How to Make Money From Your Invention (Chapter 9) – Licensing Agreements

How to Make Money From Your Invention (Chapter 9) - Licensing Agreements

1. Negotiation

You have made an invention, done your homework, applied for patents, decided to license it, found a good licensee candidate and now we have to come to terms. This step is referred to as the negotiation phase, prior to drawing up the License Agreement.

Negotiating a License Agreement is usually a difficult and complex process because there are many factors that need to be considered. The process involves a series of give-and-takes. A successful negotiation involves an agreement where both parties can proceed in the business in an acceptable manner. If you do not have any or have limited experience in negotiating license agreements, professional help should be used in this activity. Certainly, an attorney should draw up the license agreement.

Terms and ConditionsBefore negotiation begins, you should draw up a list of requirements, commonly called a “term sheet”, that is, what you would like to have in the final agreement. There should also be a separate list of issues that could make or break the deal. That is, positions you believe that you cannot move from, should the other side insist on taking them. At the start of the negotiation, it would be useful to have a draft of an agreement that makes your position clear to the potential licensee.

It is important in negotiating to understand the other parties’ interests. In this way, you can shape your positions to respond to theirs. With an understanding of the interests of the parties, the issues become less of a problem to overcome.

When you have to make some difficult decisions in a license negotiation you should ask yourself, what are the best alternatives to a negotiated agreement, or BATNA? For example, if you have other anxious candidates for the license, you may take a position that you wouldn’t if the BATNA for you is to go into business yourself.

Mutually Beneficial Agreement1a. Key Points to Remember

It has often been said that the final License Agreement needs to be mutually beneficial to both parties and a win-win deal. If the relationship is going to last, both parties need to have their interests realized, i.e., adequate compensation for the licensor and a profitable business for the licensee.

A point to remember is that it is difficult, if not impossible, to go back to the negotiating table after the agreement is signed. There are exceptions, for example, if a clause is so onerous that there is little incentive to practice the license. Before and during the negotiation, try to visualize the all the possibilities for your invention. Where else can it be used? How is the licensee using the invention? What products are they making? Are there valuable by-products being made? Does your agreement cover these potential value added products? If not, try to include as many eventualities as possible.

2. Key Licensing Clauses

There are no standard license agreements or terms because of the breadth and variety of terms that can enter the agreement. These terms also depend upon the type and stage of intellectual property under discussion, which adds to the complexity.

It also depends on the prevailing terminology used in agreements by larger entities and government labs. However, there are many clauses that will be present in most, if not all, final agreements.

Example Contract Clauses2a. Example Clauses

The following is a summary of the general form of most agreements with the key clauses explained in each part.

A. Identification of the Parties

This clause provides the names, addresses and incorporation details of the parties and the date of the agreement.

B. Whereas Clauses

Outlines the purpose of the agreement, the key terms and what each party brings to it.

C. Definitions

Provides the field of the agreement, what is being licensed, definition of terms and proprietary information.

D. Grants of Rights

1. Exclusivity

An exclusive license grants the licensee exclusive rights to the intellectual property. This can be limited by the field of use or geographical area. For example, the licensee can have exclusive rights in the U.S., whereas others might have the same exclusive rights in other countries.

Nonexclusive rights grants to you and others, the right to practice the technology. The same limitations to territory and field of use, as in exclusive rights, applies here.

Hybrid rights, between exclusive and nonexclusive, are also sometimes provided. An example would be an exclusive license, except for one other party with the same rights.

As the licensor, what is the preferred route? If the invention needs a lot of development, it may be better to grant exclusive rights to avoid conflicting efforts. It also depends on the nature of the invention. If it is a breakthrough or a platform technology, nonexclusive rights are probably best.

2. Geographic Limitations

As explained above, a licensor can restrict the geographic area where the rights can be practiced.

3. Field of Use Limitations

The grantor can also restrict the field or area of use of the rights. For example, a lubricant can be licensed for use in marine engines only.

4. Grantbacks

This clause involves the granting back of improvements made by the licensor to the licensee. The reverse of this, grant forward, can also be included.

5. Sublicenses

Answers the question of whether, or to whom the licensee can sublicense.

E. Compensation

1. Up-front payments

Payments made to the licensor at the start of the agreement.

2. Lump Sum or Paid Up Licenses

These are terms used when the technology is licensed without a running royalty. The agreed payment is made at the start of the agreement.

3. Milestone Payments

These are objectives that, when met by the licensee, trigger a predetermined amount of compensation.

4. Royalties

This part of the agreement gets the most publicity. The royalty rate is often used to gauge the value of the license. However, there are other terms and restrictions that can strongly affect the value. The net value to the licensor should take into account all the factors in the agreement, which is the product of the negotiation process.

