If you ask patent attorneys why licensing negotiations come undone, they will tell you without hesitation that it’s because of the overreaching expectations of the inventor. And if you ask the inventors, they will tell you without hesitation that it’s because of the posturing of the attorneys. Both are right and both are wrong. Many inventors DO grossly overvalue their inventions, and many attorneys DO get so involved in the oneupsmanship of the negations that they lose sight of the purpose.
Sniping aside, I maintain that the principle reason licensing negotiations often end badly is because the inventor and the attorney, if the inventor has one, both lose sight of the true purpose of the negotiation. I’ve always believed that the end purpose is of course to wind up with an agreement that gives me what I’m reasonably entitled to – but to do it in a way that recognizes the legitimate entitlements of the licensee. And, most important, to use the negotiations as a method of establishing the kind of amiable, working relationship with the licensee that will encourage him to view my next product idea favorably, and to make the next contract signing merely a formality.
I’m not an inventor – I’m in the inventing business. I intend for the guy sitting across from me at the negotiating table to be a long time customer. If I let ego get in the way and start to think my new product idea is sandwiched somewhere between world peace and a cure for cancer, the relationship I’m seeking will never happen. And if I used an attorney and allowed him to battle each point to the death, then it won’t happen either. A license negotiation is not a take-no-prisoners war. If both sides don’t win, then nobody wins.
When I sit down to work out an agreement with a potential licensee, the negotiation seldom takes more than a half hour. An hour tops. As the licensor, I always provide the contract. Since I wrote it, and since I’ve used it so many times, I know by heart what ten points I must be prepared to negotiate, and I know exactly what ten points are non-negotiable. The 10 points to be negotiated such as the royalty percentage, the amount of the advance, etc., are the subject for another article. What I’d like to review now are the 10 non-negotiable points.
When a union goes into negotiation with a list of non-negotiable demands, no one takes them seriously. They know it’s merely an opening gambit. However, for a licensing agreement, the demands I’m about to lay out are deadly serious. You are absolutely entitled to all of them – and being denied ANY of them is enough reason for you to walk away from the deal. I’ve done that several times and never regretted it. There is sweet reason to justify why each and every one of these points should be granted to you without argument. If the licensee balks, it’s time to reevaluate your relationship.
1. Royalty percentage should always be based on sales – never profits
It sounds logical when the licensee offers to share profits with you, but proceed down that path at your own peril. Profits can be creatively interpreted – one way for the tax man, another for the potential investor, and another for you. Sales, however, are absolute, detectable, and irrefutable. Whatever profit the licensee claims or denies for his own purposes is his business. Your concern is sales, and that’s what royalties should always be based on.
2. Sales are sales. Period
There is only one acceptable definition of sales – and that is whatever the licensee’s customers pay him when they purchase your product. I have had licensees demand to deduct costs for things like catalogs, trade shows, commissions, travel, etc., and I always say “no way!” That’s a slippery slope and you should never get on it. Sales are sales. Period.
3. Retain the rights to examine the books
The profits that a licensee makes on the sale of your new product are his business – but how many he sold and at what price is your business as well. Not only must the agreement specify your right to look at the sales records – but if you have to sue the licensee to collect royalties due – the licensee must pay your legal fees. You shouldn’t have to pay a $20,000 legal fee to collect $5,000 in royalties. Overwhelmingly, licensees are legitimate and will therefore not object to this clause. If you come upon one who does, I suggest you think twice about entering into a relationship with him.
4. Defining your product properly
The agreement will naturally call for a definition of the product for which royalties are to be paid, and it’s vital that you do it properly. Products evolve and change over the years and you’re entitled to receive royalties notwithstanding the fact that the product five years down the road bears scant resemblance to the product the licensee started with. When defining the product, be sure to add “and all subsequent changes and variations thereof” or else an unscrupulous licensee will easily find loopholes to cut you off from the royalty stream.
