Should I Consider Licensing?
By Mark Levy
In the wonderful world of inventing, one of our prime motivators is the knowledge we're doing what we love. In addition, we hope our ideas will change the world, help mankind, and make us rich.
In truth, most of us would settle for just the rich part. But while many or possibly even most, inventors are great at inventing, it's safe to say we all need help at some point moving our inventions onto the profitable side of the ledger.
One area that can boost inventors’ success is licensing. Hugely important for corporations like IBM which alone maintains 40,000 active patents, licensing is big business. By licensing the patent rights to your technology, one can readily earn a profit from essentially renting out their ideas to someone else who can legally make, use, and sell them.
Many independent inventors don’t consider licensing because they figure they’ll produce and market the invention themselves. But if you’re not up to that, licensing is a great option. As a licensee, someone else is building the factory, buying the materials, hiring employees, marketing and selling your invention.
Should you consider licensing? Yes! But before you even talk to a manufacturer, you should first get a handle on licensing basics.
THE TOP FIVE LICENSING AGREEMENT ISSUES
While you can license any intellectual property - copyrights, trademarks, or patents - I’m limiting this article to license issues pertaining only to patents (i.e., inventions).
As a minimum, the following are primary elements you and potential licensees should have on the table. Since you and the other party will be approaching these issues from extreme vantage points, it’s important that you be willing to negotiate each.
1) Subject Matter
Contrary to popular opinion, you can’t come up with an idea, call a major company or TV shopping club, and expect a check in the mail. In every case I’m aware of, companies require that the subject matter you’re proposing be a patented invention - or be patent pending - before they’ll even talk about licensing. That not only assures them of a well thought-out idea, but it gets them the patent protection over their competition that you’ve already obtained.
Obvious as it sounds, this means crafting a clear, well-worded definition of exactly what you’ve invented. For example, say I’ve invented a new kind of car steering wheel. It’s vital to define that I own the rights to the technology that steers the car, not the car itself.
2) Exclusive vs. Non-Exclusive
Exclusivity, as it’s called, tends to be a sticky point. Because licensees want to prevent their competitors from getting access to the technology they’re paying for, most companies will seek an agreement exclusive to them. Some companies will even require an exclusive, or even an assignment (sale) of the entire patent.
However, what's best for the inventor is almost always licensing to multiple parties. Should one or more licensees fall down on the job or disappoint you in some way, one of your protections is strength in numbers.
It used to make sense limiting licensees to selling only within certain regions of the country or different countries, thereby granting exclusive agreements based on pure geography. However, with modern distribution and the Internet, companies want to reach out as broadly as they can. So a lot of licensees aren't going to consider a geographic limitation.
When a patent expires, its information is publicly known. So a license under a patent will always expire when the patent does, if not sooner. Because anyone can use your invention after the patent’s expiration, the maximum licensing term of agreement is going to be 20 years from the patent’s filing date; or, from the filing date of continuation patents, if any.
Frankly, I would go for the shortest possible time - six months, or a year or two. Thus if the licensee doesn't perform as expected, you aren’t tied to 18 or 20 years in a bad business marriage.
Licensees on the other hand, will argue they need a longer agreement to defray costs of production, sales and marketing. They may even insist on an exclusive license the entire 20 years. So at this point you would compromise - such as agreeing to three years, or five. Just try not to sign yourself up for too long a period.
As for actually getting paid under a license, there are basically two kinds of payments and a hybrid.
Royalty - This is usually a percentage of sales, and what you read right here may come as a reverse sticker shock. These days, royalties are generally 5 percent of sales. If the license is exclusive to one company, then you might be able to seek 6 or 7 percent or more. But if it's a non-exclusive license, that’s not worth as much to the licensee so you may be looking at 3 percent. This doesn't mean you have to start negotiations at 5 percent. If you wish, start at 20 percent and see what happens.
While we’re on this subject, you should know you have the right to inspect or audit the licensee’s books to ensure your royalty is based on real sales figures. Some companies and even entire industries - music and movies, for example - have been notorious for under-paying their royalties.
Lump sum - If your potential licensee is holding an extreme position, they may offer only a lump sum. And their idea of a fair lump sum is probably different from yours. Unfortunately, many inventors accept this pay arrangement out of sheer relief, but it’s not always a good business decision.
For example, some years ago, an inventor purchasing underwear in a large grocery store was annoyed that few sizes were represented. So he invented a clever packaging technique that simplified buyer selection while making for attractive store displays. The invention was a huge hit. Since sales are still going strong, you’d hope the story has a happy ending with royalties making an industrious inventor wealthy. Not so. Since the inventor had settled for a one-time lump sum payment of a few thousand dollars, the underwear manufacturer got the riches.
It’s because of experiences like these I never advise agreeing to a simple lump sum, at least without some negotiating.
Hybrid - This is a combination lump sum / royalty agreement. It’s what I advise and what the underwear packaging inventor should have done. You might get a smaller royalty, but that’s your hedge in case the product takes off. If it doesn't, you still have a substantial lump sum.
At this point, you may be asking the million dollar question: How do you figure the license payments?
Here's my secret. Begin by figuring out what you want from the lump sum portion of the hybrid payment, and come to the negotiation meeting with that calculated and typed onto paper. As an example how, say you invented a new pencil that will retail for 10 cents. Next, calculate the size of your audience and how many pencils you might sell them per year. Pick an arbitrarily long length of time - say two years. Next, say the total sales you derived over those two years is 10 million pencils. At 10 cents each, that's a million dollars in sales.
Presuming they’ll probably offer you 3 percent as a lump sum in a hybrid arrangement, be shrewd and start your price at 7 percent, or $70,000. Because the terms - two years and 7 percent of a million unit sales - were arbitrary, they’ll probably revise your sales estimate to seek a lower payout percentage. So be ready to negotiate. After that, then you add the royalty of at least a couple percent. This is a very solid approach because you initiate a starting point with verifiable facts, and that’s always a good business strategy.
AVOIDING COMMON ERRORS
In my experience, most errors derive from impatience where the inventor accepts the first exclusive deal with one licensee. While this generates quick cash, it also means the inventor probably gave in too quickly. Even if another manufacturer sees more marketing potential later, the inventor has no more rights to license.
Other common errors are not including bail-out clauses, and not addressing product quality issues up front. For example, if the licensee’s production quality turns out poorer than expected, you should be able to get that fixed, or end the agreement. If you can’t end it, that’s another reason to have several licensees and shorter-term agreements. Also, carefully check out the track record of any company you’re licensing to and ask for references. Many inventors scammed by so-called invention marketing companies typically don’t shop around enough.
Finally, let me repeat that you and the licensee both will be approaching any agreement from extreme viewpoints. That’s why you must do your homework, write out some verifiable calculations as a starting point, and be ready to negotiate each issue.
Should you consider licensing? Most definitely. But always regard it as just another part of the invention process. While it’s your baby being haggled over, it’s still just business.
For a free initial consultation, contact a business attorney at Denver based Block45Legal today by calling us at (303) 353-4531 or submitting a form here.