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A license is just a special kind of contract between an owner and a buyer. Like any other kind of deal it is based upon the idea of fairness to both parties, as they each give up something to get something in exchange.
Let’s consider a simple sale. If one is selling a personal possession like a car or camera, it’s normal to have some sort of sales document. In the case of selling a car, there is a title issued to the owner by the state in which it is registered. This title identifies the car and its owner. Somewhere on the title is a place for the owner to sign when he or she wants to sell it to a buyer. After the title is signed the seller gives the now executed title to the buyer and the buyer, in trade, hands over a check or cash as payment.
In order for this to happen both parties must agree that the trade is fair. If either the seller or buyer doesn’t believe this is fair, they will naturally refuse to make the deal, and the car stays with its owner, and money with the would-be buyer. If either the seller or buyer forces the transaction by making the other guy do a deal they don’t want to do, such as a seller running off with the money from a buyer who has decided the car is not a fair deal, or the buyer taking the car when the seller decides the buyer’s offer is not fair, we call that theft.
In the case of a selling and buying something like a camera, the story is about the same except there is no title provided by the state. In this case the buyer and seller may create a simple one-page document that provides a description of the camera, the seller’s name, the selling price, the date, and the buyer’s name. The core idea is the same: the deal has to be seen as fair to both parties or there is no deal.
In both of these examples of simple sales, no ‘license’ was used. That’s because licenses do not normally happen in deals where a single item is sold to an individual buyer. Rather, a license is a special type of trade agreement that is used for deals that involve “intellectual property,” meaning an invention or creation such as a song or a picture.
Intellectual property is much different from ‘regular’ property, such as a car, because it can be in lots of places at one time, and usually the buyer does not need to own it to use it. |
Intellectual property is much different from ‘regular’ property, such as a car, because it can be in lots of places at one time, and usually the buyer does not need to own it to use it. Take for example a greeting card. If you create a card by drawing a beautiful picture, taking a photograph, or by drafting some inspirational writing, you have created intellectual property in the form of a copyright. It belongs to you. And, like anything else that belongs to you, you do four things with it: you can keep it for yourself, you can give it away, you can throw it away, or you can let others use it in return for some fair exchange.
Most creators hope to be compensated fairly for what they create so that they can afford to spend more time creating. If you are talented enough at creation, or invention, it is possible that you could earn your entire living by doing just what you are gifted to do –provided that you are paid by the people who use your creations. But for this to actually work, there has to be a fair deal with all of us who could enjoy your creation.
Let’s look at another greeting card example. There is a card sold by Sunrise Greetings that has two Chinese men laughing together. They are real men, an uncle, Xia Yongquing, age 84, and his nephew, Yang Ziyun, age 82, in the village of Nayang in the Sichuan province of China. The caption reads: “Laughter is the shortest distance between two people.” The picture belongs to a man named John Kaplan. We can know this because his name with the copyright, © symbol, is on the back of the card. Mr. Kaplan has granted the right to use his picture to a company known as M.I.L.K. Licensing Limited (Moments Intimacy Laughter Kinship). M.I.L.K.™ in turn has granted a license to Sunrise Greetings to sell this card, which it does under its branding of InterArt®.
So let’s think of six intellectual property rights present in this simple example:
- Mr. Yongquing and Mr. Ziyun own the right to their own images, which cannot be used commercially without their permission.
- Mr. Kaplan secured the intellectual property right, a copyright, to use the image of these two happy old men by some agreement.
- M.I.L.K.™ licensed from Mr. Kaplan the use of the picture in the card.
- Sunrise Greetings licensed from M.I.L.K.™ the right to sell the card in stores.
- M.I.L.K.™ itself has trademarked the particular use of those four letters for greeting cards, and
- Sunrise Greetings has itself trademarked its InterArt® brand.
When I buy this card in the store, a portion of the $3 selling price goes to the retail store to provide it with a fair return for having the store there for us to shop at. Some of the $3 is retained by Sunrise Greetings and is used to pay for its printing and distribution of the card and envelope. Some of the $3 is paid by Sunrise to M.I.L.K.™ for its use of the picture, caption, and layout imagery. Some of the $3 also goes in some way from M.I.L.K.™ to the photographer, Mr. Kaplan, and the two men pictured.
