What Are Some Secrets of Profitable Licensing Deals?

Hi. I’m Richard Stim, author of Profit From Your idea: How to Maker Smart Licensing Decisions from Nolo, and this episode is entitled Secrets of Profitable Licensing Deals. I am sure you’re wondering … Secrets …how could I be telling you secrets if it’s being published on the Internet. It might be more accurate to say that what I’ll be talking about here are things that are sometimes overlooked when entering into a licensing deal. And by licensing deals we’re talking about the general terms that comprise a license of a product, invention, artwork, music, trademark or image.

Let’s start with some basic principles. The business makes and sells the product is the licensee. The company that created or invented the product is the licensor.

A license – just so we’re clear -- lets someone commercialize an invention, duplicate artwork, reproduce music or place an image on a t-shirt. In return for granting the license, the licensor receives money—either a one-time payment or continuing payments called royalties. Think of a license like renting out ideas. At the end of the rental period, the rights are returned to the owner.

The ability to make this kind of agreement is based on the premise that the licensor has exclusive rights to something—that is, something is protected under copyright, patent, trade secret, or trademark laws (collectively known as intellectual property or IP laws). These laws give the owners “suing rights” – they can go after anyone who makes copies of the property without permission. So, a licensor must have something protectible to get a deal.

For example, many clothing, jewelry and furniture designs are not protectible under intellectual property laws and so chain stores are not violating the law when they knock-off these creations without paying the creators.

Determining whether you are protected is beyond the scope of this podcast, but you can find plenty of helpful resources at the Patents, Copyright and Art section of the Nolo website. If you’re in doubt, check with an attorney. In some big cities, you can get low-cost advice from arts attorney organizations such as Volunteer Lawyers for Arts. There’s a national directory at the www.VLANY.Org website .

Know the Other

The worst thing to overlook in a license deal the other party. What I mean by that is that sometimes the parties are swept up in the excitement of the licensed product and fail to properly investigate each other. For example, the licensee fails to investigate the licensor and learns too late that there is a dispute as to the ownership of the product rights. More commonly, the licensor, excited by the potential deal, fails to investigate the licensee.

Always keep in mind that as they say – when it comes down to it, it’s the people not the paper, that matters the most in a licensing deal. Do the research. There are plenty of ways to research companies on the web. Consider obtaining a Dun & Bradstreet report if necessary to determine a licensee’s history of repayment. If possible talk to other companies or individuals who have signed with the licensee.

The worst thing for a licensor is to be trapped in a bad licensing deal, chasing royalties, and trying to get your rights back.

Deductions

Many licensees, particularly first-time licensees, will focus a great deal of attention on the amount of the royalty and the advance and focus very little attention on deductions against royalties. That’s a mistake.

Deductions are amounts that the licensee can subtract from net revenue before calculating the royalty.

Last week musicians from Cheap Trick and the Allman Brothers sued an international record company over music licensing deals. The musicians wanted to know why deductions such as packaging costs and breakage expenses – deductions associated with vinyl recordings – were being made on royalty payments for digital downloads. The musicians claimed that millions of dollars were being diverted by these deductions. The record company claimed that the agreements permitted these nonsensical deductions.

Whether licensing inventions, music, or artwork, always pay attention to deductions. They often have a bigger impact on royalty checks than any other factor. Some deductions – such as shipping, credits for returns and local taxes are normal but some companies also attempt to deduct what should be costs of business from your calculation of net sales. Be wary of deductions for marketing, bad debts and sales commission deductions, for example. If you reach an impasse on deduction negotiation, at least try to put a cap of say 10% of gross sales on the amount of all deductions.

Audit Provisions

If there is a dispute over royalties, the licensor will want to audit the books of the licensee. So both parties should carefully review the audit provision to make sure they’re comfortable. Usually, a typical audit provision permits audits once a year under certain conditions. Many audit provisions require that the licensor hire a certified public accountant to perform an audit. Licensors should try to avoid this as a CPA may be a very expensive proposition and the licensor may prefer to send a non-certified accountant or lawyer to the audit, instead. Also, a licensor should seek a statement that if an underpayment of say 5% is discovered, the licensee will pay the cost of the audit and any interest on the past due amount.

