The most appropriate methodology for determining a reasonable royalty rate is that which leaves the least number of questions unanswered. Unfortunately, databases such as royaltsource.com give insufficient information about the licensee to pass a thorough inquiry wholly intact. For example:
- What is the profit before interest and tax (PBIT) of the licensee and the division in which the intellectual property (IP) is used?
- Does the IP result in the licensee adding a premium to the price of goods manufactured using the IP?
- What other IP does the licensee own and use?
- What other royalties are payable by the licensee?
- What is the net tangible asset value of the licensee?
- What were the relative bargaining strengths of the parties?
- Was alternative IP available to the licensee, and at what cost?
- To what degree is the IP a driver of sales/profits of the licensee?
- Does the IP represent a relatively strong arsenal of assets?
- Does IP grant the user protection from competition?
- Is the IP valid and enforceable?
Accordingly, despite the OECD and IRS’ apparent support of this methodology, benchmarking reports are seldom an appropriate method for determining a reasonable royalty. In my opinion, benchmarking reports should always be used in conjunction with a determination of royalty rates using first principles. Put another way: they should be used in support of a royalty rate and not as its foundation stone.