You already know you have a great idea, a great invention, or have developed a new technology. Knowing this inspired you to find a company interested in taking your idea further. And now, through your hard work, you have found a company that also thinks your invention is great! They are in the right industry, so not only can they appreciate the value of your idea, but they are also in a position to make it happen! Congratulations! This is a fantastic place to be. And at this point, you are probably asking, “Now what?”
The next step is to make some type of agreement between you and the company. The purpose of the agreement would be to give them the right to manufacture and sell your invention, in exchange for them paying you royalties. This type of agreement is commonly called a “licensing agreement,” and it’s an essential step toward getting paid for what you have created.
Precisely because it is such an essential step, it is also a step that must be taken very carefully.
There are many traps or pitfalls that can occur when drawing up a licensing agreement. In this article, we’ll discuss one of the most common traps—to help you prepare for this phase of commercializing your invention with the proper amount of caution.
There are two main types of licensing agreements: exclusive and non-exclusive. If the company you are dealing with will be the only one you allow to produce your invention, then you are talking about an exclusive licensing agreement. On the other hand, a non-exclusive license agreement means that when you are finished making a deal with this company, you can turn around and look for other companies to also make deals with.
Non-exclusive license agreements can really help a product spread. For example, when Phillips invented the compact disc, they licensed their technology to many different companies who were then allowed to produce compact disc players. This allowed the compact disc to virtually replace phonograph records within a few short years.
For an individual, however, it will usually be the case that the company you are dealing with will want an exclusive license. For this reason, you must be aware of the biggest trap that inventors fall into: What if the company to whom you have given an exclusive license decides to “shelve” your idea?
Consider this example. You are talking to XYZ Corp. about licensing your invention. They love the idea, and they project $10 million in sales over the next three years. It all sounds great, so you enter into an exclusive agreement with XYZ Corp. to manufacture your invention. The term of the agreement is for the life of the patent. They agree to pay you a 10 percent royalty on all products they sell. Sounds great! If all goes according to plan, you’ll rake in a cool million dollars in royalties!
But what happens if a year goes by and XYZ hasn’t produced or sold your product. How much do they owe you in royalties? Two years go by? Five years go by? The answer in all cases is zero. They don’t owe you anything unless they produce the product. If they never produce it, they never owe you a single dollar.
Now, if years go by and they never do anything with your invention, are you free to find another company to work on your invention—or to produce and market it on your own? NO. If you made the agreement described above, you would be effectively stuck. All of the rights to produce your invention would belong to XYZ, for the life of the patent—which is ‘forever’ in the world of innovation. (Actually, in the real world, it’s 20 years from the date you filed for patent protection.) And XYZ would never have to pay you a penny!
To avoid this trap, there are several things you can do:
1. Limit the term. This is the most basic defense against a company that doesn’t follow through with producing your invention. If the contract is for a limited term, at some point the rights will revert back to you.
2. Get money up front. Sometimes, money obtained upon signing the contract is called “good faith money.” That’s because it tends to show that the company is serious and acting in good faith. If they weren’t serious, they probably wouldn’t be willing to pay money up front. The only way for them to recoup their investment would be to actually produce your invention (which would begin generating royalties for you anyway). So the money they pay you is a strong motivation for them to get things moving forward, and usually demonstrates their genuine intent to do so.
3. Include an anti-shelving clause in the agreement. Putting such a clause in the agreement will give you the right to cancel the contract if the company doesn’t perform certain agreed upon actions. Sometimes, a timetable is created for moving the invention into production. Other times, this clause is structured as a “minimum royalties guarantee”—requiring the company to either pay you a minimum royalty in a certain time period, or default on the agreement.
Clearly, the most important thing you can do is work with an attorney who is experienced with licensing agreements. There are many more details that ought to be addressed in the agreement that are beyond the scope of this article. A professional will make sure your best interests are considered.
And remember, if you filed a patent application, and you idea is patent pending when it gets to the point that a company is seriously considering entering into a licensing agreement with you, they will have their own attorneys research your invention to determine whether you are likely to get a patent, and how strong such a patent would be.
If you don’t have a good sense of what they will find out in their research, not only could this be a deal-breaker, but it could also give them reason to move ahead with the idea without you! This is yet another reason why doing your homework ahead of time will help prevent surprises later.