Intellectual property is much different from ‘regular’ property, such as a car, because it can be in lots of places at one time, and usually the buyer does not need to own it to use it. |
Even though this simple envelope and plain folded card could be bought for, say, 50 cents, what makes me want to spend an extra $2.50 to get the faces of old men from China, who I have never met? The answer is simple: it pleased me (the buyer) to see this picture and I felt it would help me to connect with the person I was sending it to better than any picture I had on hand, or could draw. I felt the price was fair or I wouldn’t have bought the card.
So, when lots of us buyer buy these cards it’s an indication to the store, Sunrise Greetings, M.I.L.K.™, and John Kaplan that they have succeeded. And not only will these folks be rewarded for their efforts, but they will also be encouraged to do more creative cards.
What about just taking the card without paying? We would be stealing something that is owned by the store, which is just as unfair as if the storeowner stole our iPod when we’re not looking.
What about buying one card and then going into business making exactly the same card and selling it to greeting card stores? We would be stealing too. Now it would be from Sunrise, M.I.L.K.™, and Kaplan, and it would be of their intellectual property rights.
My paying for that card is not only the right thing to do, but it makes it possible for me to find greeting cards to buy. If cards don’t get sold, they will not get created, and you and I will be left with fewer and fewer cards to choose from.
What Does a Licensing Agreement Look Like?
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What did those licenses between Sunrise and M.I.L.K.™ and between M.I.L.K.™ and Kaplan look like? Of course they are private agreements between those companies and people so we cannot know specifically what’s in them. But we can know generally, because most licenses look something like this:
- A careful statement of the rights being granted by the owner. Here Mr. Kaplan may have sold his entire right in the photograph to M.I.L.K.™, or perhaps just the right to use it in a single design greeting card line. M.I.L.K.™, in turn, in its license to Sunrise Greetings likely granted a limited right to make, distribute, and sell the design of the card. A key idea here is whether the license is exclusive. An exclusive license means that the owner will not license anyone else to the same bundle of rights, considering all the aspects in #3 below. A non-exclusive license, on the other hand, means that the owner can sell exactly the same rights to as many people as it wants. Either approach can be fair, because the payment required for a less valuable non-exclusive license will be smaller.
- The payment amount and terms by the buyer, also known as the licensee (license-EE). If Mr. Kaplan sold his entire right to M.I.L.K.™ then here is where the payment amount would be specified and when the payment would be made. Just as an example, let’s say M.I.L.K.™ agreed to pay Mr. Kaplan $3,000 for M.I.L.K.™ to own the photograph and use it however it wants. In this kind of a license, the deal is essentially the same as the car and camera examples we considered: M.I.L.K.™ pays once, and owns what it bought, and can use it however it likes. Alternatively, Mr. Kaplan and M.I.L.K.™ could have agreed to a royalty payment. Again just making up a number, M.I.L.K.™ could have agreed to pay Mr. Kaplan (say) 10 cents for each dollar M.I.L.K.™ receives for anything containing Mr. Kaplan’s picture; this would be known as a 10% royalty because 10 cents is 10% of $1.00. In turn, Sunrise Greeting could have agreed to pay M.I.L.K.™ a percentage of the payment Sunrise receives from the retail store for the sale of the card. Just as an example, the $3 you or I paid for this card could have been split in this way: 50 cents stays with the store as its share of making the sale; that leaves $2.50 for Sunrise Greeting. But Sunrise had to pay for the card stock and envelope, and the color picture printing along with the text, and shipping and distribution. Let’s assume this all cost $1.50; this leaves $1.00. From this Sunrise has to pay its royalty to M.I.L.K.™. If we assume this is 50 cents, then it gets to keep 50 cents for its part in taking the risk and enduring the expense to create this opportunity. Finally of the 50 cents that M.I.L.K.™ receives from Sunrise, it pays the 10 cents to Mr. Kaplan and keeps 40 cents for its role in creating the card concept. The key point is that in each one of these deals (license agreements) the payment has to be fair for the rights being provided or no agreement is reached.
