8.5 Licensing and royalties
13 min read•august 20, 2024
Licensing and royalties are crucial aspects of international business for SMEs. These agreements allow companies to monetize their and expand into new markets without significant upfront investment.
Understanding the types of licenses, key contract components, and royalty calculations is essential for SMEs. Navigating cross-border issues, negotiating favorable terms, and managing IP rights are critical skills for success in international licensing deals.
Types of licensing agreements
- Licensing agreements are contracts that allow one party (the licensee) to use the intellectual property (IP) of another party (the licensor) in exchange for compensation, typically in the form of royalty payments
- Understanding the different types of licensing agreements is crucial for international consultants working with small and medium-sized enterprises (SMEs) to help them protect their IP and expand into new markets
Exclusive vs non-exclusive licenses
Top images from around the web for Exclusive vs non-exclusive licenses
Creative Commons - Copyright - Library Guides at Melbourne Polytechnic View original
Is this image relevant?
Conceptual Framework of Factors Affecting SME Development: Moderating Factor on the Relationship ... View original
Is this image relevant?
Los diferentes tipos de Licencias Creative Commons - Homo-Empresarius View original
Is this image relevant?
Creative Commons - Copyright - Library Guides at Melbourne Polytechnic View original
Is this image relevant?
Conceptual Framework of Factors Affecting SME Development: Moderating Factor on the Relationship ... View original
Is this image relevant?
1 of 3
Top images from around the web for Exclusive vs non-exclusive licenses
Creative Commons - Copyright - Library Guides at Melbourne Polytechnic View original
Is this image relevant?
Conceptual Framework of Factors Affecting SME Development: Moderating Factor on the Relationship ... View original
Is this image relevant?
Los diferentes tipos de Licencias Creative Commons - Homo-Empresarius View original
Is this image relevant?
Creative Commons - Copyright - Library Guides at Melbourne Polytechnic View original
Is this image relevant?
Conceptual Framework of Factors Affecting SME Development: Moderating Factor on the Relationship ... View original
Is this image relevant?
1 of 3
- Exclusive licenses grant the licensee the sole right to use the licensed IP, preventing the licensor from granting licenses to other parties
- Exclusive licenses are often more expensive and may be limited to specific territories or fields of use
- Example: A software company grants an to a distributor in a specific country
- Non-exclusive licenses allow the licensor to grant licenses to multiple parties simultaneously
- Non-exclusive licenses are generally less expensive and provide more flexibility for the licensor
- Example: A fashion designer grants non-exclusive licenses to multiple manufacturers to produce their designs
Sole vs sub-licensing rights
- Sole licensing rights grant the licensee the right to use the licensed IP, but the licensor retains the right to use the IP themselves
- Sole licenses are a middle ground between exclusive and non-exclusive licenses
- Example: A patent holder grants a sole license to a manufacturer while continuing to use the patented technology in their own products
- Sub-licensing rights allow the licensee to grant licenses to third parties (sub-licensees)
- Sub-licensing can help expand the reach of the licensed IP and generate additional revenue streams
- Example: A master licensee for a popular brand grants sub-licenses to regional distributors
Key components of licensing contracts
- Licensing contracts outline the terms and conditions under which the licensee can use the licensor's IP
- International consultants must help SMEs understand and negotiate key components of licensing contracts to ensure their interests are protected and the relationship with the licensee is clearly defined
Scope of rights granted
- The scope of rights granted specifies what IP is being licensed and how the licensee can use it
- This may include limitations on territory, field of use, or product categories
- Example: A licensing agreement for a patented technology may limit its use to specific applications or industries
- The contract should also specify any rights reserved by the licensor, such as the right to continue using the IP or to grant licenses to others
Royalty rates and payment terms
- Royalty rates determine the amount of compensation the licensee pays to the licensor, typically a percentage of sales or a fixed fee per unit sold
- Royalty rates can vary based on factors such as the value of the IP, the stage of product development, and the industry standard
- Example: A common for consumer products is 5-10% of net sales
- Payment terms specify when and how royalties are paid, including the frequency of payments, currency, and any applicable taxes
Quality control and brand protection
