Ten License Agreement Considerations

for licensing post

This post summarizes a webinar I did with Rand Brenner, President & CEO at Licensing Consulting Group on June 12, 2020, focusing on the top 10 considerations to keep in mind when negotiating a license agreement. Rand was a pleasure to work with again. He counsels clients in the acquisition and sales of licensing rights and is the author of Hidden Wealth: The Money Making Power of Licensing. Rand has developed and managed licenses with Universal Studios, Fox Interactive and Sony Pictures, among others. For a video of the webinar we did together click here.

For those who want a quick summary of what I discussed with Rand, here it is below.

1. The License Agreement Must Be a Win-Win for Both Sides or It Will Not Work

One-sided deals don’t last. Often one’s instinct is to negotiate to one-up or take advantage of the other side. But long term, if you bleed the other side with excessive demands or impose conditions and restrictions that are too onerous, the relationship will abort. For your licensing partnership to endure there needs to be a give and take.

Sure, you want the best deal; but put yourself in the other side’s shoes. They may need some help, especially these days with unemployment reaching record highs. If you are not flexible in your demands, you may find yourself a creditor in Bankruptcy Court. Think JCPenny and Neiman Marcus, to name a few.  

2. The More Either Party to the License Does Not Need to Do the Deal the More Leverage that Party Has When Negotiating It

As they say in banking circles, if you don’t need a loan, you will be the first to get it. The same in licensing. If this is a deal you have to have, you may be compelled to agree to one-sided terms you may regret. So you should set your limits before you start and be ready to walk if the other side demands you exceed those limits.

Although you may think this is a once-in-a-lifetime opportunity, you always have options no matter what side of the negotiating table you are on. Think what your best alternative to this agreement is. You have one. And the better your alternative, the greater your ability to improve the terms of this agreement. So don’t be afraid to raise the stop sign when the other side seeks to take advantage. When you signal you are ready to walk, the other side may suddenly try to pull you back. If they don’t, keep walking.  

3. Quality Matters: The Licensor Must Monitor Product Quality to Ensure it Is Consistent With the Licensed Brand

As Jeff Bezos famously said, your brand is what people say about you when you’re not in the room. In other words, your brand is your reputation. To maintain it, your brand has to reflect product quality and must also be trustworthy, distinctive, relevant, consistent, ethical and fair.

To ensure quality, the licensor must monitor the product the licensee is distributing. The licensor must also oversee the licensee’s conduct and marketing messages to confirm that they reflect the brand’s attributes. Together, both parties to the license agreement are brand ambassadors, sharing the responsibility to protect and promote brand quality and integrity.  

If the licensee has the right to use the licensor’s trademark in connection with the licensed product, the licensor’s obligation to monitor product quality is even greater. The licensor must make sure that it is identified in the public eye as the source of the product. Insufficient quality control (so-called “naked licensing”) can result in the abandonment of the licensed trademark. See Barcamerica Int’l USA Trust v. Tyfield Importers, Inc., 289 F.3d 589, 596 (9th Cir. 2002) (“Where the licensor fails to exercise adequate quality control over the licensee, ‘a court may find that the trademark owner has abandoned the trademark, in which case the owner would be estopped from asserting rights to the trademark.’”).

Finally, to confirm your licensees understand your rules of the road, you may want to insert a clause in your license agreement along these lines:

Licensee agrees that the nature and quality of the products licensed will meet or exceed the standards set by Licensor. Licensee’s failure to conform to these quality controls may result in the termination of this License Agreement.

4. Givers Get: If Your License Grants Exclusivity, You Should Receive a Higher Royalty

Royalties reflect the marketplace and are a function of a number of factors. But there is one clear rule; if you give, you get. So, if you grant your licensee an exclusive, your royalty needs to reflect that exclusivity and be higher than the royalty you would otherwise have charged multiple licensees. Why? Because when you give an exclusive you forgo other opportunities and limit your revenue source to one.

Exclusive licensees will also pay more because they now have a market advantage otherwise hard to get, uniqueness. They are the only ones distributing the licensor’s product.

But before you, as licensor, grant an exclusive, take a deep breath. Ask yourself if you want to tie yourself exclusively to the licensee. Also ask your lawyer if your termination clause allows for an easy exit or at least permits you to convert to a non-exclusive license if the licensee does not generate whatever monetary benchmarks you have set in the license agreement.

