Introducing the LES Build-up Method to Determine Royalty Rates

Abstract

Royalty rate determination has been studied extensively over the years. Still, there are no quick answers for some of the questions encountered frequently in IP licensing and litigation. These include:

- When converting a nonexclusive license to an exclusive license, or vice versa, how should the royalty rate be adjusted accordingly?

- How can you determine a royalty rate for a patent license with mature technology based on the royalty rate in a previous license with early-stage technology in the same field?

- How much should you increase a royalty rate by when a patent licensee asks for additional IP such as trade secrets, know-how, designs or drawings?

This article introduces the build-up method for royalty rate determination developed by License Executives Society (LES) USA and Canada and illustrates how this method can be used to answer such pressing, critical questions in licensing and litigation.

Specifically, it will present the premiums or discounts associated with certain license features or parameters such as exclusivity, technology development stage, and IP types licensed, among others. It will then demonstrate how to apply the premiums or discounts in royalty rate determination when negotiating license agreements with or without certain parameters.

The analysis will also describe the steps that employ the LES build-up method to decompose a royalty rate from a “good, yet imperfect, comparable” (in the words of the IRS) license to identify and quantify the value contributions of various parameters of the license. The quantified value contribution of each parameter will then be used to calculate a comparable royalty rate for the license agreement to be negotiated based on the specific parameters.

Finally, the article will discuss further adjustments needed to conclude a reasonable royalty rate.

Keywords: LES USA and Canada, royalty survey, build-up method, royalty rate, license negotiation, IRS, good, yet imperfect, comparable, comparable license, hypothetical negotiation, exclusivity premium, premium for advanced-stage technologies, trade secret, know-how, designs and drawings, basic rate

JEL Classification: O32, O34, C13