5. No end to royalty payments
“It’s very simple, Mr. Licensee, as long as you’re selling my product, or variations thereof, I expect to be paid royalties. I don’t care if it’s one year or twenty – if you’re still selling it, I expect to continue getting paid my small share.” I’ve had licensees want to put a cap on the number of years they have to pay royalties, and if I couldn’t change their minds I ended the negotiation. If someone else is making money from your creativity, why should there be a limit on how many years royalty payments are to be made? Monopoly was invented almost seventy years ago and Parker Brothers still pays royalties to the inventor’s heirs. Fair’s fair.
6. Product approval
You must have the right to sign off on the product before it’s distributed to the public. Not only is your reputation at stake, but there are safety issues (law suits) that must be addressed. This is a great responsibility and you must understand that you cannot withhold approval for esthetic reasons. If you refuse approval because you don’t like the shade of purple the licensee used, he will absolutely sue your pants off. However, if the product is out-and-out unsafe, you must have the right to withhold approval until the problem is corrected.
7. The non-refundable advance
I will never sign an agreement unless it calls for a check to be put into my hands immediately thereafter. It’s to be non-refundable and is considered as an advance against future earned royalties. How large the advance should be is for the article on points to be negotiated. In principle it’s what in some circles is called “earnest money.” It should be large enough to represent a significant commitment to your idea on the part of the licensee – yet not that large to become a stumbling block. Without the non-refundable advance you’re at the licensee’s mercy. Suppose five months down the road he suddenly decides not to proceed? Without the advance he will have stolen five months of your time without penalty. You can’t allow that and I strongly believe that you should never sign a licensing contract unless an advance is part of the deal.
8. You must have a date-certain when your product will be on the market
My standard agreement states that the licensee must have my product on the market in six months or I have the right to cancel the agreement and take my product elsewhere. The advance is mine to keep for my troubles. Six months is arbitrary, and I’m prepared to lengthen it if the licensee has good reason to need more time. What matters is the principle. A licensee can’t simply let the project drag on and on without subjecting himself to consequences. Without the advance and without the performance date, you don’t have a contract.
9. Product Liability Insurance
No sane company would sell products to the public without plenty of product liability insurance. The assumption is that if something can go wrong – it will, and if there’s even the remotest chance for someone to injure himself by using the product, that someone will find a way. If that happens, the lawyer for the injured party will look to sue everybody connected to the product, including YOU. It’s not expensive for you to be added by name to the licensee’s insurance policy, and the licensing agreement should legally obligate him to do so.
10. No obligation to sue
It’s entirely reasonable for a licensee to say “suppose a year from now we discover that we’re infringing on someone else’s patent? Will you protect us?” Or, particularly if your product is patented, he might say, “Suppose one of my lousy competitors tries to knock us off? Will you go after him?” One of my advantages in supplying my own agreement is that I don’t address these issues and the licensee rarely brings them up. But sometimes he does and I have to tell him point blank that I cannot and will not contractually obligate myself to go to court as a blanket obligation. I tell him that it’s a matter to be addressed if and when the situation arises, and that circumstances will dictate the action that he and I should take. We’re partners, I assure him, and we’ll do what’s best for both of us.
Does that sound like doubletalk? Well, it is. There’s no faster way to personal bankruptcy than to obligate yourself to take legal action to protect your licensee. It’s easy to imagine a scenario where you’ll spend $200,000 in legal fees to protect $20,000 in royalties. You owe it to your licensee to have made every reasonable effort to make sure your idea is free and clear before bringing it to him. But you should never guarantee anything beyond that. If you do, a good night’s sleep will be a thing of the past.
Certainly there are other points to be discussed that apply specifically to your own invention or new product concept – but if you enter the negotiation firm in your conviction that you are morally and reasonably entitled to these ten principles, then you are well on your way to winding up with an agreement that both you and your licensee can live with for many years to come.