Pharma royalty and licensing model
Tiered royalties, milestones, probability, purchase IRR. Value a portfolio of drug royalties from the licensee’s sales: build each product’s sales curve to generic entry, apply the licence’s tiered rates band by band, end the royalty at patent expiry, weight development products by their probability of approval, collect with the lag, and price a new royalty purchase on its IRR.
By Surojit Chakraverti, founder of L3VLUP and an investor running a long-short healthcare and technology equities strategy.
On this subject: pharma royalty and licensing model.Updated 5 November 2026
Who builds it, and for whatThe model a royalty fund, a healthcare credit or structured investment team, or a biotech’s business development team builds when a royalty changes hands: an inventor, a university or a smaller drug company sells its royalty for cash today, and the buyer prices it on the licensee’s sales, the tiers, the term and the probability that a pipeline product gets approved. Equity analysts covering a listed royalty company rebuild the portfolio the same way, product by product.
Every sheet below, in your browser, with its outputs and checks
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| A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1 | Assumptions | |||||||||||||||||||
| 2 | $m unless stated. Y0 is the base year; the portfolio is valued, and the purchase made, at its end. | |||||||||||||||||||
| 4 | Year | Unit | Y0 | Y1 | Y2 | Y3 | Y4 | Y5 | Y6 | Y7 | Y8 | Y9 | Y10 | Y11 | Y12 | Y13 | Y14 | Y15 | Notes | |
| 5 | Year number | year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14 | 15 | Y0 = 0. Product timelines are given in these years. | |
| 7 | Scenario | |||||||||||||||||||
| 8 | Scenario | # | 1 | 1 = base, 2 = earlier generic entry, 3 = pipeline failure. | ||||||||||||||||
| 9 | Generic entry brought forward, base | years | 0 | |||||||||||||||||
| 10 | Generic entry brought forward, earlier generic entry | years | 2 | A patent challenge lost: competition arrives sooner on every product. The royalty term is contractual and does not move. | ||||||||||||||||
| 11 | Generic entry brought forward, pipeline failure | years | 0 | |||||||||||||||||
| 12 | Generic entry brought forward, selected scenario | years | 0 | |||||||||||||||||
| 14 | Stage-transition probabilities (illustrative assumptions) | |||||||||||||||||||
| 15 | Phase 2 to Phase 3 | % | 35.0% | Probability of passing this stage only, not cumulative. | ||||||||||||||||
| 16 | Phase 3 to filing, base | % | 60.0% | |||||||||||||||||
| 17 | Phase 3 to filing, earlier generic entry | % | 60.0% | |||||||||||||||||
| 18 | Phase 3 to filing, pipeline failure | % | 0.0% | The Phase 3 trials fail: neither development product reaches the market. | ||||||||||||||||
| 19 | Phase 3 to filing, selected scenario | % | 60.0% | |||||||||||||||||
| 20 | Filing to approval | % | 90.0% | |||||||||||||||||
| 22 | Collection and valuation | |||||||||||||||||||
| 23 | Share of a year’s royalty collected the following year | % | 25.0% | Royalties are reported and paid a quarter in arrears. | ||||||||||||||||
| 24 | Discount rate | % | 7.5% | Illustrative. One rate for every product; development risk is carried by the probabilities, not the rate. | ||||||||||||||||
| 26 | Operating costs | |||||||||||||||||||
| 27 | Fixed operating costs, Y1 | $m | 35.0 | Staff, research on new royalties, legal and audit of licensees’ reports. | ||||||||||||||||
| 28 | Fixed operating cost growth, annual | % | 3.0% | |||||||||||||||||
| 29 | Variable operating costs, % of receipts | % | 2.0% | |||||||||||||||||
| 31 | Purchase and funding | |||||||||||||||||||
| 32 | Price paid for the Product B royalty | $m | 760.0 | Paid at the end of Y0 for the royalty and its milestones from Y1. | ||||||||||||||||
| 33 | Target return on a royalty purchase | % | 8.0% | Used for the highest price that still earns it. | ||||||||||||||||
| 34 | Share of the price funded with new debt | % | 50.0% | |||||||||||||||||
| 35 | Existing debt, end of Y0 | $m | 600.0 | |||||||||||||||||
| 36 | Cash before the purchase, end of Y0 | $m | 750.0 | |||||||||||||||||
| 37 | Interest rate | % | 5.5% | On the opening balance. | ||||||||||||||||
| 38 | Repayment period | years | 8 | Equal annual repayments of the end-Y0 balance. | ||||||||||||||||
Select a cell to see its row, its schedule and the type of cell. Font colours: blue for inputs, black for formulas, green for links to other sheets. Scroll sideways to see every period.
