Invention Licensing Strategy: What You Need To Know
Licensing your invention can be a cash cow. You need to use the right strategies to help you approach the deal, build relationships, and capitalize.
I don't have to guess that if you're on this page your level of intelligence is higher than average.
As a savvy inventor, you probably want to find the best way (maybe even the quickest way) to profit from the idea you've developed into a product.
Licensing is a powerful business model with strong, and at times predictable, financial upsides.
Whether your forte is creating new products or improving existing products, there are strategies for getting your invention licensed which can accelerate the process, add efficiency to your current model, and drive pretty incredible financial gains.
A lot of these ideas came from an interview Tim Ferris did with Stephen Key, but there are also some new tips dropped in that come from the sales aspect of the business.
Speaking of which, that's my first tip: Successful inventors need to have some sales skin. If it's not natively you, it can be born from the passion you have for your idea. Just remember, nothing happens 'till something gets sold!
What Does It Mean To License Your Invention?
The business model of licensing an invention is still a bit of a mystery to many inventors. In essence, as Steven Key eloquently put it, you are renting your idea to a manufacturer.
A good percentage of inventors are fantastic at ideation, have impeccable documentation skills, and really understand how to solve everyday problems.
That doesn't inherently make them a jack of all trades, however, and certainly most have not mastered manufacturing, distribution, marketing and all of the other steps and processes that have to happen in the commercialization process.
When you license your product, you essentially hand off these responsibilities. This makes licensing a highly attractive and lower-risk option than going down the self-manufacturing road for inventors.
The hand-off of your idea allows you to go back to your inventing drawing board.
That's to say, licensing is great for inventors that want to spend more time coming up with new products to bring to market.
If the idea of managing budgets, cash flow, human resources and sales is not your idea of a fulfilling career, licensing might be the right option for you.
Getting Paid In An Invention Licensing Deal
Inventors generally make money from royalties in a licensing deal.
Royalties are set on a contract-to-contract basis and vary between companies and manufacturers, but generally fall in the 3-6% range. The high side would yield about 25%, but that is rare (and takes some really strong negotiating skills).
Companies usually pay royalties out on a quarterly basis.
The royalty percentage you agree to is usually based on the novelty of your invention, how well the patent protects it (because retailers, manufacturers, etc. will be thinking ahead about the competition), and ultimately how profitable the product is going to be.
Remember all those financial projections you did through the various stages of the invention process? Hope you didn't slip-shod or scrap them...
Even when you successfully license your product to a company and sign a contract for a certain royalty percentage, its important to know that inventors are not guaranteed any money or income.
Inventors ultimately get paid when the invention sells.
This means you shouldn't put 100% focus into the negotiation - you also want to be sure your product has marketing support and viability in the market.
Let's do some math:
You negotiate 5% royalty with a manufacturer. Your product results in $100,000 sales in the first month. Not bad, you just earned $5,000.
Now let's say you negotiated 20%. (If you did, I commend your skills!) Your product hits the shelves and in the first month sales are just $15,000. Well, you made $3,000.
This is why creating a solid business and marketing plan is essential in your process.
Ensuring Cash Flow In Your Licensing Deal: Minimum Guarantees
Since licensing deals where the inventor collects royalties on a percentage-of-sales basis are not a guarantee, it's probably good to learn a strategy that does guarantee the inventor some revenue.
As an inventor in a licensing agreement, making sure the manufacturer performs is essential.
When you write the licensing contract (which you'll absolutely need help with, and we can help you there), you need to include a performance clause of some kind.
Minimum Guarantees: The minimum royalty payment that a licensee (the company or manufacturer) is contractually obligated to pay a licensor (you, the inventor) over the term of the agreement.
When a minimum guarantee clause is in place, the manufacturer needs to sell a set amount of your product every quarter (or year).
If the manufacturer fails to meet the performance hurdle, you as the inventor are entitled to your idea again and are legally liberated; you can license it to another manufacturer.
Minimum guarantees can be paid out all at once (in an upfront lump sum), quarterly, semi-annually or annually.
The payment of the minimum guarantee can be spread out over the established length of the license if that is mutually agreed upon; licensing agreements can have a duration of 1+ years and a typical agreement is about 3 years.
There are some factors that play into minimum guarantee but it's ultimately just a dollar figure the inventor decides they deserve.
Predicted sales are one of those factors, so make sure you know your numbers.
The minimum guarantee is usually somewhere between 8-12% of predicted revenue.
Licensing Contract Tip: More Heads Is Better Than One
Inventors need to be careful and smart in their licensing deals and always remember that greed will bite you.
Front loading your deal is not a great idea.
Keep in mind that the manufacturer is your partner.
They're investing in you; they're not out to get you. So protect yourself, but don't get on the offensive.
One way I like to approach this tendency to want to front load is to always think about future deals I might be making with the manufacturer.
