How to Make Money From Your Invention (Chapter 5) - Licensing Basics
Licensing is the granting of the right to make, use or sell a proprietary product, process or service, in return for payment. The granting of the license is done by the party that has the legal right to do so and is known as the licensor. The receiving party is known as the licensee. To grant a license presumes ownership of some form of intellectual property protection that describes the property. The protection can take the form of a patent, trade secret, trademark or copyright. Without a clear indication of ownership it will be impossible to enter into a license agreement.
There are many parameters to consider in the agreement, such as exclusivity, geographic restrictions, time, royalty and many others. Most license agreements are unique in that they are the result of a negotiation between the licensor and the licensee and it is difficult to find exactly comparable situations. There are generic license agreement forms that can be used to help in these discussions. We will discuss most of the important terms and clauses in the later section on the License Agreement.
Since the license agreement is legally binding, experienced counsel should be part of the team used to draw up the final terms and conditions. In addition to the legal aspects of the agreement, it is recommended that you use the services of a licensing professional to help frame the agreement. The licensing professional will help determine the appropriate parameters that will affect the marketing and business future for the licensee and the licensor.
2. Who Licenses and How Much?
In the past 25 years retail product royalties from licensing has grown from a few billion dollars at the global retail level to about $120 billion in 2000, according to the publication, Business and Legal Aspects of Licensing, (CONSOR, La Jolla, CA). This includes all trademark and copyright licensing as well as patents and trade secrets.
In patent licensing, major groups involved in this activity in the U.S. are the universities and the federal labs. Data from the Association of University Technology Managers indicate that the U.S. royalty income from university licenses was a little over $1 billion in 2002. The royalty income to universities has grown at nearly 17% per year since 1992.
According to the GAO report to Congressional Committees of October, 2002, the Federal Laboratories received about $70 million in royalty income in 2001 from invention licenses. The growth rate since 1997 was about 9%/yr.
Licensing, and the income derived from it, is a very big business. Royalty income is earned by independent inventors, small, medium and large businesses, universities, government laboratories and other non-profits. Every inventor has the opportunity to profit from his or her discovery. Successful licensing depends on many factors, not the least of which is an invention that meets a market place need. We will point out the important factors in the licensing process.
3. Benefits and Drawbacks of Licensing
Licensing for the individual or small business inventor is attractive because it largely avoids the risks, time and the need for special talents needed in manufacturing, sales and distribution of the product or service.
The ultimate benefit is that the time to commercialization and the start of your income stream is shortened, if you have chosen the licensee wisely.
The drawbacks are that you lose control of the commercialization process, although, within the scope of the license agreement you can control some aspects, such as appropriate milestone payments. Unless otherwise spelled out in the license agreement, the licensee controls the approach to the technology and market development of your invention.
There is also the risk that the licensee you chose does not perform as expected. This could be because you didn’t investigate the licensee well enough, the market changed or the strategic approach or objectives of the licensee changed.
Perhaps, more importantly, the major drawback is that the licensor gives up the largest portion of the potential profit from the invention. In most cases the licensee can expect about 25% of the operating profit of the business. We will discuss this rule of thumb in more detail when we discuss valuing your invention.
The choice to license as opposed to self-development is a classical example of the tradeoff between risk and reward. That is, the greater the risk, the greater the reward. In the case of a license, the reduction of risk by licensing to a more capable entity is compensated for by a lower reward.
4. Types of Licenses
Although you can choose to license any type of intellectual asset, our discussion centers mainly on patents and trade secrets. License agreements in these areas can be classified by the restrictions they place on the licensee.
For example, a license may be exclusive or non-exclusive. In an exclusive license, the licensee will be the only one to have the rights to the property, subject to the other terms of the agreement. The licensee may only have rights within a certain market. These field-of-use rights may be exclusive in these markets or not.
Similarly, the licensee may be limited to certain geographic areas where the markets and exclusivity can be limited. However, the geographic regions of the license can only apply within those areas that have patents in-force, unless it deals with trade secrets.
4b. Trade Secrets
Trade secret licenses involve the same type of agreement variables as patent licenses. One major difference is that a patent license terminates when the last patent expires. The trade secret agreement can go on as long as the trade secret remains a secret. Thus, there is no termination period. However, if someone independently discovers or uses a trade secret, the exclusivity of the intellectual asset is gone.
License agreements can also involve combinations of trade secret and patent licenses. These are referred to as hybrid licenses and are quite common when the two are needed for successful commercial implementation.
Although not an actual license, an inventor can grant an option on the technology to a potential licensee. This option typically will allow the potential licensee to determine the potential value of the intellectual property under consideration. In some cases the option will be exclusive, i.e., not given to others during the option period.
The option agreement will usually contain clauses describing the intent to agree on a mutually acceptable license, should the evaluation be positive. In return for the option agreement, the licensor will receive compensation.
A variation of the above would be an actual license with an option for a limited period of evaluation time. The terms of the license are spelled out and are applicable should the option period prove positive.
There are many parameters to consider in drafting a license agreement. The limitations presented above are just some of the possible restrictions that can be placed on the licensee. We will discuss them in more detail when we review the license agreement. Suffice it to say that the final agreement can be very complex and lengthy. Skilled professionals should be involved in the licensing process to avoid any future problems.
Compensation to the licensor is usually in the form of a royalty payment. A royalty is the agreed upon rate of compensation paid to the licensor based on a measure of revenue generated by the invention. The usual approach is to define a percentage of sales generated by the technology, although any measurable unit can be used. The percentage royalty is usually in the range of a few tenths of a percent to 10% or more, depending on the technology.
Additional compensation can be in the form of up-front payments and milestone payments. Milestone payments are made by the licensee to the licensor when agreed upon goals or milestones are achieved in the commercialization pathway.
There are many factors that need to be considered in establishing the compensation paid to the licensor and we shall discuss them further in the License Agreement section.
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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.