- Quality control provisions ensure that the licensee maintains the quality standards associated with the licensed IP
- This is particularly important for trademarks and brand licenses to protect the licensor's reputation
- Example: A licensing agreement for a luxury brand may require the licensee to use specific materials and manufacturing processes
- The contract should also include provisions for monitoring and enforcing quality control, such as regular inspections or approval of product samples
Term length and renewal options
- The term length specifies the duration of the licensing agreement, which can range from a few years to the life of the IP
- Shorter terms may be appropriate for rapidly evolving technologies or markets, while longer terms provide more stability and investment incentives
- Example: A licensing agreement for a software patent may have a term of 5-10 years
- Renewal options allow the parties to extend the agreement under specified conditions, such as meeting performance targets or renegotiating royalty rates
Termination clauses and consequences
- Termination clauses specify the circumstances under which either party can end the licensing agreement before the end of the term
- Common grounds for termination include material breach of contract, insolvency, or failure to meet minimum performance requirements
- Example: A licensing agreement may allow the licensor to terminate if the licensee fails to pay royalties for a specified period
- The contract should also outline the consequences of termination, such as the return of confidential information, disposal of inventory, and any ongoing obligations
Calculating royalty payments
- Royalty payments are the primary means of compensating licensors for the use of their IP
- International consultants must help SMEs understand the different methods of calculating royalties and negotiate terms that align with their business goals and industry practices
Fixed fee vs percentage of sales
- Fixed fee royalties require the licensee to pay a set amount per unit sold or per time period, regardless of the product's price or sales volume
- Fixed fees provide predictable income for the licensor but may not capture the full value of successful products
- Example: A licensing agreement for a patented component may specify a fixed fee of $1 per unit sold
- Percentage of sales royalties are calculated as a proportion of the licensee's revenue from the licensed product
- Percentage royalties align the licensor's compensation with the product's success but may be more difficult to monitor and enforce
- Example: A licensing agreement for a brand name may specify a royalty of 5% of net sales
Minimum guaranteed royalties
- Minimum guaranteed royalties (MGRs) are a fixed amount the licensee must pay regardless of actual sales, providing a floor for the licensor's compensation
- MGRs help mitigate the licensor's risk and ensure a minimum return on their IP
- Example: A licensing agreement may require an MGR of $100,000 per year, credited against percentage royalties earned
- If the licensee's percentage royalties exceed the MGR, they pay the excess to the licensor; if not, the MGR serves as the minimum payment
Royalty stacking considerations
- Royalty stacking occurs when a product is subject to multiple licensing agreements, each with its own royalty obligations
- Stacked royalties can significantly increase the cost of producing the product and reduce the licensee's profit margins
- Example: A smartphone may incorporate hundreds of patented technologies, each with a small royalty that adds up to a significant total
- Licensing agreements should consider the potential impact of royalty stacking and include provisions for reducing or capping total royalties
Negotiating licensing deals
- Negotiating licensing deals requires understanding the interests and leverage of both parties
- International consultants can help SMEs identify their negotiating strengths and weaknesses, set realistic goals, and develop effective negotiation strategies
Leverage points for licensors vs licensees
- Licensors' leverage points include the value and uniqueness of their IP, the strength of their IP protection, and the demand for the licensed product
- Licensors with strong, well-protected IP in high-demand markets can command higher royalties and more favorable terms
- Example: A pharmaceutical company with a patented blockbuster drug has significant leverage in
- Licensees' leverage points include their manufacturing capabilities, distribution networks, and market expertise
- Licensees with strong production and marketing resources can offer licensors access to new markets and economies of scale
- Example: A global consumer goods company has leverage when licensing a new product from a small inventor
Most-favored-nation (MFN) clauses
- Most-favored-nation (MFN) clauses require the licensor to grant the licensee terms at least as favorable as those granted to any other licensee
- MFN clauses help ensure the licensee remains competitive and benefits from any future improvements in licensing terms
