Design Royalties

[sleepworks]

I recently started (another?) company with two other self-employed engineers, this new company was born of an opportunity that presented itself to me.

Basically we will be providing an OEM with a completed machine design (electrical, mechanical, software). We will not be manufacturing or building anything, solely responsible for the engineering efforts.

Now we are still up in the air on how to get paid from this design. I feel we would best benefit from a royalty percentage of each machine sold, but literally have no clue what the percentage would be, or what the industry standard would be to start negotiations.

Currently we are working on a hand-shake (its a long-standing relationship with the OEM), but we need to discuss the compensation fairly soon, so I'm just looking to pick some brains of those who know more than myself...

 

[tygerdawg]

I hear a rumble in the distance, getting louder by the second.
It's the stampede of experienced folks rushing to tell you:

You should be talking to an Intellectual Property Attorney.

A "handshake?" Good luck with that. One hopes the damage isn't already done.

TygerDawg
Blue Technik LLC
Virtuoso Robotics Engineering

http://www.bluetechnik.com

 

[sleepworks]

Oh no, nothing has changed hands.

The opportunity is the handshake. No IP is moved until we finalize this aspect. [tt][/tt]

 

[glass99]

sleepworks: this is a very good question which I do not have good answers to, but will add more questions to that have come up for me in similar circumstances:

- What will be your liability? Do you have insurance? Getting insurance for product liability is a whole crazy world. If you have an "interest" in the product aka a royalty , it complicates insurance. There is wisdom in working on a lump sum or hourly basis for this reason.
- What scale of production run are we talking about?
- Is there an ongoing service portion to the deal?
- An industrial design client of mine designs bus stops for a manufacturer and charges in the neighborhood of 4% of the manufactured sale price. I think the lifetime sale price of these things is in the range of $20MM.
- There is variability in percentage royalties ranging across several orders of magnitude, so "it depends".
- Are you just selling generic technical service your client could get anywhere, or is there something about your design which is hard to replicate? Branding is a big deal in the product world. Patents and proprietary technologies factor in, as do difficult to replace technical skills. If your client can sell this widget for 20% more because they can market it is "design by sleepworks", your can happily charge 10%.
- Frequently designers ask for an upfront payment as well as royalties.

 

[JohnRBaker]

I feel we would best benefit from a royalty percentage...

That's how Bill Gates made his first couple a billion, licensing DOS to IBM for something like $25 a copy. IBM thought they were getting a steal since they could only contemplate selling at most, a few thousand PC's.

John R. Baker, P.E.
Product 'Evangelist'
Product Engineering Software
Siemens PLM Software Inc.
Digital Factory
Cypress, CA
Siemens PLM:
UG/NX Museum:

To an Engineer, the glass is twice as big as it needs to be.

 

[KENAT]

1. Does at least one of your team need to be PE or equivalent (depending on jurisdiction) since you might be considered to be offering engineering services to the public? I don't know the answer but it's something to consider.
2. How easy will it be to keep track of royalties etc. to make sure you get what's owed you? How do you address this in the contract?

Posting guidelines faq731-376

http://eng-tips.com/market.cfm?

(probably not aimed specifically at you)
What is Engineering anyway: faq1088-1484​

 

[glass99]

Kenat: Good points. In addition to keeping track of your customers sales, do you have the ability to finance your design investment of the duration of the royalty payments? Can you wait multiple years to get paid? What if your startup has dissolved in 5 years time and you are only part way through royalties. What if your customer changes the design a little bit and claims they don't owe you royalties any more?

- > I think you need quite a bit of business muscle to actually make use of a royalty deal.

 

[zdas04]

I signed a license/royalty deal on my GasBuster while the patent application was pending. The agreement (drawn up by my lawyer and modified by the licensee's lawyer) had a bunch of language about defending the rights to manufacture while the patent was pending and what happens if it is rejected in whole or in part. This was a complex document. I got the patent 2 months after it was executed and 80% of the language could have been eliminated, but we didn't know.

Without IP protection (patent and/or copyright), I don't know how the arrangement you describe has much protection for you. It sounds like you are foregoing current payment in lieu of future participation (much like a movie star might do). I would certainly be talking to a lawyer about formalizing the hand shake agreement.

As to hand shake agreements, I am a big fan of them. When I was working for a major Oil & Gas company I did all my contracting on handshakes. The contractors knew that I would stand behind my word and were fine with it. I always did what I said I would do and my contractors always got paid on time. Then I retired. My replacement did not value personal relationships and screwed over some (all eventually) of my contractors. She works with contracts. Period. One of the tasks I frequently did was move wellsite compressors from one well to another. My average cost for 354 moves was $5,600/compressor. With my replacement's contracting strategy her average cost is $250,000 for the same machines in the same service. The only way it works is if both sides have a personal commitment to integrity and keep their promises within their delegation of authority (e.g., if your DOA is $50k then promising to pay for something that costs $75k is outside your DOA and you need someone else's permission to pay the bill and they may withhold the permission).

As to percentage, I'd try to estimate total annual market (is it dozens of units or thousands?), total sales price, and come up with a percentage that recovered my forgone payment in the first year. Then subsequent years are payment for the risk.