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The location, use, and duration of the agreement are specified. Licenses are normally specific to a “territory,” which may be an entire country, but could be a single state or in the case of our greeting card example, a single chain of stores such as Walgreen’s, CVS, or small ‘mom and pop’ individual greeting card stores. The license between M.I.L.K.™ and Sunrise probably specifies where Sunrise can sell its licenses either by geography or by store type. Licenses also specify how the rights can be used. In the license between Kaplan and M.I.L.K.™ it would define how M.I.L.K.™ could use the photograph. One design of a greeting card? Any greeting card? Greeting cards and calendars? Any and all uses? The owner and licensee can agree on any of these possibilities so long as each side believes the deal is fair. Finally, many licenses have some duration specified, such as a defined number of years. The owner can agree to a duration of “forever,” meaning the license never expires as long as the license continues to pay the royalty it agreed to pay. In other cases, there is a specific expiration date to the license such as five years after signing of the agreement, or by some certain date as of December 31, 2009. After any specified date, the licensee no long has any right to use the owner’s intellectual property.
- Other terms and conditions. Licenses will also specify how and when payments, such as royalties, are to be made. The payments could be made yearly, or semi-annually, or quarterly, or any other frequency that is fair to the owner and licensee. They could be paid by checks through snail mail, or by direct deposit to a bank account. Licenses may also have mandatory annual dollar payments, known as “minimum royalties.” Return again to our greeting card example, the license from M.I.L.K.™ to Sunrise could, for example, have the royalty determine as we gave in the above example, namely 50 cents a card. But separately from this, M.I.L.K.™ and Sunrise could have agreed that, no matter what, Sunrise will pay to M.I.L.K.™ a minimum dollar amount each year or forfeit its license. Another issue that comes up with licenses is whether the licensee can sell its rights, however they are limited in #1 and #3 above, to someone else. This is called a sublicense right. Sometimes when the license is an exclusive license, the original owner/creator will agree with its licensee that the same rights can be licensed to someone else. In our greeting card example, the license from M.I.L.K.™ to Sunrise may include the right that would enable Sunrise to license its rights to yet someone else. This could be useful to Sunrise in case it finds that it cannot meet all the market demand for all the territory and uses that it has acquired. By sublicensing, Sunrise can then have one or more other company’s help make and distribute the greeting card. If sublicensing rights are permitted, the payments then owed by Sunrise to M.I.L.K.™ would be determined by a recipe agreed to be M.I.L.K.™ and Sunrise.
It’s amazing but this whole system works on trust and fairness. |
There are many other term possibilities in a license agreement but the above examples show how powerful and flexible they can be. What is important to realize is how a license can be used to reward a creator or multiple creators in a way that is fair to everyone who has participated in making a product possible. Each trade must be fair for the system to work, including our fair use of the final product that we purchase. In our greeting card example, we bought the one card (and envelope) that we can send to a friend. We did not buy the right to copy and duplicate, or go into the business of making these for sale to others.
It’s amazing but this whole system works on trust and fairness. If creators/owners did not trust its licensees there would be no trades possible and ultimately a lot fewer creative products on the shelves for us to choose from. So the next time you see or hear or use something that’s amazing, you can be sure that someone creative made it possible and that somewhere in the process of bringing that idea to the market was a license agreement.
How Do Licensors and Licensees Find Each Other?
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Creators of intellectual property often need to find licensees who can make the investments needed to bring their creations into being as products. This requires all kinds of other business skills, like manufacturing, sales, distribution, and administration. Generally people who are really good at creating are not as adept or interested in the essential business end of the process. Similarly, people who are good at manufacturing or selling are often not very good at creating.
So, how do creators and manufacturers find each other? Is it like finding dates and soul mates? It’s actually generally easier than that. If you are an owner of some invention or creation you often have an idea of how and where such intellectual property could be sold and are familiar with companies that are already selling similar kinds of products.
The Internet really makes this a lot easier as search engines can help us find potential partners all over the world.
In our greeting card example, John Kaplan and M.I.L.K.™found each other. If you are a creative photographer, there are various published resources on companies that are looking to buy new pictures. Some of such buyers could be clip art software companies, magazine publishing clip art services, calendar publishers, and of course greeting card designers, such as M.I.L.K.™ Companies that are looking for creative photographers may place advertisements in publications known to be read by photographers, or announce their desire for new pictures online.
