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Licensing Agreements & Royalties

When parties enter into a licensing agreement the overall scheme of the agreement is simple: the licensor grants the licensee the right to sell or otherwise exploit its technology, which may be patented or otherwise protected as a trade secret, and the Licensee pays royalties to the licensor. What is not so simple is determining a fair royalty rate.

Patent licensing revenue has grown from an estimated $15 billion in 1990 to $150 billion in 2003 – this well may reach $500 billion by 2015. This represents the largest share of intellectual property licensing revenue, thus an improper valuation could cost a licensor millions of dollars in royalties. So how we value a brand new product based on a new patent is one of the first things to tackle and possibly the most difficult.

Because of the uniqueness of intellectual properties placing a value on intellectual property assets, especially new patents, is not an exact science. There are many variables that attach to each asset and they must be analyzed on a case-by-case basis. The particulars of each business situation will often determine how these valuations translate to royalties. A trend that has developed because of this difficulty in ascertaining a fair royalty is to include an equity stake as part of the deal and accepting a lower royalty. Here are a few factors to keep in mind when deciding whether to aim for royalty rates that are in double digits or are a mere fractional percentage:

  • Cleanliness of the file history, (how safe is the patent to potential infringement);
  • Geographical size of the market, (local, national, international);
  • Potential usage;
  • Cost savings over similar products;
  • Perceived importance of the product or service to the market place;
  • Expected lifetime of the patented technology;
  • Importance of a grant of exclusivity in the market.

Once these factors have been satisfactorily defined the next step is to come up with an appropriate value and the royalty figure.

The most commonly utilized valuation approach is commonly referred to as the market or sales approach. It is premised on the notion that transactions for similar assets in the market will yield similar prices. To do this properly we must gather data of similar sales and licensing transactions. Keep in mind, however, that many patents are unique to themselves and thus there may not be suitable comparisons. Another valuation method is based on the projected income to be derived in the future- this is then converted to present value.

In attempting to put together a licensing proposal for an existing patent that has a sales history, royalties are easier to figure. The majority of licenses use past sales as the royalty rate base – usually a net sales figure; a lesser are based on units sold. This is the reason that Universal Licensing often encourages its clients to manufacture and begin to sell their product – even on a very limited basis. This provides some statistical data upon which we can rely when preparing for a royalty negotiation.

Once there is a meeting of the minds regarding royalties, a licensing agreement may be prepared and executed by the parties. The following are the most essential sections of any patent licensing agreement.

Definitions – Just so everyone is on the same page and especially if one of the parties is new to patent licensing terms used in the normal course of business, such as:

  • Licensed Patent Right – defines the particular patent, with serial number;
  • Products – notes any products associated with the patent and included in the transaction;
  • Confidential Proprietary Information – set out in detail;
  • Exclusivity – as to geographical areas, market area, term, etc;
  • Grant Of License – This is the actual grant from the licensor to licensee of the Patent.
  • License Payments – Note whether there is an advance and if so the type, (against royalties, non-refundable, etc.), and the royalty schedule. Be sure to have an interest provision in case any payments from licensee are late.
  • Accounting – Normally there is an accounting period, (monthly, semi-annually, etc.), within which a licensee shall provide sales reports, and a provision that allows for a review of licensee’s sales records by a representative of the Licensor.
  • Diligence – Normally requires the Licensee to agree to use their “best efforts” to market the patent/product. It may also require a written development or marketing plan.
  • Termination By Parties – The parties rights of termination should there be a default, (failure of licensee to make royalty payments, failure of licensor to provide patent information, etc,), are spelled out. Also to be noted are the rights of the parties after a default and termination.
  • Term of Grant of License – This could be as long as the life of the patent to as short as a few months, depending upon the patent/product.
  • Patent Litigation – Both parties normally have the right to pursue infringers and the agreement will describe when the Licensee and / or Licensor may bring an action, who pays, etc..
  • Patent Filings – Often there are patent applications pending or additional patents necessary prior to marketing the patent and normally the licensee will bear the cost. Who bears these costs need to be clearly noted in the agreement.
  • Insurance – Normally, a licensee is required to maintain general liability, of at least $1,000,000.00, workers compensation, etc.
  • Miscellaneous Provisions – These are general provisions inherent in any agreement that can include:
    • Notices to parties, with their address;
    • Indemnification, such as a hold harmless clause;
    • Complete understanding of the parties noting that any other representations must be in writing;
    • Scope of any confidentiality.
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