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Pharma royalty and licensing model: the workbook
An Excel workbook with working formulas, no macros and no external links: the same model you can work with on this page.
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- The worked model
- 12 sheets and 2,696 live formulas, all 6 schedules built and linked, every check reading zero. Change an input in Excel and the whole model moves.
- The starter
- The same inputs and layout with the tiered royalty rates left blank for you to build, each blank cell marked. The worked model is its answer.
What the base case says
- Portfolio NPV
- $2,020.6m
- Purchase IRR
- 9.7%
- Equity value
- $1,410.6m
- Product A NPV
- $1,108.9m
- Product B NPV
- $863.7m
- Product C NPV
- $398.3m
- Product D NPV
- $66.8m
- Clinical risk adjustment
- $619.0m
- Receipts, Y1
- $281.7m
- Effective royalty rate at peak, Product B
- 7.0%
- Highest price for the target return
- $838.8m
- Multiple of the price
- 1.8x
Read from the workbook as served, every input at its default. Periods: Y0, Y1, Y2, Y3, Y4, Y5, Y6, Y7, Y8, Y9, Y10, Y11, Y12, Y13, Y14, Y15. The figures are invented and move with whatever you type in.
What this model is
A fifteen-year model (Y1 to Y15, from a Y0 base year) of an invented royalty aggregator that owns royalties on four drugs sold by other companies: two marketed products, one in Phase 3 and one in Phase 2.
The holder runs no trials and sells nothing. Each licensee develops and sells its product; the holder receives a tiered royalty on each year’s net sales until the royalty term ends, and the development and sales milestones the licence sets.
Each product’s sales follow a launch, a ramp to peak and a fall when generics arrive. Development products are weighted by the probability of reaching each milestone and the market. Royalties are collected a quarter in arrears.
The portfolio’s receipts, less operating costs, service the debt that funded the latest purchase. Each product is valued at its probability-adjusted NPV; the portfolio at their sum less the operating costs, and the equity after net debt. The Purchase sheet gives the IRR on the Product B royalty bought at the end of Y0.
Three scenarios (base, earlier generic entry and pipeline failure) and a board-style sensitivity table of the purchase IRR by Product B peak sales and price.
Seats: Equity research and hedge funds, Investment banking, Private equity.
Careers that do this work: equity research, hedge funds, investment banking, venture capital, private equity.
How the schedules connect
Every row in the workbook is tagged with the schedule it belongs to; the inspector above shows the tag when you click a row. These are the schedules this model is made of and where each one lives.
