Royalty Accounting – Guaranteed Minimum Royalties (GMR)
IMC Licensing
June 20, 2024
Guaranteeing results for any business certainly comes with risks, but guaranteeing sales in an inflated economy is even more audacious. Although licensees would rather not, including Guaranteed Minimum Royalties in a licensing agreement is standard practice and mitigates risk for the licensor. This is what truly differentiates licensing agreements from other marketing initiatives and contracts.
How to calculate Guaranteed Minimum Royalties (GMRs).
It’s common practice to set the Guaranteed Minimum Royalty as 50% of the projected sales for a given period.
For example, if the royalty rate is 5% and the licensee is projecting $2 MM in sales. The GMR would be $50,000.
$2,000,000 * 5% = $100,000
50% of the projected royalty of $100,000 = $50,000
The licensee would have to sell $1M at minimum to cover the GMR payment of $50,000.
What if sales are more than enough to cover the GMR?
Best case scenario! The golden rule of royalty accounting is that the licensee pays the higher of the two. So, the licensor would get paid all earned royalties, not just the GMR.
For example, if the licensee had $3 MM in sales, the earned royalty would be $150,000 and the licensee would owe $150,000 not $50,000.
What if sales aren’t enough to cover the GMR?
This is not ideal for either party, but sometimes happens. Even if the licensee did not sell enough to cover the GMR, they still owe the GMR to the licensor.
For example, if the licensee sold $800,000 the earned royalty would be $40,000. The licensee would still owe the GMR of $50,000.
Are GMRs necessary for license agreements?
Yes, GMRs serve a valuable purpose. While there are other ways to address commitment and contractual obligations within an agreement if GMRs are not included, I advocate for GMRs for two reasons:
- It’s best for the licensor to ensure that the licensee has some “skin in the game.” Brand owners don’t want a licensee using their brand to launch new products without being fully committed to making the partnership a success. GMRs also show a licensee has the financial resources to launch and maintain the product.
- GMRs also help to ensure that licensees can’t “hold” categories to block competitors out of the marketplace. For example, you wouldn’t want a licensee to hold the exclusive licensing rights to Papa John’s frozen pizza and only continue to sell DiGiorno frozen pizzas.
WHAT ARE OTHER WAYS TO SHOW COMMITMENT IN AN AGREEMENT?
While GMRs are standard practice, there are other ways for a licensee to show their commitment to the program. Take for example the recent extended agreement between Kraft Heinz and TGI Fridays. Signing a contract in perpetuity obviously is a gamble, but with this program’s history of success we understand why this is a win-win for both parties. As a licensing agent, this type of agreement is only recommended in very specific circumstances, and certainly not one to explore for a new program.
A far less risky way to show commitment is to include stretch performance metrics that, if met, grant the licensee an automatic renewal of the contract. This arrangement proves the licensee’s engagement in growing the program, as well as the licensor’s pledge to keep a successful program in market.
If you are a licensee, don’t let GMRs intimidate you. A solid plan, good licensing partners and a great new product will prove a GMR is just a number on your royalty report. If you are a brand owner, don’t let GMRs be the only reason you are signing a licensing deal. Help your licensee succeed and the GMR will truly be the minimum royalty you receive.
At IMC we are proud to be a top brand licensing agency. If you are a trademark owner looking to license your brand, or a manufacturer looking for a brand to license, let’s talk. We are happy to learn how we can help.
