You already know you have a great idea, a great invention, or have developed a new technology. Knowing this inspired you to find a company interested in taking your idea further. And now, through your hard work, you have found a company that also thinks your invention is great! They are in the right industry, so not only can they appreciate the value of your idea, but they are also in a position to make it happen! Congratulations! This is a fantastic place to be. And at this point, you are probably asking, “Now what?”
The next step is to make some type of agreement between you and the company. The purpose of the agreement would be to give them the right to manufacture and sell your invention, in exchange for them paying you royalties. This type of agreement is commonly called a “licensing agreement,” and it’s an essential step toward getting paid for what you have created.
Precisely because it is such an essential step, it is also a step that must be taken very carefully.
There are many traps or pitfalls that can occur when drawing up a licensing agreement. In this article, we’ll discuss one of the most common traps—to help you prepare for this phase of commercializing your invention with the proper amount of caution.
Types of License Agreements
The first step in obtaining a licensing agreement is identifying the asset to be licensed.
- Trademarks: Ensure your trademark is registered with the United States Patent and Trademark Office (USPTO) to grant enforceable rights under the Lanham Act.
- Patents: Only patented inventions (granted by the USPTO) can be licensed. A provisional patent application does not suffice for licensing.
- Copyrights: While registration with the U.S. Copyright Office is not mandatory for licensing, it is advisable for better enforcement.
- Trade Secrets: Protect trade secrets through confidentiality measures before entering a licensing agreement to prevent disclosure
Drafting a comprehensive licensing agreement is crucial to protect the rights and obligations of both parties. The agreement should address the scope of the license:
- Exclusive vs. Non-Exclusive: Will the licensee have exclusive rights, or will others be allowed to use the IP?
- Territory: Define geographical boundaries where the license applies.
- Duration: Specify the term of the license and renewal options.
There are two main types of licensing agreements:
- Exclusive: You are talking about an exclusive licensing agreement if the company you are dealing with will be the only one you allow to produce your invention.
- Non-exclusive. On the other hand, a non-exclusive license agreement means that when you are finished making a deal with this company, you can turn around and look for other companies to also make deals with.
Non-exclusive license agreements can really help a product spread. For example, when Phillips invented the compact disc, they licensed their technology to many different companies who were then allowed to produce compact disc players. This allowed the compact disc to virtually replace phonograph records within a few short years.
For an individual, however, it will usually be the case that the company you are dealing with will want an exclusive license. For this reason, you must be aware of the biggest trap that inventors fall into: What if the company to whom you have given an exclusive license decides to “shelve” your idea?
Scenario
Consider this example. You are talking to XYZ Corp. about licensing your invention. They love the idea, and they project $10 million in sales over the next three years. It all sounds great, so you enter into an exclusive agreement with XYZ Corp. to manufacture your invention. The term of the agreement is for the life of the patent. They agree to pay you a 10 percent royalty on all products they sell. Sounds great! If all goes according to plan, you’ll rake in a cool million dollars in royalties!
But what happens if a year goes by and XYZ hasn’t produced or sold your product. How much do they owe you in royalties? Two years go by? Five years go by? The answer in all cases is zero. They don’t owe you anything unless they produce the product. If they never produce it, they never owe you a single dollar.
Now, if years go by and they never do anything with your invention, are you free to find another company to work on your invention—or to produce and market it on your own? NO. If you made the agreement described above, you would be effectively stuck. All of the rights to produce your invention would belong to XYZ, for the life of the patent—which is ‘forever’ in the world of innovation. (Actually, in the real world, it’s 20 years from the date you filed for patent protection.) And XYZ would never have to pay you a penny!
To avoid this trap, there are several things you can do:
1. Limit the term. This is the most basic defense against a company that doesn’t follow through with producing your invention. If the contract is for a limited term, at some point the rights will revert back to you.
2. Get money up front. Sometimes, money obtained upon signing the contract is called “good faith money.” That’s because it tends to show that the company is serious and acting in good faith. If they weren’t serious, they probably wouldn’t be willing to pay money up front. The only way for them to recoup their investment would be to actually produce your invention (which would begin generating royalties for you anyway). So the money they pay you is a strong motivation for them to get things moving forward, and usually demonstrates their genuine intent to do so.
3. Include an anti-shelving clause in the agreement. Putting such a clause in the agreement will give you the right to cancel the contract if the company doesn’t perform certain agreed upon actions. Sometimes, a timetable is created for moving the invention into production. Other times, this clause is structured as a “minimum royalties guarantee”—requiring the company to either pay you a minimum royalty in a certain time period, or default on the agreement.
Clearly, the most important thing you can do is work with an attorney who is experienced with licensing agreements. There are many more details that ought to be addressed in the agreement that are beyond the scope of this article. A professional will make sure your best interests are considered.
And remember, if you filed a patent application, and you idea is patent pending when it gets to the point that a company is seriously considering entering into a licensing agreement with you, they will have their own attorneys research your invention to determine whether you are likely to get a patent, and how strong such a patent would be.
In the event you don’t have a good sense of what they will find out in their research, not only could this be a deal-breaker, but it could also give them reason to move ahead with the idea without you! This is yet another reason why doing your homework ahead of time will help prevent surprises later.
Other Types of Licensing Agreements
Licensing agreements are legal contracts that grant permission to use intellectual property (IP) under defined conditions. These agreements enable IP owners to monetize their creations while allowing others to utilize valuable assets. Here are other types of licensing agreements:
Non-Exclusive License Agreement
A non-exclusive license lets multiple licensees use the same IP simultaneously. That way, licensors can broaden their IP’s reach and generate revenue through various partners. Licensees have full access to valuable IP without the exclusivity premium, enabling increased market competition and innovation.