Clinical probability and stage gating
The chance of reaching the market, and what it weights
Assumptions, rows 15–20 · Products, rows 6–11 · Product A, rows 6–8 · Product B, rows 6–8 · Product C, rows 6–8 · Product D, rows 6–8
Royalty receipts and milestones
Sales curve, milestones, collection lag, operating costs
Assumptions, rows 23–24 · Assumptions, rows 27–29 · Products, rows 14–18 · Products, rows 30–33 · Product A, rows 11–15 · Product A, rows 29–31 · Product A, rows 34–43 · Product B, rows 11–15 · Product B, rows 29–31 · Product B, rows 34–43 · Product C, rows 11–15 · Product C, rows 29–31 · Product C, rows 34–43 · Product D, rows 11–15 · Product D, rows 29–31 · Product D, rows 34–43 · Portfolio, rows 6–13 · Portfolio, rows 16–21 · Portfolio, rows 24–36
Tiered royalty rates
Sales bands, marginal rates, step-down, royalty term
Products, rows 21–27 · Product A, rows 18–26 · Product B, rows 18–26 · Product C, rows 18–26 · Product D, rows 18–26
Debt schedule
Tranches, interest, amortisation and the sweep
Assumptions, rows 34–38 · Debt, rows 6–10 · Debt, rows 13–20
Royalty purchase returns
Price, receipts, IRR, multiple and the highest price
Assumptions, rows 32–33 · Purchase, rows 6–8 · Purchase, rows 11–16
Sensitivity tables
Two assumptions at once, without a data table
Sensitivity, rows 5–6 · Sensitivity, rows 9–16 · Sensitivity, rows 19–39 · Sensitivity, rows 42–66
What you should be able to explain
- Why a royalty holder’s cash flow is a slice of someone else’s revenue, so it carries none of the development, manufacturing or selling cost that a developer’s rNPV deducts.
- How a marginal tiered royalty works: each band of annual net sales earns its own rate, the bands reset every year, and the effective rate rises smoothly with sales rather than jumping at a threshold.
- Why the royalty term, set by the last patent the licence names, and the year generics arrive are separate dates, and what a step-down in the rate does between them.
- How development and sales milestones are paid and weighted: a Phase 3 milestone by the chance of passing the trials ahead, the approval milestone and every royalty by the full probability of approval.
- Why a purchase is judged on its IRR against a target return, and how peak sales and the price paid trade off in the sensitivity table.
What a reviewer looks for
- The top tier’s rate applied to all sales once the threshold is crossed, which overstates the royalty and makes it jump at the threshold.
- Royalties carried to the end of the forecast when the licence ends them at patent expiry, or cut to zero at generic entry when the term runs on at a reduced rate.
- A development product’s royalties counted at full value, or its Phase 3 milestone weighted by the probability of approval rather than of passing Phase 3.
- A sales milestone paid in every year sales sit above the threshold rather than once.
- Royalties received in the year they are earned, ignoring that licensees report and pay a quarter in arrears.
Conventions this workbook uses
Stated on the cover sheet too. A model is only as trustworthy as the decisions it tells you it made.
- Annual periods. Y0 is the base year; the portfolio is valued and the Product B royalty bought at its end, and only cash flows from Y1 are valued.
- Net sales = peak sales x uptake x exclusivity factor. Uptake rises linearly from the launch year and reaches peak in the last year of the ramp. From the generic entry year a retained share of sales continues. Sales are the licensee’s and are not the holder’s revenue.
- Royalty tiers are marginal and reset each year: tier 1’s rate applies to annual net sales up to the top of tier 1, tier 2’s to sales between the two thresholds, tier 3’s to sales above. Tier 1 + tier 2 + tier 3 sales equal net sales in every year, and the Checks sheet holds them to it.
- The royalty term ends in the last year of patent protection the licence names and does not move with generic entry. From generic entry the licence cuts the royalty by the step-down for the rest of the term.
- Probability: a marketed product carries a weight of 1. A development product’s Phase 3 milestone is weighted by the probability of passing the trials still ahead; its approval milestone, royalties and sales milestone by the probability of approval (PTRS), the product of the stage probabilities still ahead. All probabilities are illustrative assumptions.
- A sales milestone is paid once, in the first year annual net sales reach its threshold. Milestones are received in the year they fall due; royalties are collected with the lag, a share of each year’s royalty in the following year.
- Discounting is at the end of each year at one rate for every product, with development risk carried by the probabilities rather than the rate. Royalty income is modelled before tax.
