Royalty analyses are usually required for at least the following situations:
- As part of an overall valuation of an intellectual asset or IP.
- As part of a licensing agreement whereby the licensor contributes the IP for a percentage of the revenues of the enterprise. Most of these deals are based on a percentage of gross revenues. Some are even varied by different percentages at certain levels of achievement.
- In determining the present value of expected royalties or fees for a singer, songwriter, author, or participant in a creative endeavor. This future income stream is also applicable to agents of all types.
On the surface, royalty analyses appear to be rather simple to understand and value. The prior royalties received establish the basis for future income streams. But do they?
As part of the analysis, the history of royalties paid is established. For example, for musicians we spread the historicals according to types of songs. A much more exhaustive analysis may be accomplished by valuing each song. Typically, songs and royalties can be categorized by logical groupings. But history often does not dictate the future royalties. Titles fade over time, as new compositions vie for play time. We gauge how each group of songs will fare for each of the next five years. Sometimes, the post death popularity (e.g. Michael Jackson) will significantly increase the royalty income. In short, the analysis must consider the future risk of achieving or exceeding the historical cash flows.
The ultimate test of our valuation is whether our projections result in a reasonable internal rate of return (IRR) for the particular IP and the industry trends.
Royalty valuations are germane to at least the following events or situations:
- Contractual agreements between companies, the licensor and licensee.
- Litigation for breach of contract or fraud involving use or misuse of the IP.
- Divorce proceedings.
- Gift or death tax filings.
- Application of the royalties as collateral or for settlement purposes.