Royalty stacking

"Royalty stacking" results from an incorrect application of "the 25% Rule". The best way of explaining this concept is by way of example:

Opco uses trademarks, patents, designs, copyright and know‐how in its business. Opco wishes sequentially to assign each category of intellectual property (IP) to a wholly‐owned subsidiary (IPSub) (possibly using the corporate rules) and licence the IP back to itself. As a first step, Opco determines reasonable royalties for the licences. Assuming that Opco generates R100m in turnover and R20m in profits before interest and tax, OpCo calculates reasonable royalty rates for:

The sum of all royalties payable by Opco to IPSub is 15.254% of turnover, or 76.27% of profits! Viewed from any angle, the total royalty is excessive ‐ overvalued by more than 200%.

(Updated 2007)

Articles: Valuation