Cross-License Agreement
Cross-licensing involves two parties granting each other rights to their IPs. This mutual exchange fosters collaboration, reduces litigation risk, and speeds up technological advancement. Often, companies use cross-licenses to pool strengths, avoid infringement disputes, and enhance product offerings by combining complementary technologies.
Royalty-Free License Agreement
A royalty-free license allows the licensee to use the IP without making any further royalty payments. In most cases, the licensee pays a one-time fee. This model is common for open-source software and some creative works, where financial barriers to use are removed to encourage widespread adoption and innovation.
Perpetual License Agreement
Perpetual licenses grant the licensee indefinite rights to use the IP. Unlike time-limited licenses, perpetual agreements are paid for life with a one-time payment. This arrangement is common in software licensing and gives businesses stability and predictability of costs for essential tools.
Compulsory License Agreement
Compulsory licenses are government-mandated authorizations to use IP without owner consent, usually for public interest reasons. They are common in the pharmaceutical industry, allowing the production of generic drugs to improve accessibility and affordability while balancing IP rights with societal needs.
Source Code License Agreement
Source code licenses cover how a software’s source code is used, modified, and distributed. They define permissions and restrictions that affect collaboration and development. Open-source licenses, for example, encourage community contributions, whereas proprietary licenses protect commercial interests by restricting access and modification rights.
End User License Agreement (EULA)
An EULA is a contract between software developers and users outlining terms of use, restrictions, and rights. Users must agree to the EULA before installing or using the software. These agreements safeguard developer IP, limit liability, and inform users of obligations, ensuring legal compliance and proper software usage.
Patent Licenses
Patent licenses authorize a patented invention’s use, production, sale, or distribution. These licenses may be exclusive or non-exclusive and often include royalty payments. Such licenses let inventors monetize their innovations and allow others to use patented technology. This, in turn, fosters technological progress and industry growth.
Trademark Licenses
Trademark licenses allow using a brand’s name, logo, or other identifiers. These agreements protect brand integrity while expanding market presence. Franchising is one typical example, where the franchisee uses the franchisor’s trademarks under specific conditions, giving them the right to enjoy established brand recognition and consumer trust.
How Do Licensing Agreements Work?
Licensing agreements are legal contracts that allow the owner of the intellectual property, known as the licensor, to enable another party, the licensee, to use the IP under specific terms. These agreements define the scope of use, duration, financial terms, and limitations or obligations.
For instance, a software company may license its program with specific terms regarding how and where it can be used and any associated fees. These arrangements let licensors monetize their IP without directly producing or distributing it, and licensees get access to assets without developing them themselves.
Clear terms in licensing agreements help avoid misunderstandings and protect both parties.
Subsidiary Licensing
A subsidiary licensing arrangement occurs when a licensee obtains rights from the original licensor and grants those rights to another party, a sublicensee. This practice allows wider distribution and use of licensed IPs. For instance, a company with a patent license might sublicense manufacturing rights to another firm in another region.
The original licensing agreement must permit sublicensing. Otherwise, the licensee might not be authorized to grant such rights. The terms of a sublicense must also comply with the original agreement to maintain consistency and protect the licensor’s interests. Properly managed subsidiary licensing can expand market reach and revenue streams for all parties.
Sub-agreements
Sub-agreements are supplementary contracts that support the main licensing agreement and define particular terms or obligations more fully. They might cover quality assurance standards, confidentiality requirements, or performance benchmarks. For example, parties might enter a non-disclosure agreement alongside a licensing agreement to protect sensitive information shared during the partnership.
These sub-agreements make sure that all critical elements of the business relationships are defined and legally binding, reducing the risk of disputes and increasing collaboration. Sub-agreements help focus the licensing arrangement overall because they address particular issues separately.
Non-disclosure Agreement
A Non-Disclosure Agreement (NDA) is a legal contract that establishes a confidential relationship between parties, guaranteeing that any shared sensitive information remains protected. In licensing contexts, NDAs are critical when disclosing proprietary details like trade secrets or business strategies to potential licensees.
By signing an NDA, the receiving party agrees not to disclose or misuse the information for a specified period. This protection builds trust and allows open communication so that licensors can share necessary information without fear of unauthorized dissemination.
NDAs generally outline the scope of confidentiality, exceptions, and consequences for breaches, setting out the parameters for secrecy and protecting intellectual property during negotiations and collaborations.
Related Questions
How Much Do Licensing Deals Cost?
The cost of licensing deals varies depending on the intellectual property type, industry standards, and the details of the deal. Depending on complexity, legal fees for drafting or reviewing licensing agreements range from $730 to $1,050. In addition, licensors may charge upfront fees, ongoing royalties (typically a percentage of sales), or both.
Why Is IP Licensing Important?
Intellectual property (IP) licensing lets owners monetize their creations by allowing others to use them under defined terms. This approach enables licensors to expand market reach without direct investment and allows licensees to access valuable IP, encouraging innovation and collaboration. Effective IP licensing may lead to new business, brand expansion, and partnerships, benefiting both parties.
What Is Patent Licensing?
Patent licensing is a legal agreement where the patent owner (licensor) lets another party (licensee) use, make, sell, or distribute the patented invention. This is exclusive or non-exclusive and usually includes royalty payments or lump-sum fees. Patent licensing allows inventors to monetize their inventions and allows licensees to use existing technologies, promoting industry development and technological advancement.
Conclusion
A strong licensing agreement safeguards intellectual property while providing a pathway for collaboration and revenue generation. Steps like limiting terms, securing upfront payments, and including performance clauses can prevent common pitfalls. With careful planning and professional guidance, licensing agreements can transform innovative ideas into sustainable financial opportunities.
