The great author and influencer Napoleon Hill once stated, “Ideas are the beginning points of all fortunes.” Hill believed that with an idea, perseverance, and definiteness of purpose anything was possible.
So how does one monetize an idea to achieve fortune? Well that path has many routes… and many pitfalls. One particular route that is believed to have started back during the Middle Ages was the advent of merchandising. Today, merchandising, or licensing as we commonly know it, has become a mainstream way of strategically achieving profitability in the market by forging strategic partnerships to achieve resources that the idea generator may not have had at his/her disposal.
Licensing, at its core, is simply a granting of rights of usage from one party (licensor) to another (licensee). This relationship can be a great way to generate a market opportunity for a person or business that has neither the desire nor resources to manufacture, develop, and/or sale the idea. However, this is only the case if the licensing is done right.
Because it’s important to know the fundamentals of licensing before licensing your idea, the remainder of this editorial will elaborate on some of the basics of licensing and some strategic considerations to think about when deciding on the scope of the licensing agreement.
Protectable Legal Right In The Idea – The beginning of any licensing opportunities start with the idea generator (licensor) having some sort of rights of ownership in the idea or product that is to be licensed. This can be through a trademark, copyright, or patent. It can also be through usage, secrecy, or a very specified know-how as related to a particular process. The greater and more formal the protection, the better leverage you have when negotiating the licensing deal.
Strategic Partnership Match – One of the biggest predictors of the success of your licensing relationship is whether both parties to the partnership are a match for one another. A licensing relationship should always be a win-win situation for everyone involved. If the goals of the parties, or fundamental principals relating to the licensed product, don’t match, chances are the relationship will not be a good one.
Non-Disclosure Agreements – Before entering into detailed talks with any potential licensee, it is necessary that you have them sign a non-disclosure agreement. A non-disclosure agreement binds the other party to secrecy in regards to your private information and restricts them from using that information for any purpose not related to a potential or current business deal between the two of you.
Licensing Agreement Considerations – The actual licensing agreement is the most crucial part of any licensing relationship. It controls the rights and responsibilities of each party. Here are 10 high-level aspects to think about when looking over a licensing contract:
- Agreement Length– How long does the intended relationship last. The average licensing agreement will have a length of 3-5 years. It is important to not enter into an agreement that will be too lengthy or too short. A contract that is too short won’t allow the licensee to properly engage the market with your idea, which won’t allow you to accurately assess the worth of that licensing relationship. A licensing contract that is too long might leave you stuck with unfavorable terms for longer than you would like. Remember that the game of licensing is not an exact science and the terms first entered in to based on predicted market performance may not be the most beneficial terms once you see the idea’s actual performance in the marketplace.
- Termination of Agreement – How do you get out of the contract if necessary? It is always important to have an exit strategy to make sure that you are able to get out of a relationship that ends up being a bad one. Some agreement hold that one party can unilaterally end the agreement by giving ‘x’ amount of days notice while others say that both parties have to agree. Another strategic way to set up a termination agreement is to set certain criteria that must be met over the length of the agreement.
- Mandatory Minimum – One such criteria that can be used is a mandatory minimum. This means that you set a floor for either revenue that you receive from the partnership or the number of units sold by the licensee within a specified amount of time (i.e. $15,000 in royalties by end of year 1; or 50,000 units sold in 6 months).
- Royalties – The royalty is the payment you receive in exchange for licensing your idea. The two main types of royalty payments are lumps sum royalties and running royalties. A lump sum royalty is exactly what it sounds like; you receive all the money for the contract up front. A running royalty means that you will receive a percentage (royalty rate) of the sale price of each unit sold. The typical royalty rate is 4%-10% of the wholesale prices. For example, let’s say you sale your idea to a company for the wholesale price of $20 per unit and they sale 10,000 units of the idea to the public for $30 per unit. Let’s also say you have an 8% royalty rate. Your payment would be $16,000 (10,000 x $20 = $200,000; $200,000 x 0.08 = $16,000). Broken down on the front end, you are receiving $1.60 for every unit sold, $20 x 0.08 = $1.60.
- Time of Payment – As a side note, it is very important to consider time of payment when you enter into these agreements. You can contract to be paid monthly, quarterly, bi-monthly, etc. The other terms of the agreement and the relationship of the parties will better indicate the payment schedule you should lobby for.
- Scope of Use – A licensing agreement has to set clear parameters on how the licensee may use the licensed idea. This means detailing what type of products or other resulting content you are comfortable with allowing the licensee to produce with your idea.
- Restrictions on Use – Outside of saying what a licensee may do, it is equally as important to clearly delineate certain activities or content that you do not want your idea to be associated with. While this will not be an exhaustive list, it should highlight a few of the main things that you are not willing to accept with the use of your licensed material.
- Quality Control – This sets the guidelines for the manner in which the licensed idea must be produced. What quality of inputs are you requiring? If you’re licensing a dresser model, are you comfortable with the licensee manufacturing with plywood? Does the production require a more steady or high quality material?
- Rights of Modification – This is very important for considerations such as liability. Are you allowing the licensee to modify your idea to better meet the market needs of their particular customer base? Will dimensions or designs be altered? If it is a product and you are allowing alterations to the design, it is imperative that you set standards for being released from any liability that results from those alterations. If you have a bike design and the manufacturer alters the design of the bike for purposes of meeting its clients needs and the new bike design has defects which causes injury to the rider, you don’t want to be held at fault.
- Rights of Sub-Licensing – Can the licensee sub-licensee this idea to other organizations or individuals? Sometimes allowing for sub-licensing increases your market reach but it also has the possible effect of putting your idea into the hands of someone who negatively affects the brand surrounding your idea. Deciding on this piece takes a balancing of risk vs. benefits.
- Territory – What geographical areas are you allowing the licensee to sale your product in? Territories can be broken down by city, state, region, etc. A breakdown is important if you have different licensees who have a stronger presence in different geographic markets. Territory restrictions, however, are not necessary or beneficial in all circumstances.
- Exclusivity – Some licensing contracts provide that only one particular licensee has the right to redistribute the licensor’s idea. Exclusivity clauses are good when you are working with a licensee that has a powerful national reach. Otherwise, non-exclusive agreements are generally the route taken by licensors.
This is a very high-level overview of only a few of the considerations that need to be taken into account when entering into a licensing agreement. It is very necessary to enlist the services of a qualified attorney when engaging in talks with possible licensees. To cover the full extent of issues that need to be covered, it takes multiple in-depth conversations and a strategic game plan that will ensure that you are fully protected and come out profitable in the endeavor.
Jamal Jackson, JD/MBA is a corporate attorney licensed in the State of Illinois. Jamal is the CEO & Managing Attorney of Jackson Corporate Law Offices (www.JacksonCounsel.com), Co-Founder of Initiative Consulting Group, LLC (www.initiativecg.com) and a Public/Motivational Speaker engaging audiences in the topic areas of Business, Leadership, and Legacy (www.JamalEJackson.com).