The Prosecute Infringement Provision

When you license your work, the licensee generally assumes the obligation of chasing infringers. That’s a good thing for licensors and one of the major advantage of signing a license agreement versus manufacturing a product. Plus, just having a big name licensor such as Black & Decker, Mattel or Time-Warner on your side, often deters someone from infringing in the first place. Review this provision and examine how the recovery from these lawsuits will pay out. The most equitable approach is to split the recovery after the licensee’s legal fees and costs are deducted. The least equitable is to pay the licensor the same royalty on recoveries as on licensed products.

Know the Industry

Just as some licensors fail to investigate the licensees, they also fail to properly investigate the industry in which they are licensing. After my book, Profit from Your Idea had been out for a few years., I heard from an inventor, David Silva, whose company Localoc had successfully used the book to license two of his patented hair accessory products invention. When I asked David if he had any tips when making a product pitch this what he told me.

Pitching something you believe in and worked hard to create is always nerve racking. My advice is to not only prepare exactly how you will present the invention, making sure it can be understood in a short period of time (a few minutes or forget it), but to also learn the history of the company you are pitching to, including the names of the people who run it, and the industry itself.

The company you're pitching to really needs to sense that you know what you're talking about. You would think a company that sells a particular type of product would be aware of all their industry’s latest trends, but nine times out of ten they are experts in advertising, marketing, and distributing, not experts in the latest trends relating to their industry.

For example, when I asked Helen of Troy how many hairstylists they had working in their 500-employee hair-product company, their answer was “None.” Believe me, convincing a company that you know a lot about their industry and its trends makes all the difference. Also, the old saying “don't take no for an answer” is true. If they do say no, continue to come up with reasons why they are wrong.

What happens when one party says “That’s the best we can do.”

Let’s say you believe your product will be very successful. However, the licensee is offering you what seems to be the royalty rate of say 5 to 10% and a relatively small advance. Having worked for years to perfect your product, you feel that the proposed royalty and advance is too small. After all, the licensee is a successful company, so it should be able to pay more money.

Before assuming that the company is bluffing examine the two most important numbers in the licensing negotiation. Cost of goods – what it costs to manufacture your product – and retail price. What you expect the consumer to pay (often a multiplier of five of the cost of goods). That’s how the licensee is looking at it. If your price is, for example, higher than competing products, you may have an explanation right there why the licensee is cautious about offering a higher royalty.

If you believe that the company is simply bluffing, you may have to -- as my office mate Lisa Guerin says -- play it like Columbo.”

Weigh the alternatives, consider the people involved and consult with someone in the industry, before rejecting any offer. One possible solution may be to accept an offer but limit the time period for the agreement for as short as possible. That way, if the product is successful, you can renegotiate for a better arrangement. Another possible solution is to suggest a fluctuating or sliding royalty that increases as sales increase. That’s what David Silva did, for example, in one of his licensing arrangements.

Tip #5 Keep it Short

One successful licensor I’ve worked with is a cartoonist who has followed two basic principles. Always make sure that all rights revert after the license is over and always keep the deal as short as possible. Why keep it short? If it’s successful, the licensor will want to renew and you’ll have an opportunity renegotiate. If it’s unsuccessful you’ll probably want out as soon as possible anyway … in order to try somewhere else. Using this approach he has entered into three separate videogame licenses as well as a license for Saturday morning TV shows, all the while retaining all rights in his characters.

I’m afraid that’s all the time we have for right now and if there’s enough of a demand maybe we can follow up with another set of tips in the future.

Finally, I’m proud to say that Nolo has the best collection of licensing materials available to help you. Even if you get an attorney, our materials will help you save on attorney fees. If you’re an inventor, check out my book, Profit from your Great Idea, and if you’re a musician or artist, check out my book, Getting Permission.