How to Invest in Royalty Income

Investing in royalty income can provide long-term returns to investors seeking to fund retirement or diversify a portfolio beyond stocks and fixed-income securities. Owning rights to royalties provides a steady income that tends to be insulated from fluctuations in the equity and bond markets. Investors can acquire rights to royalty income by purchasing shares of royalty trusts or bidding on royalty auction exchanges. If you’re looking for an alternative investment to generate regular income, this is how to invest in royalty income.

If you’re thinking about investing in royalty income, you may want to speak with a financial advisor first.

Royalty Basics

A royalty is a payment made by one party to another for the use of an asset. Often, the asset consists of intellectual property. For example, the patent owner may receive a royalty payment from the manufacturer of a product for each unit made or sold using that patent.

Other examples of royalties from intellectual property include payments for the use of patents, trademarks and copyrighted materials, such as books, films or musical compositions. In addition to intellectual properties, oil, gas and mining leases generate royalties paid for the use of natural resources.

Royalty income is considered passive income by the Internal Revenue Service. This means it is generally taxed at capital gains tax rates. These are usually lower than the rates paid by individuals for earned income, such as wages and salaries.

Types of Royalty Income

Spanning diverse industries and applications, royalties come in various forms, with each tailored to the nature of the asset and its market. Whether earned through artistic endeavors, such as music, literature and films, or the licensing of patents, trademarks and natural resource leases, royalties offer a passive income opportunity that grows with demand.

Common Types of Royalties

Energy. Oil and gas landowners who retain mineral rights can receive royalties, which consist of a percentage of the value of energy resources extracted from their property.
Mineral. Owners of land with mineral resources, such as gold, silver and valuable metals, are paid royalties for any minerals removed through mining.
Invention. An inventor receives royalty payments for licensing the use of the patent to makers of products using the patent.
Trademarks. Owners of valuable trademarks can receive royalties for licensing the use of their logos and brand names.
Music. Composers of songs can receive royalty payments each time their composition is publicly performed, streamed, downloaded, played on the radio, used for a film or TV score or sold as a CD or record.
TV and cinema. Movies and TV writers, directors, producers, performers and others with copyrights to films and TV shows are entitled to residuals (as royalties are known in Hollywood) any time the show is streamed, played or sold on a DVD or other media.
Books. Publishers typically pay authors or other copyright holders a royalty consisting of a percentage of the sale price for each copy of a book sold in hardcover, paperback, electronic or audio formats.
Business funding. Investors who provide money to new businesses may be repaid by royalties on revenues from products or services sold by the business.

Investors who receive royalty income will get the payments as long as a copyright, patent, trademark, mine, oil well or other source is generating income. This makes royalties a potential source of long-term and relatively stable income.

The only significant risk associated with investing in royalty income is the potential opportunity cost of better returns from investments in riskier assets. Sometimes, royalties can increase sharply. Such as when a song is used in the soundtrack to a popular movie or there is a big rise in energy prices.

How Licensing Agreements Work for Royalties

The easiest way to invest for royalty income is by purchasing shares of a royalty trust.

Licensing agreements are essential tools in the world of intellectual property, allowing creators and businesses to monetize their innovations. These agreements grant permission to another party to use a product, brand or technology in exchange for royalties.

A well-structured licensing agreement clearly outlines the rights and responsibilities of both parties. It specifies the scope of the license, including the geographical area and duration, as well as exclusivity.

The agreement also details the royalty structure, which can vary widely, depending on the industry and the nature of the licensed material. For instance, a flat fee might be appropriate for some agreements, while others might involve a percentage of sales. Additionally, the agreement should address issues such as quality control, reporting requirements and dispute resolution mechanisms to ensure a smooth partnership.

Investing in Royalty Trusts

The easiest way to invest for royalty income is by purchasing shares of a royalty trust. Royalty trusts are a type of income trust. These are publicly traded corporations that acquire ownership of rights to leases and deposits of oil, gas and minerals. The income generated from royalties is distributed to shareholders as dividends.

Royalty trusts that distribute 90% of their income as dividends are exempt from the double taxation that burdens most corporations. Instead, investors in royalty trust shares pay taxes on the dividends at their rates. Owners of mines and wells can deduct the costs of operating their property as business expenses.

Royalty trusts do not do any mining or drilling. That part of the business is handled by another company. This allows investors to participate in the energy and mining industries without owning mines or wells.

Investing in Royalties Through Auction Sites

Royalty auctions offer another opportunity to invest in royalty income. Several sites conduct online auctions of royalties for music, minerals and many other types.

Songvest, for example, focuses on music royalties. Investors can purchase fractional shares of the royalty streams from popular songs. EnergyNet allows bidders to purchase royalty interests in oil wells, gas wells, logging operations and more. Royalty Exchange auctions rights to royalties on a wide range of properties, including music, movies, TV shows, oil and gas.

Risks and Considerations for Royalty Investors

While royalty income can offer long-term cash flow and diversification, it comes with specific risks and considerations that investors should evaluate. One key risk is the declining value of the underlying asset. For example, a song may lose popularity, a patent may expire or a mine may become less productive. This would then reduce or eliminate royalty payments.

Another factor is market demand. Royalty payments often depend on how frequently a product or asset is used or sold. Economic downturns, competition or shifts in consumer behavior can decrease usage, reducing the associated income. Additionally, some royalty sources are tied to commodities, such as oil and gas, which are subject to price volatility and regulatory changes.

Legal structure and ownership rights also matter. Investors should review licensing agreements or trust structures to understand the duration of payments, exclusivity terms and how ownership is transferred. Not all royalties are permanent, some may last only for the duration of a copyright or lease.

Before investing, conduct due diligence or seek professional guidance to verify the income history, terms of the royalty agreement and risks tied to the asset. While royalties can be a stable income source, they are not risk-free, and the quality of each opportunity can vary widely.

Bottom Line

Royalty income can provide steady, stable, long-term income to investors.

Knowing how to invest in royalty income can prove to be lucrative for your overall investment portfolio. Royalties can provide steady, long-term income to investors looking for greater stability in their portfolio. They’re generated by many types of assets, including musical compositions, oil wells, gold mines, books, movies and TV shows. As passive income, royalties are taxed at lower rates than wages and salaries. Investors can invest in royalty income through auction sites and royalty income trusts.

You can use SmartAsset’s free tool to match with advisors in your area who can consult on royalty investments.

Investing Tips

A financial advisor can help you invest in royalty income as part of an overall investment strategy. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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