- Example: An MFN clause may entitle the licensee to a reduced royalty rate if the licensor grants a lower rate to another party
- MFN clauses can be limited to specific territories, fields of use, or time periods to balance the interests of both parties
Territory and exclusivity tradeoffs
- Licensors and licensees must negotiate the territorial scope and exclusivity of the licensing agreement based on their respective goals and resources
- Larger territories and exclusive rights can justify higher royalties and minimum guarantees but may limit the licensor's ability to expand the market
- Example: A licensor may grant an exclusive license for a specific country in exchange for a higher royalty rate and upfront payment
- Non-exclusive or territorially limited licenses can help the licensor diversify risk and adapt to local market conditions but may reduce the licensee's incentive to invest in the product
Intellectual property (IP) considerations
- Licensing agreements are based on the licensor's intellectual property rights, which can include patents, trademarks, copyrights, and trade secrets
- International consultants must help SMEs understand the scope and limitations of their IP protection and develop strategies for managing IP in licensing relationships
Patents, trademarks, and copyrights
- Patents protect inventions and grant the owner the exclusive right to make, use, and sell the invention for a limited period
- Patent licenses are common in technology-intensive industries such as pharmaceuticals, electronics, and machinery
- Example: A medical device company licenses a patented surgical instrument to a manufacturer
- Trademarks protect brand names, logos, and other distinctive signs that identify the source of goods or services
- Trademark licenses are common in consumer goods, fashion, and hospitality industries
- Example: A fashion designer licenses their brand name to a clothing manufacturer
- Copyrights protect original works of authorship, such as literature, music, and software
- Copyright licenses are common in the media, entertainment, and software industries
- Example: A software developer licenses their code to a company for use in a mobile app
Trade secrets and confidentiality
- Trade secrets are confidential business information that provides a competitive advantage, such as formulas, processes, or customer lists
- Trade secret licenses are less common than other IP licenses due to the risk of disclosure, but can be used for know-how or technical assistance
- Example: A food company licenses its secret recipe to a contract manufacturer
- Licensing agreements should include confidentiality clauses to protect the licensor's trade secrets and other sensitive information
- Confidentiality clauses should specify what information is considered confidential, who can access it, and how it must be protected
- Example: A licensing agreement may require the licensee to sign non-disclosure agreements with all employees who have access to the licensor's trade secrets
IP ownership and improvements
- Licensing agreements should clearly specify the ownership of any IP created during the licensing relationship, such as improvements or derivative works
- Licensors may want to retain ownership of improvements to maintain control over their IP, while licensees may want to own improvements they develop to capture additional value
- Example: A licensing agreement may grant the licensee ownership of any improvements they create, subject to a grant-back license to the licensor
- The agreement should also address the parties' rights and obligations with respect to prosecuting and enforcing IP rights
- This may include provisions for sharing costs, cooperating in legal actions, and allocating any damages or settlements
- Example: A licensing agreement may require the licensee to promptly notify the licensor of any suspected and provide assistance in enforcing the licensed IP
Accounting and auditing of royalties
- Accurate accounting and reporting of royalties are essential for maintaining trust and compliance in licensing relationships
- International consultants can help SMEs establish effective systems for tracking and verifying royalty payments and resolving any disputes that may arise
Record-keeping requirements
- Licensing agreements should specify the record-keeping requirements for the licensee, including the types of records to be maintained and the retention period
- Records may include sales reports, invoices, inventory logs, and marketing materials
- Example: A licensing agreement may require the licensee to keep accurate records of all sales of licensed products for a period of five years
- The agreement should also specify the format and frequency of royalty reports to be provided to the licensor
- Royalty reports should include sufficient detail to allow the licensor to verify the accuracy of the reported sales and royalties
- Example: A licensing agreement may require the licensee to provide quarterly royalty reports within 30 days of the end of each calendar quarter
Audit rights and procedures
