Understanding what a license agreement is

When you are trying to license your invention for royalties, the end result of all your hard work is to secure a license agreement. A license agreement is when the inventor [licensor] agrees to let a third party [licensee] commercially use his invention for a period of time. As a result of the agreement, the inventor would receive either ongoing payment called a royalty or a one-time lump-sum payment. The likelihood of an inventor striking a license agreement would depend on the premise that the inventor “owns” the invention (i.e., a patent). Without patent protection, any individual or company could make or sell the invention; therefore, it would be unlikely that a company would license or buy the invention.

When negotiating a license agreement, there are various items that must be addressed between the inventor (licensor) and company (licensee). Some of these items are royalty rate, up-front payment (if any), term and territory. For example, the agreement can be limited to a particular area of the country, for a certain period of time or could be structured to allow for licensing to more than one licensee.

Types of payment under a licensing agreement

1. Percent Royalty – This refers to regular payments the inventor receives for licensing his invention. Percent royalties are based on a percentage of sales. The payment frequency is negotiated and defined in the license agreement (e.g., annual, semi-annual, quarterly or monthly).
2. Use Royalty – This form of royalty is based on number of units sold or frequency of use.
3. Lump Sum Payment – A lump-sum payment is a one-time payment for the transfer of licensing rights.
4. Advance – It’s possible that you can receive an up-front payment instead of future royalty payments or you could receive a partial advance up front, which would then be deducted from future earned royalties.
5. Guaranteed Minimum Payments – This is a guarantee that the inventor will receive a certain minimum royalty payment each year.  Although you should push to have guarantees included in your license agreement, many companies will be reluctant to guarantee future royalties due to the difficulty in predicting sales volumes.  If you cannot negotiate the annual guarantee element of the royalty, one work-around would be to stipulate annual royalty amounts, but rather than lock in the guarantee, ask for a walk-away clause that would give you an out if the company is not meeting performance expectations. 

How much will I get paid?

I assume that earning money is the main reason why you are considering licensing or selling your invention in the first place. The amount of money will vary with each scenario and will be a central point of negotiation in each license agreement. However, some basic guidelines to base royalty payments on are as follows:

• Industry standards – the rate that is customary in the industry. You may find that the prospective licensee is looking at industry standards as a guide in determining the royalty amount. It is difficult to pinpoint a standard due to the fact that circumstances vary for each agreement.  A rule of thumb is that rates can fluctuate between 2% and 10% (unit rates will also vary). For example, the direct TV industry (i.e., infomercial companies) will usually pay lower royalties between 1-3%, due to the fact that they are selling directly to consumers and that they view their position as highly speculative (risky).  However, manufacturing or product companies licensing a high-margin item may be willing to pay 5-10%. 
• Analysis of profit potential – the company will back into this number based on profit potential (i.e., sales predictions, manufacturing costs).
• A combination of both.

Licensing your invention prior to receiving a patent

Although you are not legally prohibited from licensing your invention without a patent, it is less likely than if your invention possesses some form of protection. Two reasons are: (1) without a patent, the company is not breaking any laws or “infringing” if they just make the product on their own, and (2) without a patent, the company would not be able to stop OTHER companies from making and selling your product (this would put them at a cost disadvantage since they must pay a royalty which other companies are not obligated to pay). If your patent is “pending,” your chances are better as you do have some protection on your invention as you wait for your patent to issue. The “patent-pending” period runs from the time that the application is filed to the point when the patent finally issues, and can typically range from 1 to 3 years.

In my experience, I found that most companies are not interested in licensing products unless they have patent protection, either issued or pending. While an issued patent is no doubt better than an invention in patent-pending status, it is usually not a problem for companies if the product is patent pending.

Some final words about licensing…

Don't get carried away

Many inventors strive for the “million-dollar agreement.” Although a good product could earn millions in royalties over the life of the license agreement, it is extremely unrealistic that you will earn a million dollars up front or even over the course of several years. Don’t blow a good deal out of greed.  You need to be realistic and objective, or you may possibly end up with no deal at all.

Inventors repeatedly ask me the same question: “How much will I make on my invention?” As discussed above, and throughout this guide, success and royalty payments do not come without hard work and effort, and the actual payment amount will depend on the merits and market success of your invention.