- Scenarios: earlier generic entry brings competition forward on every product while the royalty term stays as written; pipeline failure sets the Phase 3 probability to zero, so neither development product earns anything. The purchase price and the Y0 balance sheet are the same in all three.
- The purchase loan and existing debt are one balance, repaid in equal annual instalments with interest on the opening balance. Cash after debt service is retained; no dividends are paid.
- The sensitivity table recalculates Product B’s royalty from its sales at each peak; its centre equals the Purchase sheet.
What this model does not cover
Where its answer stops, so you know what to add before relying on it.
- Country-by-country royalty terms and patent expiries; each product carries one term and one generic entry year.
- Royalty caps, buy-downs, anti-stacking deductions and royalties shared with a co-owner.
- Synthetic royalties and funding agreements that pay a capped multiple of the investment.
- Tax: royalty income is modelled before tax.
- Quarterly reporting, foreign exchange on non-US sales and audit adjustments to licensees’ reports.
- New purchases after Y0: the portfolio runs off as its royalty terms end.
Build it yourself
The starter workbook
The tiered royalty has been cleared on each product sheet: the sales in each tier, the royalty at the contract rates, the effective rate, the step-down, the term flag and the royalty earned. Rebuild it from the Products sheet, then watch receipts, the NPVs and the purchase IRR calculate again. The Checks sheet shows when the three bands add back to net sales.
Blanks: Tiered royalty rates. Download it beside the worked model.
The path around this model
Understand it, drill it, read the build, then apply it to a real company.
Build · Lab · ~12 min
Biotech Readout
Multiply stage probabilities, risk-adjust a programme, value a company in each outcome with a cash floor, and read the implied probability of success off a share price.
Read · Guide · 16 min
Biotech Valuation: rNPV, Launch Curves and the Sum of the Parts
Read · Guide · 7 min
Equity Research Interview Questions: The Coverage Mindset
Read · Guide · 16 min
How to Build a DCF Model: From Operating Assumptions to a Defensible Valuation
Apply · Skill
Company Profile
Build a banker-grade one-pager on any company, fast.
Apply · Skill
Model Audit
Find the errors in a financial model before someone senior does.
Vocabulary: Tiered Royalty, Royalty Monetisation, rNPV (Risk-Adjusted Net Present Value), Probability of Technical and Regulatory Success (PTRS), Peak Sales, Loss of Exclusivity (LOE), IRR, MoIC.
Questions about this model
How does a tiered royalty work?
Like income tax: each band of annual net sales earns its own rate. Product B pays 5% on sales up to $500m, 7% on sales between $500m and $1,500m and 9% above. At its $2,000m peak that is 5% x $500m + 7% x $1,000m + 9% x $500m = $25m + $70m + $45m = $140m, an effective rate of 7.0%. Applying 9% to all $2,000m would give $180m, overstating the royalty by more than a quarter.
What is the Product B royalty worth, and what does it return?
Its receipts, discounted at the 7.5% rate, are worth $863.7m, against a $760m price paid at the end of Y0. The purchase earns an IRR of 9.7% and returns 1.83 times the price; the highest price that still earns the 8% target is $838.8m. If generics arrive two years earlier, the IRR falls to 7.1%, below the target.
How much of the portfolio is probability?
The four royalties are worth $2,437.6m at their probability-adjusted NPVs, and $2,020.6m after the present value of operating costs. The two development products contribute $465.1m. Valued as if both were certain to be approved, the products would be worth $619.0m more: that gap is the clinical risk adjustment. In the pipeline failure scenario both Phase 3 trials fail and the portfolio NPV falls to $1,564.9m.
How is this different from the biotech rNPV model?
The biotech model is the developer: it pays for the trials, makes and sells the drug, and keeps the operating margin, so its value is revenue less every cost, weighted by probability. Here the royalty holder owns a contractual share of the licensee’s sales and milestones, bears none of those costs, and its risks are the size of the product, the date generics arrive and whether the trials succeed.
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