A ‘license date’ generally starts with a telephone call or email that describes a little about the owner or buyer’s interests and asks whether there is any possible interest and, if so, how such a discussion could best take place. At this initial stage, no content or “secrets” are shared by either side. The buyer may ask to see some published examples of the seller’s other work to determine credibility of a seller’s capabilities. The seller may ask that the prospective buyer/licensee company identify products it has introduced to the marketplace under a license from a creator of a similar product.
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Usually many such prospective discussions have to take place before there appears to be a good possibility for mutual interest. For the owner of an invention or creation, the process of finding someone interested in being a licensee can be discouraging not only because of the unavoidable rejections involved in the process but also because of the time and effort required.
It’s a good idea to do a critical self-examination at various points along the way to assure that what you have created is really special. If it’s not, then maybe the better course is go back to the creation step and come up with something new. “Going back to the drawing board” is not only a well worn saying, it’s the common experience of inventors and creators. In fact, Thomas Edison, who invented the light bulb and numerous other things, had tens of thousands of unsuccessful inventions along the way. The good news is that this experience often leads to a better idea than the original. And once one has demonstrated success, it is far easier to get people to listen and consider your next concept.
At some point, the prospective buyer will ask about the specific opportunity. At this point the seller/owner must consider whether a confidentiality agreement is necessary prior to disclosure.
In most cases, prospective buyers are reluctant and often slow to enter an agreement of this sort. However, in certain cases the seller may be comfortable in making a partial or full disclosure without concern about a confidentiality agreement. If the invention is contained within an unobservable component or system, the so-called “black box,” then it may be possible to demonstrate the effect of the opportunity without yet disclosing how the effect is achieved. In other cases, the owner has filed or already obtained a patent from the Patent Office. In this situation, the patent is actually a public document, by law, protecting the creation so that the inventor can disclose a copy of the issued or published patent. In still other cases, there is a measure of trust between the two sides that is sufficient to warrant making a disclosure.
Once a disclosure has been made, the two sides should seek to reach an early agreement on how further study, if needed, will be done leading to a final decision to negotiate or “pass” on the opportunity. Such further study is “due diligence” and is usually about what a buyer/licensee needs to do to persuade itself that the invention or creation has real commercial potential. But a seller can do his or her own due diligence on the buyer by examining the kinds of products it has brought to the marketplace and how successful it has been. The buyer may provide the names of other inventors that can serve as references.
A license is a trade. It only happens when both sides conclude that they will benefit by entering the deal more than the cost, or loss, required to make the deal possible.
What is a Royalty?
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A royalty is a common form of payment made by a licensee. The royalty is a kind of rent. But instead of it being due on the 1st of the month, it is owed on each item sold by the licensee. Because it is paid on each unit it is often called a “running royalty” to make it clearer that it is not just a series of fixed payments.
There are two ways of expressing such a running royalty: as a percentage of the dollars received by the licensee for its sales of products containing the creation or invention, or as a fixed dollar or cents amount per unit sold. So a royalty could be expressed as (say) 5% of the dollars received by the licensee, or it could be given as (say) $1 per unit sold.
Running royalties can be a fair way for both the seller and the licensee because the more that gets sold the more the owner is paid and the less that is sold the less the licensee is obligated to pay. So if the product is wildly successful, the owner under a running royalty structure will receive a larger benefit. And, if the product turns out to be a disappointment, then the licensee will not owe the owner very much in the way of royalties.
A second type of payment for a license is called a period payment. The most common example of this would be a fixed annual payment, which is usually specified in a license agreement. Under such an arrangement the licensee does not pay any per unit running royalty. If the product is very successful the licensee is better off with a fixed period payment than a running royalty. However, if the product is very unsuccessful the licensee can be much worse off financially.
A variation on a fixed payment is a milestone payment. Such a payment would be required of the licensee based on the completion of some specified milestone. One example would be for a payment due when, and if, the patent office issues into a patent a then pending application by the owner. Another example would be a specified payment being due upon the licensee’s reaching a certain amount of sales, either in total, or on an annual basis.
In addition to any of the above, it is not uncommon for their to be an initial payment made upon execution of the license or shortly thereafter.
More resources on licensing, click here
