The Truth About Licensing A Product (Part 4)

By Guest Author Jim DeBetta of the Academy for Entrepreneurs

[Jim concludes his series with common myths and misconceptions entrepreneurs may have about licensing agreements that may prevent them from bringing their product to market in the most advantageous way.]

 Myths and Misconceptions

Now that we have covered the basic terms of a license, let’s look at some common myths and misconceptions of licensing.

Highway Robbery!

Many inventors are skeptical about licensing because they feel the licensee is somehow out to get them. I have never encountered this situation. Many inventors feel if they are getting a 5% royalty then someone else, usually the licensee, is making 95%. Highway robbery, these inventors shout! But if you look at the Hitchy example above, the licensee has other mouths to feed, including their own. The licensee had a net margin of 35%. The royalty was $0.507, which is 17% of the licensee’s margin. That’s a great deal considering the licensee had to pay to tool, manufacture and package the product to get it up and running. Your licensee should be your partner, not your adversary. If a potential licensee isn’t offering you a fair royalty, and you can show them on paper, let them know your concern and if they don’t come around, walk away.

Giving Away the House

Some inventors feel if they license their product they are giving it away. First of all, when you license a patent, you still own the patent. If you own a house and rent the house you still own the house. If the tenants don’t pay rent on time or if they wreck the place, you can kick them out and rent it to someone else. This works the same for a license. If the licensee doesn’t pay royalties or doesn’t do what they agree to do in the license agreement, you can terminate the license and license to another company. And if you are careful about licensing the proper rights, you can usually seek multiple licenses.

The Grass is Always Greener

When dealing with a potential licensee, some inventors develop the attitude that they can get a better deal from someone else. They think, “If this company wants my product, others must.” While that might be the case, you had better be sure you have another deal on the table before you walk away from a fair deal. When you are attempting to license your product, you should be talking to all the qualified companies that could license your patent at the same time. Or you can divide your prospective companies into tier 1 and tier 2 companies and go after tier 1 first and then drop down to tier 2 if you are not getting a good response from the tier 1 companies. It can take four to six months for a company to evaluate a license offer. So you don’t want to go down that path with one company and if you don’t like their offer, you have to start all over with the next company. If the other company comes back and isn’t interested in licensing or gives you a lower offer it may be too late to do the deal with the first company. They may have already committed the budget for your product to another project.

I Can Make More Money on My Own

Another common reaction I get from inventors once a company comes to the table to license their patent is I can make more on doing it myself. This is especially true when an inventor looks at the royalty versus the wholesale price and retail price. Sadly they don’t understand what “it” requires. In the Hitchy example above, without knowing the mark up in the channel the licensee was selling to, some inventors might wrongly think the licensee was selling the product for, say, $13 to the retailer. Then they would ask, why should I get $0.50 when the licensee is getting almost $8 per unit? That is why it is important to know how each channel of distribution works. In fact, the licensee was netting $2.60, and while this is more than what the inventor was making ($0.507), you have to consider the risk the licensee took to tool, manufacture and package the product. In risk-adjusted terms the royalty is fair. But some inventors think, I’ll just make it myself. This leads to my next misconception.

All I Need is A Manufacturer

Manufacturing a product in any reasonable volume is risky. It means investing money in set up, tooling and inventory—often before you have sold a single unit. Depending on the product, this figure could range from $5,000 for a short-run, single cavity mold, to $100,000 for a multi-cavity mold. Next, the manufacturer will quote you a unit cost for the product at various quantities. So before you have sold a single unit, you are looking at a significant investment. On top of the tooling and manufacturing cost, you must also look at packaging, marketing, sales, freight and storage costs. And don’t forget about product liability insurance.

My Product is a No-Brainer

Most inventors feel as though their product is so good that all they need to do is send a letter to a company and the money will come pouring in. Take a second to think about your day. What if you had to do all the work expected of you this week AND consider 20 to 50 new business opportunities? Could you do it effectively? I doubt it. As Herbert Simon said, “A wealth of information creates a poverty of attention.” So, sometimes the easiest thing to do is to maintain the status quo. Companies are constantly looking for ways to improve and differentiate their product lines. Ironically, such a focus on their products can lead to myopia. As a result, good ideas often originate from outside a company or industry. You would think these ideas would be easy to introduce to companies. In reality, convincing companies who rightly feel they are experts in their product line and industry to pay for your idea is difficult. Most companies have people that do nothing but focus on new products and ideas and they often suffer from a syndrome called Not Invented Here.

All I Need is My Patent

To license a product or patent, you need to know how to qualify companies AND know how to give the decision-makers at these companies all the information they need to make a well-informed decision. At a minimum, this will include a proof-of-concept prototype, renderings of a finished product and a positioning of the product with the prospective company you are targeting. You have to show a company how your product fits their product lines, distribution channels or customer base. And you have to show them how your product will be profitable. The more innovative the product or concept, the more difficult it is to convince a company to go for it. When dealing with far reaching innovations, try to also focus on the steps in between and show the company how they can ease their customers into the long-term objective.

Licensing for Long-Term Success

Licensing is and always will be an effective method for profiting from patents. Understanding the realities and value drivers of a license will help you be successful in your licensing efforts. When exploring a license with a company, I recommend using a simple term sheet to nail down the basic terms of the license. Do this in English. Then let the attorneys put it in legal format. Agreements serve to memorialize what the parties agree to on a certain date in time. But we live in a constantly changing world, so agreements often need to be updated. Make sure you leave the door open to future evaluations.

Happy licensing!

This segment is part 4 in the series : The Truth About Licensing A Product
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