Licensing Artwork: Negotiating and Monitoring Royalty Payments

Licensing agreements are important for establishing clarity and ensuring fairness.

Professional visual artists need to earn a living. Some make all of their income by selling original work. They paint portraits, make sculptures, or design etchings, and then sell those to customers.

But many artists also make money through licensing, allowing their images to be reproduced by other people or entities in exchange for royalty payments. In many cases, this allows artists to have a stream of income without requiring them to continue producing new original works.

Not all royalty deals are created equally, however. Negotiating a good royalty deal when licensing your artwork is critical to maximizing profits. Before signing on the dotted line, learn the basics of royalty payments and take the time to negotiate a contract that works for you. And then, once the deal is signed, keep a close eye on the vendor to catch any shortfalls in your royalty payments.

What Are Royalties?

When you license your artwork, you retain legal ownership of the work. This means that you keep your copyright or design patent, while someone else makes and sells the item (for example, duplicating your imagery on merchandise).

In return for granting the license, you receive a royalty, which is usually either a lump-sum payment or a continuing payment (on a monthly or quarterly basis), based upon a percentage of the income from the licensed artwork.

Imagine that you have just created a beautiful painting of a dog. A pet store comes to you saying it would like to print that image on T-shirts, which it will then sell. You could likely negotiate for a percentage of the sales of each T-shirt over a certain period of time. For example, you might keep 20% of gross revenue. The store, which undertook the cost of production and sales, would retain 80%. To state the obvious, you would seek as high a percentage of revenue as possible from licensed products.

Note that it's also possible to "assign" your copyright in the work. In other words, you could "sell" your intellectual property ownership interest to a buyer, such as the pet store, which would then be able to do whatever it pleased with the dog painting. The store might offer a larger lump-sum payment, but you would not see any of the royalties from later sales.

Regardless of whether you license or assign your copyright, the agreement should be in writing. Having a written agreement will ensure that both sides understand their respective obligations and responsibilities, hopefully bringing clarity to the relationship.

Understanding Licensing Agreements

Like many legal areas, licensing involves a good amount of jargon. The key to negotiating payments in a licensing deal is to understand the terminology used in the agreement. Below are some definitions.

Advance Against Royalties

An "advance" is an up-front payment to you, usually made at the time the license agreement is signed. An advance is almost always credited or "recouped" against future royalties, unless the agreement provides otherwise. The person or entity you're contracting with is essentially saying, "I expect you will earn at least $1,000 in royalties, so I am going to advance you that sum at the time I sign the agreement."

When you start earning royalties, the licensee (the company that licensed the artwork) keeps the first $1,000 to repay the advance to itself. If the artist does not earn the $1,000 in royalties, the licensee takes a loss. You do not have to return the advance unless you breach the agreement. Thus, an advance gives you some degree of security, since it puts money into your pocket immediately.

One-time License Fee

On rare occasions, a licensee may pay a "one-time license fee" at the time of signing the agreement. This differs from an advance in than it's not deducted from royalties. It's simply a sum of money, usually given instead of any payments down the road. This sort of deal can be good for you if you believe the product being licensed might not actually sell well, since you can put money in your pocket immediately. But if it does sell well, you might feel foolish for having given up the income stream.

Gross and Net Sales

"Gross sales" refers to the total amount billed to customers who buy the product containing the licensed artwork. "Net sales" are usually defined as the licensee's gross sales minus certain deductions. In other words, the licensee calculates the total amount billed to customers and deducts certain items, such as the costs of goods, before calculating and paying the royalty.

Deductions

Deductions are subtracted from sales before the royalty is calculated. It is ordinarily acceptable for a licensee to deduct from gross sales any amounts paid for taxes, credits, returns, and quantity discounts made at the time of sale. It is also not unusual for a licensee to deduct shipping (the cost of getting the products to the buyer). While you may not see the significance at first, deductions are as important as the royalty rate in determining how much money ultimately comes your way. For example, a royalty rate of 2% of net sales with no deductions may earn you more than you would receive from a 5% royalty rate from which various licensee expenses are deducted.

If possible, avoid deductions for:

  • bad debts and uncollectible accounts (that is, when a third-party orders products and then fails to pay)
  • sales commissions (a salesperson is paid a commission for each sale of the licensed product)
  • fees (a vague term that includes a wide range of licensee costs and business expenses), and
  • promotion, marketing, or advertising costs (these are costs of the licensee's business, not yours).

If it is difficult to negotiate individual deductions with a licensee, consider setting a fixed percentage for deductions, say 10%.

Calculating Your Royalties

Determining your royalties is important, partly because you need to ensure that the licensee is paying you correctly. This means you must do your own calculations. Here is how your agreement might specify that royalty amounts will be calculated.

Royalty rates. Royalty payments are computed by multiplying the royalty rate against net sales. For example, a royalty rate of 5% multiplied by net sales of $1,000 equals a net sales royalty of $50.

Royalty rates for licensing vary depending on the artwork involved. Below are some royalty estimates, though note that these vary considerably depending on the size and resources of the company with which you are negotiating:

  • Greeting cards and gift wrap: 2% to 5%
  • Household items such as cups, sheets, towels: 3% to 8%
  • Fabrics, apparel (T-shirts, caps, decals): 2% to 10%
  • Posters and prints: 10% or more
  • Toys and dolls: 3% to 8%.

Per unit royalty. In some cases, an artists may negotiate a "per unit royalty," which is tied to the number of units sold or manufactured, not to the total money earned by sales. For example, under a per unit royalty you might receive $.50 for each licensed product sold or manufactured.

Demanding a Guaranteed Minimum Annual Royalty Payment

If the licensee that you are approaching is especially excited about your artwork and wants a long-term license, you may want to consider negotiating for a guaranteed minimum annual royalty payment ("GMAR").

With a GMAR, the licensee promises to pay you a specific amount, usually at the beginning of every year, regardless of how well the merchandise sells during the year. At the end of that year, if the earned royalties exceed the GMAR, you would be paid the difference. If the GMAR exceeds the earned royalties (you were paid more than the product earned), the licensee usually takes a loss (unless the licensee has negotiated to apply the difference to future GMARs).

Auditing Your Royalty Income

To a certain extent, artists are trusting the licensee to accurately pay them for royalties based on sales. But how do you know that they are selling the number of products claimed in a given year? In your agreement, you should include an audit provision so that you can detect and quantify a possible shortfall in your royalty payments. The provision should:

  • describe when you or your representative (e.g., accountant or business manager) can access licensee records, and
  • provide that if the audit uncovers an error of a certain magnitude—commonly a sum between $500 and $2,000—the licensee will not only have to compensate you for the shortfall, but also for the costs of the audit.

You should also ask for an attorneys' fees provision in your licensing agreement, so that in the event you must sue the licensee for royalties or audit costs, any court judgment would include your legal fees.

Finally, remember that it does not matter what royalty rates or other provisions you negotiate if the people you're dealing with are crooks (or broke). Always research the companies with whom you contract. Due diligence before you sign an agreement can save much grief.

For information about licensing fine and graphic arts, see Getting Permission: Using and Licensing Copyright-Protected Materials Online and Off, by Richard Stim (Nolo).

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