The royalty rate is an important consideration in the agreement and is generally a percentage of an easily determined unit of sale or a fixed amount per unit of production. Small differences can result in large amounts of money, so the exact number is important.

How do you determine what is an acceptable royalty? There are several ways to approach it as we have described earlier in valuing intellectual property. In the market approach, we try to find royalties from comparable license agreements. This is a good method but remember, that you may not be able to determine the rest of the details in the agreement, so the royalty number may not tell the whole story.

Another method is to use the “25% rule of thumb”, an income approach. The premise for this rule of thumb is that the licensor is entitled to 25% of the expected operating profits from the product that uses the licensed intellectual property. For example, if the operating profit return on sales is estimated to be 12%, the royalty should be 3%, i.e., 25% of 12%.

The final royalty rate depends on other factors besides the 25% rule. For example, an exclusive license can command a higher royalty than a non-exclusive one. Territorial restrictions would tend to lower rates compared to a world-wide license. An early stage technology should have a lower royalty than a fully developed product.

In negotiating the royalty, the licensor should understand and be able to defend the royalty rates offered.

5. Minimum Royalties

This is an approach to assure that the licensee makes a diligent effort developing and commercializing the licensed product or process.

6. Auditing

This sets out the method to determine whether the licensee is paying the right amount.

F. Infringement

This clause determines who will go after infringers, who will defend the licensed intellectual property against infringement suits and who will pay for the effort.

G. Term Termination

Termination clauses define the conditions under which the license becomes null and void. The term is usually defined as when the last patent expires.

H. Dispute Resolution

This clause provides the means to resolve disputes. The usual approach is to require arbitration. An alternate approach is to require mediation, where a compromise settlement is possible, before binding arbitration is attempted.

I. Indemnity

Defines who is responsible for any problems, claims, law suits or other damages resulting from the use of the licensed property. Whose insurance will cover any unforeseen problems?

J. Assignment

Defines the conditions, if any, under which the license can be assigned or transferred.

K. Applicable Law

This article states the governing law that will be used in resolving differences.

L. Other

There can be other clauses depending on the complexity of the business area, the technology and the needs of the parties.

M. Signatures

The agreement will be officially executed when it is signed by the responsible parties from both sides.

3. Maintaining the License

3a. Milestones

The signing of the license agreement requires that a new set of “due diligence” processes must be developed to verify full compliance of the licensee with the components of the license.

Of foremost importance is the meeting of milestones incorporated into the agreement along with the attendant financial considerations for the license itself.

Line DiagramIt is quite common for licensors to set up standard time line diagrams to alert themselves regarding specific items that are triggered by dates within the agreement. Items that may be included in such a time line are:

• Payment dates for royalties, annual minimums, options, etc.

• Milestone dates for commercial or technical implementation requiring reporting of status, back to licensor

• Technology or business updates by both licensor and licensee for maintenance of any ‘Grant Back’ or ‘Grant Forward’ provisions relative to new technologies as extensions from the original date of the agreement.

Clearly the focus of traditional monitoring has been towards financial payments with the agreed upon dates. Clearly defined within the agreement will be the dates when payments are to be made and for a royalty, clearly how they are to be calculated. The attendant record keeping requirements will also be present. Lastly the need to have within the agreement “late fee payment penalties” is always good practice.

Auditing3b. Auditing

Included within the license agreement should be a section on “Audit Rights”, which gives the licensor provisions to conduct annual audits on the licensee (including foreign subsidiaries). It is important to do this once the royalty provisions are triggered within the agreement and generally at the end of the first year of the license. Basically this will prevent any communication breakdown and will insure that the licensee is living up to their part of the agreement. Practical experience in the licensing arena suggests that it’s far easier to correct issues after the first year than after the fifth year of any agreement.

Successful proactive monitoring of agreements will result in a consistent cash flow to the bottom line. The use of standardized internal procedures also allows the handling of multiple license agreements routinely, and also provides an important tie in with other important dates, e.g. continuing prosecution of new patents in the field as well as monitoring the maintenance fees due for all patents that have subsequently been issued.

Negotiations Meeting3c. Grant Forward and Grant Back Provisions

The inclusion of “Grant Back” or “Grant Forward” provisions will require that meetings be set up at some frequency, for the exchange of appropriate information. It is important that all information transmitted and the discussions taking place during these meetings be properly documented in writing and substance, agreed to by all parties. This insures that even innovations conceived during the meetings will be documented and accrue to the appropriate parties designated by the licensee.

Should issues arise which cannot be amicably settled between the parties then the provisions dealing with arbitration, mediation or separation will need to be invoked.

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This information is presented for the general education of independent inventors by the Invention Patenting Group. The Invention Patenting Group makes no warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product, or process disclosed herein, or represents that its use would not infringe privately owned rights. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer or otherwise, does not necessarily constitute or imply its endorsement, recommendation, or favoring by the Invention Patenting Group.

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