So, you have been successful, a manufacturer has just signed you to a contract to produce your textile design on 5,000 meters of fabric and carpet, and as compensation has agreed to give you a royalty of five percent of all retail sales.

Based on this joyous news, you have put a deposit on your new Mazda Astina and are now considering a shopping spree to spend your forthcoming wealth because you are going to be the Ken Done of fabric and carpets.

Unfortunately, the joyous occasion may be short lived. A contract based on a royalty is a success-based payment. If the fabric or carpet is a success you receive a percentage of the profits - or price the seller would receive, whereas if no fabric or carpet is sold you get no payment.

Consider payment by royalties carefully. If no advances are given or no up front set fee is paid to you, you may receive nothing for your hard work in producing the design, which can lead to your feeling cheated by the manufacturer or other people.

In this article I’ll explain some of the basic information about royalties, their rates, and possible alternatives, for example, what can you ask for? – What is the going rate? – And all those other questions so often asked and which designers have been afraid to raise except in the dim lit coffee houses.

A royalty as such is a success-based fee. It is a right to be paid a sum of money, for the use of your creative work, and is based on the number of articles made, sold or the number of times a process is used. A manufacturer does not pay a cent to you if none of the articles using the design are sold. A royalty-based contract allows the commercial risk to be shifted from the manufacturer to you, the designer. This means you are accepting the commercial risk as to whether the design is going to be a great seller or not.

The first misconception to overcome is royalties; there are not set standards for industry-based royalties. The basic rule is a royalty is as much as you can ask for and the other party is willing to pay. It is therefore the outcome of a process of negotiation.

If you are a new and unknown designer, you are unlikely to obtain astronomic royalty payments as percentages. Once you become known for successful designs, then you are able to demand higher royalty rates.

If the royalty is based on net profit received, then the agreement should specify exactly what is to be considered as a deductible expense from the gross price of the article, otherwise extra miscellaneous expenses can be included and affect the net profit in such a way that it turns out to be a net loss and you are not paid a cent.

Royalties can be based on either net income or gross profit. The general rule regarding royalty rates is that a rate based on net income is generally half the rate based on gross profit or price.

On what basis can you have your royalty set? This depends on the type of item you are producing and the medium for reproduction. If the product is a carpet, you could work out a royalty as a set dollar figure per meter of the design made, $3 per meter on a carpet costing $30 to make, or a percentage of the recommended retail or wholesale price.

An important aside relates to promotional items. Carefully consider how much or how many of the product or articles are to be given away as promotional items. Promotional items are FREE and you will not receive any royalty payments on these items. Negotiations of a reasonable amount or limit is wise so that you will receive some payment from the sales of the articles themselves.

If possible, negotiate an up front non-refundable payment from the manufacturer to cover the out of pocket expenses (labour and material – paper, dyes etc.) you incur in producing the work and leave the profit element of your work as the royalty. This way, if you obtain the up front payment it ensures you are not completely out of pocket, if the product is not successful. Such a payment if negotiated early can be built into the manufacturers cost base.

In any agreement, you must have the right to audit the manufacturer’s records to verify the amount of royalties you have received. You should be allowed access to all source documents, receipts and records the manufacturer keeps on sales of your articles. If valid discrepancies arise you can obtain payment for these discrepancies and have the costs of the audit paid by the manufacturer. If no discrepancy occurs, then you must pay the costs of the audit.

This is just a brief introduction to the interesting world of royalties. Royalties are not to be feared nor are they to be considered as an immediate right to wealth. Royalties are a well-accepted technique for payment of fees in business, however they are a form of deferred payment, which requires the product to be a success for you to receive payment. Be aware of these issues in your next negotiation and if you have any problems, consult a solicitor to discuss the issues arising in your particular contract.