David Simpson, PE
MuleShoe Engineering

In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual. Galileo Galilei, Italian Physicist

 

[glass99]

zdas: this is totally off topic, but one of the more interesting discussions I had with an architect a few years ago was on the topic of "what do you trust" when you are handing the project over to a contractor. The obvious answer is you have to trust your drawings specs and the contract, but we all know that a sleazy contractor can wiggle out of pretty much whatever you have in writing, especially in the environment of a performance specification. So what else can you trust? Obviously a relationship with the contractor is something useful. They have to believe they are going to work with you across dozens of projects, and would not screw that up for the sake of this one.

But what if you are doing a one off thing, say a project in a foreign city where there is no relationship? A good answer is you trust their attitude. You trust that they care about the same things as you. They have some love for their craft outside of it just making money. You also trust their culture, intelligence, integrity, and creativity. Actually when it gets down to what really matters, all the non-documented stuff is more important than the drawings and contract, and it even goes into reverse when you are dealing with a contractor who only cares about legalities. They will screw you if its legal, plus you add in a bunch of overhead for having to work through all the contract stuff. You have the kind of project where the contract negotiation takes longer than the construction.

 

[zdas04]

So far (touch wood) when working out of town I've worked for people who think like me and have established relationships with contractors that both sides hope will last for years. I think that if I had to do a one off project on my own in a strange place I'd take a pass on the work. Life is too short to spend it writing iron-clad contracts that can only be resolved in court.

The MBA 3-bids-and-a-buy nonsense leaves you with no room for goodwill (on either side) and low bidders are too often bottom feeders who will sign any contract with never an intention of following it. I got a 65 page master service agreement from one of the Oil & Gas majors once. I read it, sent them a bill for 2 hours of my time and refused to sign it. When the guy that wanted me to work for him called I told him that no one that he wanted working for him would sign the I-win-you-bleed contract, and anyone willing to sign it would be someone who would adhere to it. I got a 3 page contract (basically an NDA) the next day and worked for them for 4 years before he moved on and his replacement set me the 65 page contract to renew. Haven't worked for them since.

David Simpson, PE
MuleShoe Engineering

In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual. Galileo Galilei, Italian Physicist

 

[zdas04]

I just this minute got an 85 page master services agreement from a potential client. I haven't read it yet, but if it takes them 85 pages to nail down a simple engineering consulting agreement with a one-man company I have a feeling that I won't be signing it. We'll see over the next couple of days.

David Simpson, PE
MuleShoe Engineering

In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual. Galileo Galilei, Italian Physicist

 

[TheTick]

As they say in diplomacy, trust but verify. Any royalty agreement should have clear language about how to verify what was sold. A clause for third-party audits is a good plan.

Trustworthy people never say "trust me".

 

[glass99]

zdas: Do us all a favor and push back on that agreement. Just because its a standard agreement for your customer doesn't mean the standard is right.

TheTick: What does a third party audit look like? Who does it? Is it an accounting firm?

 

[zdas04]

I'm about half way through it and in my 35 years of reviewing contracts I have to say I've never seen one that was more in the I-win-you-bleed category. This is the worst piece of dreck I've ever picked up. I want to wash my hands after every page. I'm pushing back a tiny bit (not a single page without major strike-throughs, few paragraphs without revisions).

David Simpson, PE
MuleShoe Engineering

In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual. Galileo Galilei, Italian Physicist

 

[glass99]

zdas: I was forced by a major corporate architect client a couple of years back to sign their master services agreement, which excluded my standard terms and conditions. My standard terms and conditions exclude third party peer reviews because I know how drawn out they can be. Lo and behold, we are now near the end of construction and the contractor is late, so the owner is looking for blood wherever they can and they sent over a peer reviewer. Both my architect client and I are having to dedicate dozens/hundreds of unpaid hours answering idiotic questions by this peer reviewer. My standard terms and conditions are two pages long, and are tightly focused on what might go wrong with a structural glass project. My client's stupid 60 page master services agreement and contract attempts to cover anything which might go wrong in the whole construction industry, so clearly could not have realistically anticipated a peer review. No one is seriously suggesting there is a problem with the engineering (they are just pissed that its late), and the peer reviewer wouldn't know anyway because he's not a glass guy so he's picking on all this secondary stuff. We are about to do a round of testing to show that Dow Corning's structural silicone is in fact structural when applied in a standard manner under controlled conditionsrd substrate.

 

[TheTick]

My experience is from my dad's company. We made and licensed capital equipment for making fiber and film.

Customers cheat. It's what they do. They tell you the machine never worked; all the while they're pumping product onto store shelves.

 

[zdas04]

Glass,
I have reached a point (I was probably always there, but I've finally realized it) that there are not a lot of people who are interested in doing what I do so I am not powerless. I just replied to the latest travesty with "the contract is unacceptable, fix it or don't send it back to me, you need me way more than I need you". Problem is that the Supply Chain Management Contract Specialist doesn't need me at all. The engineers that don't have a clue how to fix their screw up know that they aren't going to fix it on their own without starting over from scratch. We'll see if the actual user has any stroke over the pissant contract guy.

David Simpson, PE
MuleShoe Engineering

In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual. Galileo Galilei, Italian Physicist

 

[glass99]

Being small does not mean you have no power. In fact, there are some extremely influential one man consulting shops out there that really set the tenor for much larger projects and companies. Also in the nature of small consulting shops is that you are in a niche of some sort, so its hard for the client to shop you around too much.

I want to get to this: you all have to sign my short tightly focused agreement, and we are not signing your long rambly agreement because mine is better for everyone. If your lawyer can't handle my very practical and easy to understand document, get a new lawyer.