To many inventors, licensing IP to a third party is often considered to be the best way of getting a monetary return as it represents a way of recouping the money spent on IP protection as well as making a profit. Better yet, the inventor won’t have to worry about manufacturing, supply chains and distribution, as the licensee will take care of production and sales.

Here are some useful things to know when it comes to licensing your IP.

1. What won’t happen

First off, it is important to understand what will (almost certainly) NOT occur:

• You have an idea
• You reveal your idea to someone with deep pockets that you think might be interested
• This person is interested in the idea and its potential value and immediately agrees to partner with you, putting up all of the money for IP protection and agreeing to mentor you through the process
• Everyone who sees the new idea wants to buy it or invest in it
• You become immensely rich!

This very rarely happens. There might be the odd lightning strike, but most of the time, in order to get an idea off the ground, you have to be prepared to invest time and resources to make the idea into a real product and then work hard to convince someone else to believe in the product enough and for long enough to invest their own money in it, before you begin to see a moderate return.

2. The Golden Rule

In IP, the Golden Rule is not: the person with the money makes the rules.

In IP, the Golden Rule is: if it is not in writing, it doesn’t exist.

In other words, if you are going to license your IP to a third party, you will need a formal, written licence agreement.

We understand that many types of agreements do not have to be in writing and that an oral agreement can be as effective as a written agreement. However, our advice is to always record IP agreements in writing – they are too complicated to risk anything else.

Where possible, you should have a formal document prepared by a solicitor trained to prepare licence agreements.

A licence agreement prepared by a solicitor will cover the specific situation that you are in, including a lot of standard terms or ‘boilerplate terms’ to cover most eventualities and also the specific terms you want to be included, which may include things like royalty rates, how royalties are calculated, when royalties are paid, the term of the licence, whether the licence can be renewed, and whether the person taking the licence (the ‘licensee’) can license it again to someone else (a “sub-licensee”).

If you think about what you want in the licence agreement before going to the IP solicitor, it will be a lot simpler (and less expensive) to write the licence agreement.

Unless a licence agreement (or any agreement for that matter) is written specifically for use in multiple situations, or unless you know exactly what you are doing, never simply take an agreement that you (or anyone else) have used before and try to modify it for a new situation.

3. Think about what you want out of a licence

Before you visit your IP solicitor, think about what you want out of the licence. You will need to know what you want so you can explain it to the person taking the licence as well, so it is a good exercise to undertake at the very start of your licensing journey.

The royalty rate and/or lump sum is an important feature of the licence. Too high, and the person taking the licence may not be motivated to push sales because they do all the work and you reap a disproportionate reward (so they won’t want a high royalty rate); but if the royalty rate is too low, you miss out on a decent return for your hard work in developing the IP.

There are many ways to structure the money that flows to an IP owner under a licence agreement.  For example, the royalty rate may be a flat rate such as 3%-7%, but of what amount? The sale price? The manufacturing cost? The profit made on the sale? Net or gross? Each of these has its own advantages and disadvantages.

Further, a royalty rate may change over the period of the licence or with the number of products made or sold.  For example, you might incentivise a longer licence agreement by agreeing to decrease the royalty rate over successive years. A royalty rate may also decrease the more products that are sold or made, for example, 5% per item for the first 10,000, then 4% for the next 10,000, then 3% for any more than that.

Ultimately, you can ask for whatever you think you can get in a licence agreement but that must be balanced with commercial sense, in that if you ask for too much, then the potential licensee will be less motivated to push sales of the product once a licence is agreed and will be less likely to take up a licence in the first place.

Royalties can be kept separate from other forms of payment such as initial licence fees, development instalment payments, consulting payments, and the like.

As with any relationship, the best licence agreement will be a ‘win-win’, with something in it for both parties, which will also help the relationship prosper. You need to remember that 20% of nothing is still nothing whereas 3% of 100,000 sales can amount to a lot, so always strive to be realistic in your requests.

Resource: Download our licensing checklist to review typical terms that could be included in your licence 

4. Think about the other terms

The royalty rate may be the most often thought about term in the licence agreement, but there are many other terms that are equally important. Remember, the licence agreement defines the rights and obligations of both parties, sometimes for quite some time.

• What form the payment actually takes? Percentage, lump sum, initial fee + rate, instalments or a combination of these. Ramping (increasing) royalty or decreasing royalty? Is there a cap on royalties or a premium royalty rate for high performance?
• What is being licensed? Just registered IP or know-how as well.
• What can they do with it? Is it a licence to make and sell, can they export it, can they make improvements or develop it or modify it?
• Where can they do it? Geographical scope – worldwide or limited countries?
• What happens with developments or improvements? Who owns them? Whose responsibility is it to protect them?  What if they don’t take the agreed steps?
• How long will the licence last? Pretty basic but surprisingly often missed out!
• How is it renewed/options for extending? Can it be extended? Is there a renegotiation of the terms or can it just be renewed on the same terms if a notification is made? What happens if the licensee keeps paying you but doesn’t formally notify you that they want to continue?
• Sublicensing – can they license to others too? If so, on what terms and how is any payment to you calculated?
• Minimum performance standards – are there any? These can be a good idea to ensure that the licensee doesn’t just sit on the idea.
• Auditing – how can you check up on them to make sure that they are paying you for every product made or sold?
• What can trigger the end of the contract and what happens?
• Product warranties – who will assume liability if a customer or purchaser sues for product defects or failure to perform to specification?
• Indemnification – who bears the risk of third-party claims for IP infringement?
• Infringement of the licensed IP rights – who has responsibility to take action?

These are just some of the terms that need to be clarified and included in the agreement.  Hopefully the list above clarifies why you should absolutely follow the Golden Rule!

5. You need some form of IP in order to license it

This last one is simple but is overlooked by a lot of people. You must have some IP in order to license it to someone else. That generally means that you must obtain some protection of your innovation so that you can then license it.

You can license non-registered IP rights, such as know-how, technical information, copyright and even goodwill, but aside from copyright, it is much easier to negotiate and police a licence if your licensed IP right is a registered right such as a patent, registered design, or registered trade mark. Often know-how and technical information is bundled up with a patent in any licence agreement.

Many potential licensees will not even begin to negotiate a technology licence unless there is at least a pending patent application covering the technology in the country or countries they wish to trade in; and some potential licensees may even require a granted patent.

You don’t need to have granted or registered protection before starting licencing, but it does help as you may only be able to charge a lower royalty rate before your protection is granted or registered which then rises once you get to grant or registration.

As should be clear by now, licensing IP to someone else is not easy nor is it straightforward, but for many people who do not want to organise manufacturing or sales networks for their innovative products or processes, licensing represents the most common form of commercialisation of IP.  You just have to think your way through it!

If you have any questions about anything we have covered in this article, or intellectual property in general, please get in touch with one of our team.