Helping readers protect their new ideas and inventions, Grid Law founder David Walker explains everything small business owners need to consider when negotiating an intellectual property licence.
In my last article I gave you a seven-step formula for turning your new product idea into a profitable business. A crucial stage in achieving this is licensing your intellectual property rights to someone else, rather than trying to do everything yourself.
The licence agreement is therefore a fundamental part of your business, so it’s essential to get it right. To help you negotiate the best deal, I’m going to take a closer look at the top five issues you should be thinking about.
What does a licence do?
By granting a licence of your intellectual property rights, you (the licensor) are giving the other party (the licensee) permission to use your IP on pre-agreed terms.
If the licensee doesn’t abide by these terms, or trades outside them, they will be in breach of contract. This will give you the right to terminate the licence, take legal action and potentially claim compensation.
Where do you start when negotiating an intellectual property licence?
Naturally, the licensee will want as much freedom and flexibility as they can have but you need to be careful not to give too much away. In the early days, when the product is still being developed or is new to market this can be difficult to judge and your bargaining position won’t be as strong. However, it’s still possible to add provisions to the licence to protect you in the long term.
Exclusive or non-exclusive?
This is probably one of the first points to discuss and agree. If you grant an exclusive licence you’re granting the rights to your intellectual property to only one licensee. You don’t even have the right to sell the products yourself. If you grant non-exclusive licences, you can have as many licensees as you wish.
Nine times out of ten, the licensee will want the exclusive right to sell your products. If they’re investing significant amounts into developing your idea into a market ready product, they will want the best opportunity they can have to recoup that investment without competition from other licensees.
When you have a fully developed product and it has become established in the market place it will be easier to negotiate non-exclusive licences or offer exclusivity only in specific territories.
Licences can be worldwide or limited to specific territories. If a licensee doesn’t have the resources to sell your products on a global scale, you can specify a limited area in which they can operate.
You can then grant a number of exclusive licences and each licensee can operate in their own particular area without having to compete against other non-exclusive licensees. This gives you, the licensor, the best chance of maximising your profits because an exclusive licence is always more valuable than a non-exclusive licence.
Normally, the territories are geographic areas. For example, the licence could be restricted to a continent, country, or even a town. The size of the territory is usually decided according to the number of potential customers in that territory. There must be enough to make a license an attractive proposition for the licensee.
Also, carefully consider who has the right to sell online where geographic boundaries are less important.
Licences are usually granted for an initial term of between three and five years. After this, they can then be extended, either annually or indefinitely until one party gives the other notice to terminate.
The licensee will often want as long a licence as they can have, especially if they are investing heavily in development costs or the product is a great seller and they want to profit from their exclusivity for as long as possible.
As a licensor, you may want a break clause in a long licence. This will give you the option to terminate if the licensee isn’t selling as many products as you had hoped and you want to appoint an alternative.
Our recent webinar with David covered the basics of intellectual property for small business owners, helping entrepreneurs give their brand a competitive edge.
Intellectual property protection
Your intellectual property is your most valuable asset so it’s crucial to consider all the relevant issues to protect it.
First, during the development of a market ready product, the licensee may move away from your original idea and create some new intellectual property. It’s essential that this new IP is assigned to you, so that you own it. Then you licence it back to the licensee.
If the licensee owns the new intellectual property, they no longer need you. They can manufacture and sell the products without a licence and without having to pay you a royalty!
Next, consider who will be responsible for the costs of protecting your intellectual property. This is likely to be your biggest expense. Therefore, you can agree that the licensee will pay these costs or give you an advance on royalties so you can.
If the licensee agrees, it will mean they’re making a much greater financial investment into your product and this will likely be reflected in a lower royalty rate. However, if this means you don’t need loans or other investment, it can be a huge advantage to you.
Finally, you have to be prepared to defend your intellectual property against infringements. Both you and the licensee should be on the lookout for potential infringers and if you find them you need to take action fast.
It’s important to agree in advance who is responsible for taking legal action against any infringers. To compensate the party who takes the action, it’s usual to agree that they keep any costs or damages they recover.
If it’s the licensee’s obligation to defend the intellectual property, try to negotiate that you receive a percentage of the damages recovered equivalent to the royalties you would have received from a legitimate sale.
Royalties are always a hotly debated subject and are often the final point to be agreed because their rate depends on a number of factors. As we have seen, an exclusive licence will be more valuable than a non-exclusive licence. If the licensee is responsible for protection costs, the royalty rate will be lower than if the licensor pays them.
Royalties are usually calculated as a percentage of a particular price. For example, it could be the net sales price of the product, the landed price or the FOB (free on board) price. Whichever it is, be very clear about what this means and don’t think that five per cent of a net sales price is going to be much the same as five percent of a landed price. They could be very different.
If there’s an international element to the licence, think about the currency the royalties are calculated and paid in. With fluctuations in exchange rates this can also make quite a difference to the amount you ultimately receive.
If you have granted the licensee an exclusive licence you can specify a minimum royalty they have to pay each year to keep their exclusivity.
This protects you from a licensee that isn’t maximising their efforts to sell your products. If they don’t make sufficient sales to achieve the minimum royalties you have three options. You can:
- Require them to personally pay the shortfall in royalties
- Take away their exclusivity and convert their licence to non-exclusive
- Terminate their licence so you can appoint a new exclusive licensee
These are just five issues you should be considering and as with all contracts, the devil is in the detail. The more effort you put into discussing and agreeing the licence terms now, the less chance there is you will end up in a dispute later.
If you have any questions about intellectual property licences or how to turn your product idea into a profitable business, please email me at email@example.com.
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