Crisis/Turnaround
Management
Private Investment
Banking
Balance Sheet
Restructuring
Intellectual Property
Transaction Advisory
     home  |  services  |  news  |  about us  |  contact us
News
San Francisco, April, 2009
GERBSMAN PARTNERS UPDATE: Structuring Licensing Programs and Agreements

Andrew J. Sherman is a Partner in the Washington, D.C. office of Jones Day, with over 2,400 attorneys worldwide. Mr. Sherman is a recognized international authority on the legal and strategic issues affecting small and growing companies. Mr. Sherman is an Adjunct Professor in the Masters of Business Administration (MBA) program at the University of Maryland and Georgetown University where he has taught courses on business growth, capital formation and entrepreneurship for over twenty (22) years. Mr. Sherman is the author of seventeen (17) books on the legal and strategic aspects of business growth and capital formation. His eighteenth (18th) book, Road Rules Be the Truck. Not the Squirrel. is an inspirational book which was published in the Fall of 2008. Mr. Sherman can be reached at202-879-3638 or e-mail ajsherman@jonesday.com.

Licensing is a contractual method of developing and exploiting intellectual property by transferring rights of use to third parties without the transfer of ownership. Virtually any proprietary product or service may be the subject of a license agreement, ranging from the licensing of the Mickey Mouse character by Walt Disney Studios in the 1930s to modern-day licensing of computer software and high technology. From a legal perspective, licensing involves complex issues of contract, tax, antitrust, international, tort, and intellectual property law. From a business perspective, licensing involves a weighing of the advantages of licensing against the disadvantages in comparison to alternative types of vertical distribution systems. From a strategic perspective, licensing is the process of maximizing shareholder value by creating new income streams and market opportunities by uncovering the hidden or underutilized value in your portfolio of intellectual assets and finding licensees who will pay you for the privilege of having access and usage of this intellectual capital.

Many of the economic and strategic benefits of licensing to be enjoyed by a growing company closely parallel the advantages of franchising, namely:

  • Spreading the risk and cost of development and distribution
  • Achieving more rapid market penetration
  • Earning initial license fees and ongoing royalty income
  • Enhancing consumer loyalty and goodwill
  • Preserving the capital that would otherwise be required for internal growth and expansion
  • Testing new applications for existing and proven technology
  • Avoiding or settling litigation regarding a dispute over ownership of the technolog

The disadvantages of licensing are also similar to the risks inherent in franchising, such as:

  • A somewhat diminished ability to enforce quality control standards and specifications
  • A greater risk of another party infringing upon the licensor’s intellectual property
  • A dependence on the skills, abilities, and resources of the licensee as a source of revenue
  • Difficulty in recruiting, motivating, and retaining qualified and competent licensees
  • The risk that the licensor’s entire reputation and goodwill may be damaged or destroyed by the act or omission of a single licensee
  • The administrative burden of monitoring and supporting the operations of the network of licensees

The usage and application of Intellectual Assets inside both large as well as medium-sized and smaller companies range from being actively exploited to benign neglect to everything in between. Research and development efforts may yield new product and service opportunities which are not critical to the company’s core business lines, technologies which become “orphans” (e.g., lacking internal support or resources) due to political reasons or changes in leadership, or where the company simply lacks the expertise on the resources to bring the products or services to the marketplace. In other cases, the underlying technology may have multiple applications and usages but the company does not have the time or resources to develop the technology beyond its core business. The better managed intellectual capital-driven companies will recognize these assets as still having significant value and develop licensing programs.

Companies of all sizes are realizing that invention for the sake of the inventor or innovation without revenue streams can be very harmful to shareholder value. In a post-Enron world where boards of directors are governed by the pressures of Sarbanes-Oxley and an unforgiving capital market, no company can afford to allow valuable assets to be ignored or go to waste. If there is no desire or no resources available to directly transform innovation into new products and services, then licensing (as well as joint ventures as discussed in the next chapter) offers an excellent way to indirectly bring these innovations to the marketplace, particularly in rapidly-moving industries where the windows of opportunity may be limited.

