Negotiating Startup Product Royalties

Tactical considerations for licensing innovative consumer product ideas to bigger companies

Q.  I have developed a really good BBQ sauce. I'm looking at different avenues for getting my special sauce to market including selling the rights to a bigger company. What type of royalty percentage can I expect from a food company?

A.   Excellent question, but first, here's a question for you.

Which is the better deal? Would you rather receive a 7% royalty on $5,000 worth of sales or a 1% royalty on $500,000 of sales? Even though 1% doesn't sound too impressive, of course it's the better choice in this example.

It's easy for inventors and entrepreneurs to get tripped up on royalty percentages. Yes it is one factor in the income generation equation, but the bigger driver will always be units of product sales. This said, deal-hungry entrepreneurial chefs like you should focus on finding partners that have a strong but realistic profit incentive to actively sell your product in the marketplace.

In just about every industry, potential licensing partners project all costs associated with bringing a product to market before sitting down for serious royalty payment negotiations. The company will also measure product uniqueness, the strength of the competition and ongoing consumer education and advertising needs. Simply stated, the more a company has to spend, the lower the royalty percentage.

Take for example the pharmaceutical industry. Royalty percentages are based on the development status of the technology or product. A patent may get 1% to 2% royalty; a pharmaceutical product with strong clinical trial support may secure a 3% to 4% royalty; and a proven drug that is already in the marketplace may secure a 7% to 10% royalty.

In the consumer packaged goods industry, royalties can range between 2% to 7% with higher rates paid to health and beauty aid products than food products. And, expect established brands with a regional or national following to get more generous royalty treatment than a recipe with unproven customer acceptance.

Sports stars and celebrities who license their name for shoes, perfume and clothing lines can command double digit royalty rates. Of course many of these goods are sold at much higher profit margins than packaged food, providing more room for generous royalties.

Entrepreneurs often complain that they have a tough time getting into corporations to present their product ideas. And they are right. Corporations are sensitive to receiving unsolicited ideas because of the risks of intellectual property conflict on products with patent potential.

You can improve your chances of getting a fair hearing by demonstrating that you are professional and understand the condiment market. Look to well-respected trade publications like Mass Market Retailers and food manufacturer associations as sources for industry information. While pricey, Information Resources, Inc. sells product category unit and dollar sales reports to the public.

Because your product represents a different flavor in a relatively crowded grocery shelf, you will have to present an unusually strong business case to potential partners. For example, manufacturers that have excess production and packaging capacity are promising candidates for product line or brand extensions. If you are determined, you can find them.

Take Command Action Step

Within every major metropolitan area there are companies that help manufacturers sell goods to grocery, drug and mass market chain retailers. Make a significant effort to find a willing mentor within these firms to learn more about the inner workings of the packaged food industry and names of potential manufacturing partners. Use the search words "food brokers' and "manufacturer's representatives" to get the names of brokerage firms in your area. If you have an established brand, search for "brand valuation firms" to help determine the right royalty rate for your BBQ product. You can do it!

Do you need time-saving tips to help fund and grow your business? Ask Susan How! Write to small business funding expert Susan Schreter at susan@takecommand.org