- Licensing agreements should include audit rights for the licensor to verify the accuracy of the licensee's royalty reports and payments
- Audit rights typically allow the licensor to appoint an independent auditor to review the licensee's records and facilities
- Example: A licensing agreement may grant the licensor the right to conduct an audit once per year, with reasonable notice to the licensee
- The agreement should specify the procedures for conducting audits, including the allocation of costs and the treatment of any underpayments or overpayments
- Audit costs are typically borne by the licensor unless the audit reveals a material underpayment, in which case the licensee may be required to reimburse the costs
- Example: A licensing agreement may require the licensee to pay any underpaid royalties plus interest within 30 days of receiving the audit report
Resolving payment disputes
- Despite best efforts, disputes over royalty payments may arise due to differences in interpretation, calculation errors, or other factors
- Licensing agreements should include provisions for resolving payment disputes, such as escalation procedures, mediation, or arbitration
- Dispute resolution provisions should specify the governing law, venue, and allocation of costs
- Example: A licensing agreement may require the parties to first attempt to resolve any payment disputes through good faith negotiations, followed by binding arbitration if necessary
- The agreement should also address the consequences of unresolved payment disputes, such as the right to terminate the agreement or seek legal remedies
- Termination rights for payment disputes should be balanced against the potential impact on the parties' business and the value of the licensed IP
- Example: A licensing agreement may allow the licensor to terminate the agreement if the licensee fails to cure a material underpayment within a specified period after receiving notice
Cross-border licensing issues
- International licensing presents additional challenges and opportunities for SMEs due to differences in legal systems, cultural norms, and economic conditions
- International consultants must help SMEs navigate the complexities of cross-border licensing and develop strategies for success in foreign markets
Territorial restrictions and parallel imports
- Territorial restrictions in licensing agreements limit the licensee's rights to specific countries or regions
- Licensors may use territorial restrictions to maintain control over their IP, optimize pricing, or comply with local regulations
- Example: A licensing agreement may grant the licensee exclusive rights to sell the licensed product in the European Union but not in the United States
- Parallel imports, also known as gray market goods, are genuine products imported from one country to another without the IP owner's consent
- Parallel imports can undermine territorial restrictions and erode the licensor's profits, particularly when there are significant price differences between countries
- Example: A licensee in a low-price country may sell the licensed product to a distributor who resells it in a high-price country, competing with the licensor's authorized distributors
- Licensing agreements should include provisions to prevent or limit parallel imports, such as prohibiting the licensee from selling outside their designated territory or requiring them to implement tracking and enforcement measures
Currency fluctuations and tax withholding
- Cross-border licensing agreements often involve payments in different currencies, exposing the parties to foreign exchange risk
- Currency fluctuations can impact the value of royalty payments and create uncertainty for both parties
- Example: If the licensee's local currency depreciates against the licensor's currency, the licensee may struggle to make the required royalty payments
- Licensing agreements should include provisions for managing currency risk, such as specifying the payment currency, using forward contracts or currency hedges, or adjusting royalty rates based on exchange rate movements
- The choice of payment currency and risk management strategy should consider the parties' respective exposures and preferences
- Example: A licensing agreement may require royalty payments in US dollars but include a clause allowing for adjustments if the exchange rate moves beyond a certain threshold
- Cross-border royalty payments may also be subject to withholding taxes in the licensee's country, which can reduce the net amount received by the licensor
- Withholding tax rates and requirements vary by country and may be governed by bilateral tax treaties
- Example: A licensee in China may be required to withhold 10% of the royalty payment and remit it to the Chinese tax authorities
- Licensing agreements should address the responsibility for withholding taxes and the gross-up of payments to ensure the licensor receives the intended net amount
- The agreement may specify that the licensee is responsible for all withholding taxes and must gross up the payment so that the licensor receives the full royalty amount
