Unless you plan to create a company to actually mass produce an invention, most private inventors look to create a new product and then sell or license it to an existing company for immediate and ongoing profit. This allows the inventor to continue doing what he enjoys most, which is inventing something new. The profit streams that come from ongoing licensing rights are known as royalties, and in some cases they can be enough to live on as an income. However, this is not the case with all inventions as many only produce a small amount annually.
Agreements and Royalties
Inventors typically look for royalty agreements because they don’t necessarily have the resources, interest or time to mass assemble and sell a new invention themselves. This trade-off via a licensing agreement with a company that can take on such a pursuit allows the company to make money from a ready invention and allows the inventor to be financially rewarded for his creation. However, since the company is doing much of the work building, marketing, selling and supporting the invention product, the inventor typically gets a small percentage as a royalty in payment of licensing.
Calculation of Royalties
The amount of royalty paid to an inventor by a licensee company is influenced by three issues. First, much depends on how unique the invention product is. If everyone will likely want it and has never seen it before, this makes a strong argument for a hefty royalty. Second, whether or not the inventor has solidly patented the product with the U.S. government can influence royalty price. Companies won’t pay for inventions they don’t legally have to license. Finally, the last issue concerning royalty calculations is if the company thinks the product will sell. If there is no demand for the invention, companies don’t want to waste their time paying royalties on it.
Actual royalty payments frequently equal something between 3 and 6 percent of the product’s wholesale price. The wholesale price is what a manufacturing company asks for a product when it sells it to a retail company. The retail company then sells the product to the final consumer. The manufacturing company assembles the product en masse and then distributes it to retailers. As a result, if a product sells for $20 at retail, the wholesale price is frequently half, or $10. Thus, a 5 percent royalty per item sold would equal, in this case, 50 cents. It doesn’t sound like much but when multiplied by regular ordering of 10,000 units at a time, it starts to add up. In this example, one order would result in royalties of $5,000.
Making a Living
Few inventors make a living or get rich from just one invention. According to a 2006 "Forbes" magazine article, research estimates that maybe 13 percent of inventors actually secure a licensing agreement. Many continue to invent and begin to earn multiple royalty streams from multiple inventions. When the multiple payments begin to add together every month, the aggregate becomes a sizable income that a person can live on. However, royalties don’t last forever; the popularity of new inventions grows and wanes with consumer interest. Eventually, even the best products suffer declining sales until retailers no longer want to carry them. As a result, inventing a product someone wants to buy should not immediately convince a person to quit his day job.
Since 2009 Tom Lutzenberger has written for various websites, covering topics ranging from finance to automotive history. Lutzenberger works in public finance and policy and consults on a variety of analytical services. His education includes a Bachelor of Arts in English and political science from Saint Mary's College and a Master of Business Administration in finance and marketing from California State University, Sacramento.