5. Before Entering Into a License Each Party Should Have an Exit Strategy

Each party to a license agreements looks forward to a mutually satisfactory relationship. But we know that things change and pandemics happen. So each side needs to decide, before signing the agreement, when to exit. There is no one exit strategy. Maybe it will be when one of the parties to the license has satisfied its profit projections. Maybe the exit will be in a few years when the product licensed will likely lose its market appeal or competitive edge. In any case, no licensing agreement is forever and so, before each party begins the relationship, decide when and how to end it. And if either party to the license is a startup hoping to attract early investors, they will be especially interested to learn your exit strategy before they invest.

6. The Duration of the License Should Allow the Licensee a Reasonable Time to Recoup Its Investment in the Deal

The costs for a licensor and licensee differ. A licensor has few fixed costs at the outset of a licensing deal. That’s because the licensor is authorizing the licensee to market what the licensor already has, the licensed product or service. But the license has to make a considerable investment before it sees any profit. A licensee’s fixed costs include salary, distribution expenses, advertising and quality control costs, as well as a portion of the overhead. A licensee’s investment may also include manufacturing the licensed product according to the standards set by the licensor. All these costs may be considerable and can only be recouped over time. So the licensor needs to give the licensee a reasonable time to recover those costs if the license is to be a win-win for both.

7. Do Your Homework: Find Out the Royalty Other Licensees Are Paying to License Similar Products Under Similar Terms

Forget about determining the perfect royalty. It doesn’t exist. But the parties to a license can reach agreement on a fair royalty by looking at comparables. What royalty have other parties agreed to when distributing similar products or marketing similar services in similar territories over comparable periods of time? To gain that market knowledge maybe you need to retain an expert like Rand or speak to your friends in similar businesses or your trade association. There are benchmarks out there and, though it may take some digging to find them, they will guide your negotiation as you fix the royalty.

Here are a few royalty options. You might negotiate an escalating royalty. It allows the licensee to keep more proceeds at the beginning of the agreement and then pay increasingly more to the licensor as it continues. This royalty works best when the licensee is poorly capitalized and needs to retain revenues at the beginning of the agreement to increase production.

Use a de-escalating royalty when the parties expect sales and therefore royalties to increase over time so that increased revenues trigger a lower royalty rate. A de-escalating royalty also creates an incentive for the licensee to become successful quickly to qualify for the lower rate.

A licensor might also include minimum payments along with a royalty. This structure ensures certainty for the licensor and is especially useful when the product is new and untested and therefore its ability to generate revenues and royalties is uncertain.

Whatever royalty is agreed to, the licensor should include in the agreement a right to audit the books of the licensee to ensure compliance with the license terms.  

8. Discuss Money After Agreeing to Other Issues

Yes, money is important. But you will best be able to reach agreement on a fair royalty after discussing other key elements of a license such as geography, term, exclusivity and licensed rights. Think of it this way, when you negotiate to buy a house, you consider many factors that help determine price, such as location, square footage, number of bedrooms, outdoor space and the like. All these elements in combination help you make a fair offer. The same in a license. If you want global rights as opposed to a limited geographical region, those rights will cost more assuming the licensor is willing to give you those rights. If you want a long-term deal with no right to terminate if you meet minimum sales goals, that will also cost you. So first reach agreement regarding the bundle of rights in your license. That bundle will help you then fix a price.

9. Whether Licensor or Licensee, Negotiate With Respect to Build Trust

Trust is hard to get and is easily lost; but the effort to gain trust in a relationship is always worth it.

Sure, you should confirm your relationship with a signed license agreement. That agreement will be useful to resolve disputes down the road. But the day-to-day relationship between licensor and licensee is fueled and aided by trust and respect, not by a signed agreement. And the best way to gain trust is to keep your promises and not overstate. At each stage of the negotiation the other side is appraising you, asking “Can I do a deal with this person.” The answer will more likely be “yes” the more trustworthy and respectful you are at each stage.  

10. Take Your Time to Ensure the License Agreement Creates a Long-Term, Mutually-Beneficial Relationship

A license agreement is a bit like a marriage. Two sides join together for mutual advantage. Sure, your business courtship might be brief; but the better course is to take your time. Due diligence is not simply a matter of looking at the hard numbers but answering the question “Should I partner with the other side?” To answer that question you need to form a relationship with the other side. That means in-person communication and socializing in a relaxed setting where you both can let you hair down a bit and share your concerns and maybe even your fears. Investing that time and effort before you reach agreement will pay dividends down the road when the unexpected happens, which it will.

Comments and questions welcome to andrew@ipinbrief.com