Sibanda & Zantwijk

“Royalty stacking” results from an incorrect application of “the 25% rule”. The best way of explaining this concept is by way of example:

Opco uses trademarks, patents, designs, copyright and know-how in its business. Opco wishes sequentially to assign each category of intellectual property (IP) to a wholly-owned subsidiary (IPSub) (possibly using the corporate rules) and licence the IP back to itself. To do this, Opco approaches a practitioner to determine reasonable royalties for the licences. Assume that Opco generates R100m in turnover and R20m in profits before interest and tax. The practitioner calculates a reasonable royalty rate for:

• the trademark at 25% of profit before interest and tax (PBIT), i.e. 5% of turnover;
• the patent at 25% of PBIT, i.e. 25%xR15m/R100m = 3.75% of turnover
• the designs at 25% of PBIT, i.e. 25%xR11.25m/R100m = 2.81% of turnover
• the copyright at 25% of PBIT, i.e. 25%xR8.4375m/R100m = 2.11% of turnover
• the know-how at 25% of PBIT, i.e. 25%xR6.328m/R100m = 1.582% of turnover

The sum of all royalties payable by Opco to IPSub is 15.254% of turnover, or 76.27% of profits! Viewed from any angle, the total royalty is excessive - overvalued by more than 200%. However, this misapplication of basic royalty determination and valuation principles is surprisingly common.

See our table of royalty rates.
 

Anthony van Zantwijk (January 2007) 

Sibanda & Zantwijk  

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