royalty-licensing-agreement

royalty-licensing-agreement

Q: We are beginning negotiations for a royalty/license agreement. What is the customary way to value what we should receive as a royalty/license fee? Do you have a template we could use to save on legal fees?

A: A license and royalty agreement would generally be used when an author, producer, inventor, or other creator licenses their product, content, or invention to another company to take it to market for them. See How to Determine Whether to Patent and Produce an Invention or License it to Another Company and How to Take an Invention to Market for some examples. The bottom line is that creating a product or content is a different capability than taking it to market and for that reason alone, many creations are taken to market by a licensee rather than the creator, the licensor.

Prior to sitting down at the table with any potential licensor of your offering, be sure to prepare diligently. See Eight Ways to Prepare for a Licensing and Royalty Agreement Negotiation for more tips on how to prepare.

In terms of negotiating the rate itself, there seem to be a few general “rules of thumb” to arrive at “fair” royalty payment:

  • The first is sometimes called the “25% Rule” and relates to how much one would expect to receive as Royalties as a percentage of the increase in profit that your intellectual property provides to the licensee’s business.  This rule of thumb will often give the licensor about 25% of the profit made by the licensee from the exploitation of the intellectual property over the life of the license gives the licensor. This is only a guide and in at all to be considered to standard rate.
  • Another is the “5% of Net Rule” and is based upon a payment from the licensee to the licensor of 5% of the net selling price.  Much care must be taken here in terms of what “net selling price” means and how it is calculated.  This means Gross Sales less certain items such as Discounts and Returns, but could also mean less Advertising, Sales Costs, etc., so be sure to define this clearly in the agreement.

There are many key deal terms when negotiating a Royalty or License agreement and here are a few based upon the needs of each party:

License Negotiation Table

Here is a full list of potential negotiable terms you will want to familiarize yourself with and be prepared to negotiate:

License Grant and Restrictions:

  • Exclusive vs. Non-Exclusive vs. Semi/Co-Exclusive
  • Granting Clause
  • Licensor’s Reservation of Rights

Territory: 

  • Worldwide or Specific Countries
  • Infrastructure and Abilities of Partner
  • Available Patent, Copyright and Trade Dress Protection
  • Strategic Goals
  • Certain Rights May be Limited to Specific Territories
  • Other Issues (e.g. product leakage)

Intellectual Property: 

  • Define Rights
  • Utility and Design Patents
  • Copyright
  • Trade Dress
  • Trademark and Trade Name
  • Confidential and/or Proprietary (trade secret)
  • Protecting Confidential Information
  • Control
  • Cost
  • Protection against competition
  • Managing IP

Compensation Structures

  • Royalty-Bearing License
  • Fixed Sum per Unit or Period vs. price list discount
  • Variable or Fixed Rate
  • Based on Invoiced Amounts or Amounts Received
  • Reductions, Credits, and Caps
  • Bundling
  • Upfront Payments
  • Milestone and other Payments
  • Based on sales levels
  • Profit Sharing
  • Net sales less cost of goods and enumerated expenses (can be more lucrative than royalties, but beware of sharing losses)

Diligence

  • Standards
  • Best Efforts vs. Commercially Reasonable Efforts vs. Reasonable Efforts
  • Internal Standard
  • Performance Requirement
  • Minimum Sales or Profit
  • Minimum Royalty Payments

Consequences

  • True-up
  • Convert to Non-Exclusive
  • Reversion of Rights
  • Liquidated Damages
  • Termination of Specific Rights or Agreement

Other Matters

  • Indemnification
  • Sublicensing
  • Licensor Concerns
  • Licensee Concerns
  • Change of Control
  • Non-Competition
  • Governance and Monitoring
  • Licensor Support

Termination

  • Grounds
  • Standard Termination Provisions
  • Licensee Contests Validity or Ownership of Licensor’s Rights
  • Commercially Unviable
  • May Be Country Specific, Product Specific or Complete
  • Effects of Termination
  • Reversion of Rights
  • Reimbursement of Certain Costs
  • Survival of Sublicenses
  • Access to IP and License to Use It

Dispute Resolution

  • Internal Escalation
  • Non-Binding Mediation vs. Binding Arbitration
  • Judicial Intervention

Recommended Resources:

Document Downloads:

Ask an Expert:

Training:

  • See Venture Academy Course #9 – Legal (and in particular the Harvard Business School case study and video featuring Palm Computing and a licensing agreement put together with a software entrepreneur)
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About Wade Myers

Wade has founded or co-founded, invested in, and been a director of over 25 companies and has completed 55 financing and M&A transactions. His previous work experience includes the Boston Consulting Group and Mobil Corporation. Wade also served as an Airborne Ranger in the US Army where he was a decorated veteran of the Gulf War. He is a Baker Scholar graduate of Harvard’s MBA program and is married with five children.

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