Here’s what to consider before signing that license agreement.

Driving innovation is a critical factor in growing many companies. Ideally, your organization has an R&D engine that generates the kind of new products and services that fuel your growth. But sometimes, you might have a need for an outside boost to help launch new products, fill a technology gap, or open new markets. That’s where it can make sense to consider licensing some intellectual property from someone else. That might be an inventor, a university, a government think tank, or even another company.

If someone else has some IP or technology you’d like to access, how do you make a licensing agreement work? Here are seven factors you should consider when answering that question.

1. How protected is the technology?

Before striking out to license some technology, do some research to understand if it’s truly protected. You might find, for instance, that there are no patents or trademarks associated with it, which means you can just copy it and use it without any agreement or paying a fee. There is some complication if the technology is a trade secret and never disclosed to the public. In that case, you’ll have to reverse engineer their approach. It’s worth remembering that even patented technology can be worked around if you can figure out a way to deliver the same result without violating the intellectual property. Be ready to go to court to protect your new idea, even if it doesn’t violate the patent.

2. Can it give you a significant competitive advantage?

If you find some technology that is nicely protected and that you think can give you a significant competitive advantage in the market, then it makes sense to reach out to the owner of that IP and find a way to craft a licensing agreement. The key is to assess whether the technology is significant enough to give you an edge either in features or speed to market over your competition. Ultimately, this plays out in higher revenue, better price, or longer-term customers, one of which is needed to help pay for the technology.

3. Do the math

Most licensing deals come down to negotiating a deal that makes sense for you, the licensee, and the owner of the IP, the licensor. Most licensing deals are built around a percentage of sales or revenue because that is easy to audit. If you license some IP from a university, for instance, you might expect to pay somewhere between 2 percent and 5 percent of annual revenues as part of the deal. If you’re licensing more elaborate technology that creates significant margins for you, you should expect to pay more–potentially as high as 14 percent of revenue.

That might sound expensive, and it is. But if it drives a significant competitive advantage, it can still make sense. How much you are willing to pay should all come down to understanding what kind of upside you can reap from putting the IP to work in growing your business.

4. Why revenue?

One of the most common questions I get asked is why licensing deals use revenue instead of, say, margins or units sold. Basing a deal on either of those measures would help ensure both sides have some skin in the game, right?

But the answer is that revenue is the easiest measure to audit from the licensor’s perspective. After all, margin and profit can be manipulated. That reminds me of a joke.

  • Question: What did the accountant say when you asked him what one plus one equals?
  • Answer: What do you want it to equal?

Profit can be manipulated but revenue is harder to hide and easier to audit. That’s why most IP attorneys stick to using revenue, just to keep things simple.

5. Length of time

Another factor to consider when putting your licensing agreement together is the length of time it will be effective. If you’re licensing a patent, for example, you might want to structure the deal so that it lasts the life of the patent. If you’re dealing with a trade secret, on the other hand, you might want to leave a loophole that lets you exit the agreement if an alternative comes onto the market.

6. Exclusivity

An important question to ask with any licensing agreement is whether anyone else is getting access to the same IP. If so, then you might be able to negotiate a much lower payment rate. But if you can obtain some level of exclusivity over, say, the North American market, or in your vertical, that might be worth paying somewhat of a premium.

7. Termination rights

While no licensee likes the idea of termination rights, which is the ability of the licensor to cancel or terminate the agreement, you’ll likely have to accept them as part of a deal. One of the big sticking points in some of these deals is where the licensor sets a minimum payment from the licensee. This makes sense if the licensor has a patent, for example, and thus wants to maximize the return they get from it over the limited lifespan of the patent. And if the licensee fails to meet that minimum payment, it becomes grounds for terminating the agreement or moving to a non-exclusive agreement.

If you think that some technology or IP could give you a significant advantage in the market, it can make sense to strike up a licensing agreement with the owner of that IP. Before you do, just make sure you understand the potential downside and costs that come with all that upside.

Jim Schleckser

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