When contracting goes smoothly (and your product is amazing, of course), its going to be easier to get back in the door and get deals done in the future...and you're an inventor - you're going to have more products.
That's why you're licensing, so you have more time to invent (yes, and to make money...)
If you come into the contracting phase requesting large upfront sums of cash, it's much easier for the manufacturer to say no to your deal.
Remember, as a corporation or large entity, they do have more leverage than you.
That doesn't mean you're backed into a corner; you have a valuable product that they want.
It just means you need to be reasonable. Shoot for smaller upfront payments and then use the minimum guarantee to increase what's owed to you on a quarterly basis.
The minimum guarantee numbers are set up when you negotiate the contract. Set up numbers and goals you think the manufacturer can actually hit and that drive revenue you’ll be OK with if the manufacturer simply just meets the agreed upon quota.
Last note, your bank will need to be involved in this step - they will help you with setting up the guarantee by telling you some ballparks and ranges that will work for you.
Time Is Your Enemy In Licensing Agreements
The majority of inventors spend most of their time on patenting and prototyping; the most successful (richest) ones don't.
A patent can run you anywhere from $2,000 - $25,000, and can take up to three years to get issued.
Prototyping varies greatly depending on the invention, but it's almost never quick, and it nearly always has iterations, revisits and unforeseen costs.
Are both of these steps necessary in the invention process?
But time is essential for inventors, and that's why getting feedback from manufacturers is an essential early-stage step in the process.
As an inventor, a great tip is to set yourself a goal of finding out if your idea has the potential to be successful before you get too far down the road.
If the idea has legs, its worth the time; if not, then back to the drawing board.
Some experts recommend inventors spend no more than three weeks to three months before making the decision to follow through with their idea, or to dump the project and move onto the next idea.
The smallest possible amount of time and money possible should be spent on your invention idea before soliciting feedback from a manufacturer.
Truth of the matter is that not every idea is going to be a home run. There can be snags, hold ups, and issues at any step in the process, whether its challenges in manufacturing, the cost of raw materials is too high, the market is exhausted from a competitor, other pending or existing patents would block you from thriving, etc.
Manufacturers have access and resources to help you vet these things. I mentioned before that you want to be respectful going into your licensing contract negotiations and this is one opportunity where making a "friend" can help you out later. (Hopefully your contact list fills up a bit and you have several manufacturers that you can contact)
A manufacturer will give you current feedback and constructive criticism about your idea based on their expertise in the industry.
Since you are in fact sharing your idea with someone, filing a provisional patent application first is the smart approach.
PPA's give you 12 months to work on the idea and they have a low barrier to entry, around a hundred bucks.
They also put you in a bucket where you can say your idea is "patent pending" and that holds some weight.
Become A Licensing Pro: Know The Lingo
Getting lost in terminology can really hinder your ability to follow a conversation.
Also, referencing the tip above, it adds to the amount of time your licensing deal takes to execute.
I've always recommended inventors learn constantly; always be a sponge for knowledge.
If this is your first time contracting a licensing deal, below is a glossary of terms that you should become familiar with.
I also highly recommend you contact us and talk to someone about the questions you probably have; we're here to guide you in the right direction and add some strategy to your plan.
Exclusivity: Inventors are usually giving exclusive rights to the company to use the product within the parameters specified. The manufacturers and companies will almost always ask for exclusivity.
One tip is to consider charging a premium for this if you do offer it- but remember not to get greedy. You're starting a partnership.
For exclusive agreements, the royalties are usually higher; just remember that you're now dependent on one source to hit the targets.
With a non-exclusive licensing deal, you'll be seeing lower dollars upfront and lower royalty percentages, but you have a pool of sales vehicles working for you. Like most things, weigh the options.
Territory / Geography: This determines the physical location where a customer may use your product; geographic scope is usually worldwide. But you might have other intentions - a national licensing deal where you have different licensees in different regions of the world, for example.
Markets: If you have a product with many potential use cases or which can thrive in different markets, you have the right to grant to one licensee while holding back rights to award to other potential licensees for other applications.
Royalty Payment Terms: I think this one is important! You want to determine the schedule and timing for which your royalties are paid out - usually monthly, quarterly, or annually.
Indemnification: If you breach a representation or warranty and your customer incurs damages, this assures them you will cover the costs.
IP claims sit at the front of people's minds, but personal injuries and property damage are other common grounds for indemnification claims. Make sure that the licensee is required to indemnify you against any litigation arising from any actions taken by them.
Guaranteed Minimum Royalty: We covered this above, but to reiterate, in some cases, particularly when an exclusive licensing contract is negotiated, you can require that the manufacturer or company be responsible for paying you a minimum royalty amount regardless of the unit sales or revenue.
Termination: Short version = Exit Strategy.
You should know upon entering your licensing agreement if and how you can get out; usually this is based on a performance clause. I would recommend an attorney to help you scribe or negotiate this.