- Example: If the royalty rate is 5% and the withholding tax rate is 10%, the licensee would need to pay a gross royalty of 5.56% to ensure the licensor receives the full 5% net of tax
Language and cultural barriers
- Language and cultural differences can create misunderstandings and conflicts in international licensing relationships
- Differences in communication styles, business practices, and legal traditions can lead to divergent expectations and interpretations of the agreement
- Example: In some cultures, a verbal agreement may be considered binding, while in others, a detailed written contract is essential
- Licensing agreements should be drafted in clear, concise language and translated into the parties' native languages to ensure a common understanding
- The agreement should also include a clause specifying the governing language version in case of discrepancies between translations
- Example: A licensing agreement between a German licensor and a Japanese licensee may be drafted in English but include German and Japanese translations, with the English version prevailing in case of conflict
- International consultants can help bridge cultural gaps by providing guidance on local business norms, facilitating communication, and fostering mutual understanding and respect
- This may involve organizing cross-cultural training, adapting the agreement to local preferences, or acting as an intermediary in negotiations and dispute resolution
- Example: An international consultant may advise a US licensor to adopt a more formal and hierarchical communication style when working with a Japanese licensee to show respect for their business culture
Key Terms to Review (18)
Advance payment: An advance payment is a sum of money paid before the actual delivery of goods or services. This payment method is often used in licensing and royalty agreements to secure a commitment from the licensee and ensure that the licensor receives some upfront financial support before products are developed or released into the market. Advance payments help in mitigating risks for licensors while providing licensees with assurance that they have the rights to use specific intellectual property.
Auditing rights: Auditing rights refer to the legal entitlements granted to a party, typically a licensor, to examine the financial records and practices of a licensee to ensure compliance with the terms of a licensing agreement. These rights help maintain transparency in the payment of royalties and other financial obligations, allowing licensors to verify that they are receiving accurate compensation for the use of their intellectual property.
Coca-Cola Franchising Model: The Coca-Cola franchising model is a business strategy where the Coca-Cola Company licenses its brand and product rights to independent bottlers, allowing them to produce, package, and distribute Coca-Cola products within specific geographic territories. This model enables Coca-Cola to maintain brand consistency while leveraging the local knowledge and operational efficiencies of its bottlers.
Contractual obligations: Contractual obligations refer to the legal duties that arise from a contract, which require the parties involved to fulfill specific terms and conditions outlined in the agreement. These obligations are binding and enforceable by law, meaning that if one party fails to meet their responsibilities, the other party may seek legal remedies. In the context of licensing and royalties, understanding contractual obligations is crucial as it governs the relationship between licensors and licensees, dictating how intellectual property rights are managed and compensated.
Cross-licensing: Cross-licensing is a legal arrangement where two or more parties grant each other rights to use their intellectual property, such as patents or trademarks. This agreement allows companies to leverage each other's innovations while avoiding potential patent infringement disputes. Cross-licensing can be especially beneficial in technology and pharmaceutical industries, where it encourages collaboration and accelerates product development.
Disney licensing agreements: Disney licensing agreements are contracts that allow companies to use Disney's characters, trademarks, and intellectual property in exchange for royalties or fees. These agreements enable partners to create and sell products that feature Disney's iconic brands, while also expanding Disney's reach and revenue through strategic collaborations.
Exclusive License: An exclusive license is a legal agreement that grants one party the sole right to use a specific intellectual property, such as a patent, trademark, or copyright, while prohibiting the original owner from licensing that same property to others. This means the licensee can exploit the intellectual property without competition from the owner or anyone else. Exclusive licenses are often used to encourage innovation and investment, as they provide the licensee with guaranteed market control over the licensed property.
