Licensing is a way of doing business that has existed for at least centuries.
Note: The advice in this article about licensing agreements is written from a business perspective, not a legal perspective. It is based on my experiences as a successful inventor. I am not an attorney, and this is not legal advice.
What Is Licensing?
Within the product development and innovation space, licensing is a way of facilitating the transfer of rights and ownership of assets from one party to the other. All forms of intellectual property — including provisional patent applications, utility patents, design patents, copyrights, trademarks, and trade secrets – can be licensed.
A licensing agreement sets the terms of the exchange taking place, including for how long, under what circumstances, where, and for what price.
Do entrepreneurs need to know about licensing? Yes! Licensing is a way of getting paid for doing something new.
It is especially important that creative people understand licensing, because licensing is often how people in the arts make money. You can license an idea for a new product, a brand, an established product, an entire product line, music, art, and so much more.
What Is A Licensing Agreement?
Every licensing agreement is different. In this article, I’m going to cover some basic elements of a licensing agreement.
The AUTM Technology Transfer Practice Manual explains the following:
A licensing agreement is a contract between parties to grant one party the right to utilize something owned or controlled by another party. The owner or controlling party typically receives compensation in return for granting this right. By maintaining clear, concise, and simple language, the intentions of the licensing agreement can be understood by anyone who reads it.
Clear, concise, and simple language is crucial to achieve the following:
- Ensure that both parties comprehend the terms of the contract and their
- Guarantee that any other individual who reviews the agreement interprets it in the same manner as the involved parties.
- If the agreement leads to legal action, such as in a court of law, it ensures that any third party, including a judge or jury, interprets the agreement according to your intended meaning.
Common Components Of Licensing Agreements
A licensing agreement typically begins with a section stating the effective date — the date the terms of the agreement are in effect and become enforceable — and the “parties” involved. The parties involved simply means which individuals or businesses are entering into the agreement. The parties are the ones signing the agreement, which typically includes the inventor (licensor) and the licensee — the person or company being granted the license to use your asset(s).
The agreement begins by clearly stating the names of the parties, their business forms, and their business addresses.
The book Profit from Your Idea: How to Make Smart Licensing Deals by Nolo Press provides the following as a sample:
This agreement is made, and effective as of ___________(“effective date”), by and between ________, a licensed corporation of the state of Florida, having its principal place of business at_________(“ licensor”), and ________, a Delaware corporation, having its principal place of business at __________(“ licensee”).
Should You Sign A Licensing Agreement In Your Own Name?
I do not sign any licensing agreements in my own name. Instead, I sign them in the name of my business entity for legal reasons. It is important to choose the correct business entity. If you require guidance, consult with your accountant or attorney to determine the appropriate business entity that suits your needs. In my case, I have always operated as an LLC.
In a licensing agreement, the party who is licensing the assets is the “licensor.” The party who is acquiring the assets is the “licensee.”
Items That Often Require Specific Definitions In A Licensing Agreement
To ensure clarity, here are a few items that may require specific definitions in a licensing agreement:
- Licensed patents
- Technical information
- License territory
- Licensed products
- Net selling price
- Trade secrets
- Confidential information
- Gross receipts
- Net sales
- Patent rights
- Property rights
- Effective date
Property rights, for example, encompass intellectual property rights such as patents, trademarks, and trade secrets — as well as domain names, copyrights related to the product, as well as other ownership rights including technical data, design, formulas, know-how, and artwork created, owned, and/or controlled by the licensor with respect to the product.
Interestingly, many licensing agreements lack definitions. Personally, I prefer including definitions in the licensing agreement for maximum clarity.
What “Grant Of License” Means In A Licensing Agreement
In my opinion, one of the most important clauses in a licensing agreement is the “grant clause.” This is also known as the “grant of license.” The grant clause defines the scope of the legal rights being given by the owner (the licensor) to the user, the licensee.
In intellectual property law, licenses allow individuals and entities to use patents, trademarks, and creative works owned by others without infringing on the owners’ property rights. (Source: Cornell Law School)
As a licensee, what I prefer to do is open the “grant of license” to include the product, not just the intellectual property, as well as any improvements. This allows you to be compensated regardless of whether a patent (or any other form of intellectual property) is issued or not. I will describe this strategy in another article.
What “Exclusivity” Means In A Licensing Agreement
Exclusivity refers to whether the rights in the agreement will be restricted to the party signing the agreement. In an exclusive agreement, the licensor is the only entity that gains the rights to use the assets under the terms set.
In my experience, most companies prefer exclusivity due to the time and expense involved in bringing a product to market. There are ways of carving out certain rights within your licensing agreement to give you the ability to continue monetizing your assets. For example, you can negotiate to retain the rights to your product in a different category or territory. I will discuss “carve outs” in greater detail later on.
What A Royalty Means In A Licensing Agreement
A royalty is a payment made by the licensee to the licensor. Royalty rates are often expressed as a percentage of the revenue obtained by using the owner’s property.
Royalty rates refer to payments of any kind received as consideration for the use of, or the right to use, the copyright of literary, artistic, or scientific work, including films, patents, trademarks, designs, models, plans, secret formulas, processes, or information concerning industrial, commercial, or scientific experience. (Source: RoyaltyRange)
You can earn a royalty by licensing know-how, design patents, and provisional patent applications as well.
A very standard royalty rate is 5 percent. There are many strategies you can employ to negotiate a higher royalty rate.
What “Performance Clause” Means In A Licensing Agreement
When you grant someone the right to market, manufacture, and sell your product idea, you need some type of performance clause. Basically, they need to fulfill certain obligations to retain the right to sell, manufacture, and market your product idea.
Performance clauses can take various forms. I particularly like to take performance clauses to sales and minimum guarantees.
Your licensee must sell a certain quantity of your product each quarter to maintain the rights to your intellectual property/product. If they fail to perform, you regain ownership of your technology, product, or idea.
Minimum guarantees necessitate a guaranteed payment, due either at the beginning of the transaction or with the start of a reporting period. The minimum royalty must be paid regardless of whether they have made that many sales, if they wish to retain the rights.
Performance clauses protect you, the licensor. Without some form of minimum guarantee when granting an exclusive license, technically they are not obligated to sell even a single unit! If you do not include minimum guarantees in an exclusive license, you are essentially giving away your product for free.
In another article, I will provide strategies on how to negotiate minimum guarantees. This is just a brief overview of some important aspects of the licensing agreement.
Excellent Resources To Learn More About Licensing Agreements
AUTM — The U.S. Association for Tech Transfer Professionals
Licensing International — The Global Trade Association For Brand Licensing
Licensing Executives Society (LES) — Worldwide Association For Licensing Professionals
inventRight’s Free Resources — We are the leading experts on product licensing.
My book, One Simple Idea: Turn Your Dreams Into a Licensing Goldmine