The Key Components of a Licensing Agreement

Dissecting the Key Terms of a Licensing Agreement

Since you can’t even use a photograph on the Internet without obtaining permission, startups and other early stage businesses should be familiar with the inner-workings of licensing agreements. While obtaining the rights to use an image is often a simple task, licensing agreements governing the use of music, software, patented inventions, and trademarks can be extremely complex. If done incorrectly, your business could face significant liability.A licensing agreement is a contract under which the owner of certain property (known as the licensor) gives another party (known as the licensee) permission to use its property in a certain way. The contract may give the other party the right to manufacture and/or sell goods, use a brand name or trademark, or use a patented invention. In exchange for the right to use the licensor’s intellectual property, the licensee generally agrees to pay a specified royalty payment, which often represents a percentage of all its net sales. 

Below are several other key terms of a licensing agreement to understand:

• Exclusivity

An exclusive license prohibits the licensor from granting licenses to other parties. Meanwhile, a non-exclusive license means that the licensor can grant similar rights to another party. Venture capital firms and other potential investors typically find non-exclusive licenses less attractive since competitors may have access to the same technology.

• Net sales

In basic terms, the royalty is calculated by multiplying the net sales by the royalty rate. However, it is rarely that straightforward. It is important to understand how “net sales” will be determined, i.e. whether royalties include intercompany and third-party transactions, whether they will be calculated on an accrual or cash basis, etc.

• Guaranteed payments

Many licensing agreements include fixed, up-front payments, in addition to royalty payments. The periodic payments often referred to as “minimums,” are determined based on a percentage of the forecasted net sales and resulting royalties.

• Quality standards

Licensing agreements typically require that all licensed products meet certain quality standards in order to be approved for sale. To avoid potential product delays and legal disputes, it is imperative that both parties understand the industry test protocol that the licensor will apply.

• Assignment

For startups, it is particularly important to carefully review the assignment terms, as they will govern the circumstances in which you will be able to transfer your rights under the license to another entity. In addition to assignability, royalty buy-out provisions may also impact your ability to sell your business down the road.

The Bottom Line

Finally, when negotiating a licensing agreement, the scope of the rights granted under the licensing agreement, such as geographic limitations or number of user restrictions, are often a sticking point. To help ensure that your rights are protected, it is advisable to work with an experienced intellectual property attorney.

Do you have any questions regarding what makes up a licensing agreement? Would you like to discuss the matter further? If so, please contact me, Shane Birnbaum, at 201-806-3364.