Franchising: Franchising is a business model that allows individuals or groups to operate a business under an established brand and system, in exchange for fees or royalties. This arrangement enables franchisees to benefit from the brand recognition and operational support of the franchisor, while also maintaining some level of autonomy in their operations. It plays a vital role in the global expansion of businesses and impacts ownership structures and control dynamics within various markets.
Infringement: Infringement refers to the violation or unauthorized use of someone else's intellectual property rights, including patents, copyrights, trademarks, or trade secrets. This breach can lead to legal consequences and damages for the infringer, emphasizing the importance of protecting intellectual property in business practices. Understanding infringement is crucial for managing licensing agreements and ensuring that rights holders are compensated appropriately for their creations.
Intellectual Property: Intellectual property refers to the legal rights that protect creations of the mind, such as inventions, literary and artistic works, designs, symbols, names, and images used in commerce. These rights are designed to encourage innovation and creativity by granting creators exclusive rights to use and benefit from their creations for a certain period. This protection is crucial for businesses and individuals in managing their inventions and negotiating terms of use or commercialization.
Joint venture licensing: Joint venture licensing is a business arrangement where two or more parties collaborate to create a new entity, sharing resources, risks, and profits, while one party licenses its intellectual property or technology to the joint venture. This arrangement allows companies to combine strengths and enter new markets more effectively, leveraging the local knowledge and distribution channels of partners.
Licensing negotiations: Licensing negotiations are discussions between parties where one party grants permission to another to use intellectual property, such as patents or trademarks, under specific conditions. These negotiations are essential for establishing the terms of use, including fees, duration, and rights, which ultimately create a legal framework for both parties to operate within. Successful licensing negotiations ensure that the interests of both the licensor and licensee are met while providing a pathway for collaboration and innovation.
Market Access: Market access refers to the ability of companies to sell their products and services in foreign markets without facing restrictive barriers. This concept is crucial as it influences the competitiveness of businesses in international trade, impacting factors such as tariffs, regulations, and other trade barriers that can hinder entry into new markets. Understanding market access is essential for businesses seeking to expand internationally and navigate the complexities of customs, pricing strategies, licensing agreements, and political environments.
Non-Exclusive License: A non-exclusive license is an agreement that allows the licensee to use a licensed asset, such as intellectual property, without granting them exclusive rights over it. This means that the licensor can grant similar licenses to multiple licensees, leading to the potential for broader market penetration and revenue generation. In this arrangement, the licensor retains ownership of the asset and can continue to exploit it independently or through other agreements.
Royalty rate: A royalty rate is the percentage or fixed amount paid by one party to another for the use of intellectual property, such as patents, trademarks, or copyrights. This rate is critical in licensing agreements, as it determines how much a licensee must pay a licensor for the rights to use their intellectual property. The royalty rate can vary significantly based on factors such as the type of intellectual property, industry standards, and the specific terms negotiated between parties.
TRIPS Agreement: The TRIPS Agreement, or Trade-Related Aspects of Intellectual Property Rights, is a comprehensive international treaty administered by the World Trade Organization that sets minimum standards for the protection of intellectual property rights across member countries. It covers a wide range of intellectual property areas, including patents, trademarks, copyrights, and licensing practices, aiming to balance the interests of creators and users while fostering innovation and creativity on a global scale.
Value Chain: A value chain is a set of activities and processes that a company uses to deliver a valuable product or service to the market, encompassing everything from production to marketing and distribution. This concept helps businesses identify areas where they can create more value for customers and improve competitive advantage, focusing on both primary and support activities that contribute to delivering a final offering.
WTO Agreements: WTO Agreements are the legal texts that form the foundation of the World Trade Organization, which governs international trade relations between countries. These agreements aim to create a fair and transparent trading environment by establishing rules that member nations must follow regarding trade in goods, services, and intellectual property. They ensure that trade is conducted smoothly, predictably, and freely, while also addressing issues such as tariffs, customs procedures, and licensing arrangements.