Negotiating a license agreement? There are primers telling you how to take advantage and one-up your license partner. Ignore them. Unless the agreement works for both sides, it won’t last.
When negotiating your license, here are ten win-win points to keep in mind.
1. Tilting The License Agreement In Your Favor Won’t Work
Resist the instinct to bleed the other side with excessive demands or impose conditions and restrictions that are too onerous. If you do, the relationship will abort. For a licensing partnership to endure there needs to be give and take; that means compromise.
Sure, each side wants the best deal; but put yourself in the other’s shoes. They may need some breathing room and flexibility, especially with supply chain problems compounded by Covid 19 and the war in Ukraine. If your demands are too onerous in the context of an uncertain and challenging marketplace, you may find yourself a creditor in Bankruptcy Court. Think JCPenny and Neiman Marcus, to name a few.
2. The More A Party to the License Doesn’t Need to Do the Deal the More Leverage that Party Has When Negotiating It
As they say in banking , those who don’t need a loan are the first to be offered one. The same in licensing. If you have alternatives to the deal you are being offered, you can more easily evaluate it objectively. But if this is a deal you fell you must have, watch out: you may be compelled to agree to unfavorable terms you may regret. So set your limits before you start negotiating and be ready to walk if the other side demands you exceed them.
You always have options no matter what side of the negotiating table you are on, though the alternatives may not be immediately apparent. So don’t be afraid to raise the stop sign if 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 its 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 must reflect product quality and be trustworthy, distinctive, relevant, consistent, ethical and fair.
To ensure quality, the licensor should monitor the product the licensee is distributing. The licensor should also oversee the licensee’s conduct and marketing messages to confirm they reflect the brand’s attributes.
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 be identified in the public eye as the source of the product. Insufficient quality control by the brand owner (so-called “naked licensing”) can result in the abandonment of the licensed trademark. The licensor’s supervision should produce consistent quality.
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.
Remember brand monitoring, as obtrusive as it may sometimes seem to the licensee, is a win-win for all parties because it ensures product or service quality and integrity.
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 obtain, uniqueness. The licensee is the only one distributing the licensed product.
But before either party to the license enters into an exclusive, each should take a deep breath. Ask yourself if you want to tie yourself exclusively to the other side. Also check that your termination clause allows for an easy exit or at least permits you to convert to a non-exclusive license if the license does not generate the benefits you expected.
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 therefore, before each party begins the relationship, decide when and how to end it. That exit strategy will be of special interest to investors if either side hopes to attract them.
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 created whether the licensed product or service. But the license usually 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 attributable to the licensed product or service. 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 work for both.
7. Find Out the Royalty Other Licensees Are Paying to License Similar Products Under Similar Terms
Forget about fixing the perfect royalty. It doesn’t exist. Better to 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 (more on him below) or speak to your friends in similar businesses or your trade association. There are benchmarks 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 an increasing royalty as the relationship 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 to increase over time triggering 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 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 the licensor is offering global rights, those rights will cost more than the right to distribute in a fixed territory. If the licensee wants a long-term deal with no right by licensor to terminate if minimum sales goals are met, that will also cost you. So first reach agreement regarding the bundle of rights in your license. That bundle will help both sides come to a fair price.
9. 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. You will need that agreement to resolve disputes down the road. But the day-to-day relationship between licensor and licensee is 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 straightforward each is to the other.
10. Take Your Time to Ensure the Agreement Is Mutually Beneficial
The trust referred to above that fuels a licensing relationship takes time to develop. That means each side needs to personally engage and socialize with the other in a relaxed setting where you let your hair down and share your concerns and maybe even your fears and limitations. Investing that time and effort before you reach agreement will pay dividends down the road when the unexpected happens, which it will.
For a more in depth discussion of these points, click on a video of my presentation on this subject with Rand Brenner back in 2020. Rand, a branding specialist, is the author of Hidden Wealth: The Money Making Power of Licensing.
Comments and questions welcome to andrew@ipinbrief.com.