduction of their songs.

However, royalties provide an important source of income for many diverse businesses. Many toy manufacturers pay Disney royalties to license their famous characters. Intellectual property royalties can be a lucrative source of predictable income for entities that license drug formulates to large pharmaceutical companies. NewsCorp, the parent company of the Wall Street Journal, and OpenAI have a content licensing partnership whereby OpenAI receives permission to use content from NewsCorp’s publications to train its AI models in exchange for a hefty ongoing royalty payment. Franchise royalties allow companies such as McDonald’s and Marriott hotels to maintain an asset-light business model while generating recurring royalty revenue for the use of its brand and operating system.

Recurring royalties can be structured in many unique ways. Some license agreements have ongoing royalty payments that are tied to an activity. The payment may be a percentage of the income per use, a percentage of the licensed product’s sales price, or some other metric. Other license agreements have a base rate or a tiered rate structure.

In order for a royalty revenue stream to be an enforceable obligation, the legal drafting of the license agreement must be sound. The scope of the license, including whether rights are limited by territory or whether license rights are exclusive, should be explicitly specified.

Most-favored nation (MFN) provisions in license agreements prevent the licensor from granting more favorable terms to other licensees. The inclusion of an MFN provision is usually subject to heavy negotiation, since such a provision limits the licensor’s power and can result in refunds. Licensees with enough negotiating leverage will try to get an MFN provision to prevent competitors from potentially gaining a cost advantage.

Sublicensing rights must be expressly granted. Such provisions should be carefully drafted to outline whether a sublicense survives in the event the main license is terminated. Legal documents should also address the sublicense compensation to the licensor.

Legal agreements often limit the assignability of the license in order to protect the licensor’s ability to control the identity of the licensees. Granting audit rights to the licensor to inspect the records of the licensee from time to time is another protective mechanism in royalty license arrangements. Auditing and compliance requirements can also help the licensor detect potential violations of the licensing agreement before they escalate.

Under many licensing agreements, the licensor disclaims any warranty with respect to the validity of the intellectual property being licensed. This effectively shifts the risk exposure

burden onto the licensee in disputes over IP validity. It is important to review such provisions of the legal agreement carefully to manage risk exposure expectations.