It is also critical to develop an overall set of intellectual capital licensing policies, strategies and objectives. The goals of the licensing program should be aligned with the overall strategic goals and business plans of the company. The licensing process should help determine which technologies or brands will be made available for licensing, and which will not be, and why. The process should also define how licenses will be selected, how their performance will be monitored and measured, and under what circumstances will licensees be terminated.

Technology Transfer and Licensing Agreements

The principal purpose behind technology transfer and licensing agreements is to join the technology proprietor, as licensor, and the organization that possesses the resources to properly develop and market the technology, as licensee. This marriage, made between companies and inventors of all shapes and sizes, occurs often between an entrepreneur with the technology but without the resources to adequately penetrate the marketplace, as licensor, and the larger company, which has sufficient research and development, production, human resources, and marketing capability to make the best use of the technology. The industrial and technological revolution has witnessed a long line of very successful entrepreneurs who have relied on the resources of larger organizations to bring their products to market, such as Chester Carlson (xerography), Edwin Land (Polaroid cameras), Robert Goddard (rockets), and Willis Carrier (air-conditioning). As the base for technological development becomes broader, large companies look not only to entrepreneurs and small businesses for new ideas and technologies, but also to each other, foreign countries, universities, and federal and state governments to serve as licensors of technology.

In the typical licensing arrangement, the proprietor of intellectual property rights (patents, trade secrets, trademarks, and know-how) permits a third party to make use of these rights according to a set of specified conditions and circumstances set forth in a license agreement. Licensing agreements can be limited to a very narrow component of the proprietor’s intellectual property rights, such as one specific application of a single patent, or be much broader in context, such as in a classic ‘technology transfer’ agreement, where an entire bundle of intellectual property rights are transferred to the licensee typically in exchange for initial fees and royalties. The classic technology transfer arrangement is actually more akin to a ‘sale’ of the intellectual property rights, with a right by the licensor to get the intellectual property back if the licensee fails to meet its obligations under the agreement.

Key Elements of a Technology Licensing Agreement

Once the decision to enter into more formal negotiations has been made, the terms and conditions of the license agreement should be discussed. Naturally these provisions vary, depending on whether the license is for merchandising an entertainment property, exploiting a given technology, or distributing a particular product to an original equipment manufacturer (OEM) or value-added reseller (VAR). As a general rule, any well-drafted license agreement should address the following topics:

Scope of the grant. The exact scope, extent of exclusivity and subject matter of the license must be initially addressed in the license agreement. Any restrictions on the geographic scope, rights and fields of use, permissible channels of trade, restrictions on sublicensing (including the formula for sharing sublicensing fees if provided), limitations on assignability, or exclusion of enhancements or improvements to the technology (or expansion of the product line) covered by the agreement should be clearly set forth in this section.

Term and renewal. The commencement date, duration, renewals and extensions, conditions to renewal, procedures for providing notice of intent to renew, grounds for termination, obligations upon termination, and licensor’s reversionary rights in the technology should all be included in this section.

Performance standards and quotas. To the extent that the licensor’s consideration will depend on royalty income that will be calculated from the licensee’s gross or net revenues, the licensor may want to impose certain minimum levels of performance in terms of sales, advertising, and promotional expenditures and human resources to be devoted to the exploitation of the technology. There might also be milestone payments that are tied to the achievement of certain key events, such as regulatory approvals of the core technology. Naturally, the licensee will argue for a ‘best efforts’ provision that is free from performance standards and quotas. In such cases, the licensor may want to insist on a minimum royalty level that will be paid regardless of the licensee’s actual performance.

Payments to the licensor. Virtually every type of license agreement includes some form of initial payment and ongoing royalty to the licensor. Royalty formulas vary widely, however, and may be based upon gross sales, net sales, net profits, fixed sum per product sold, or a minimum payment to be made to the licensor over a given period of time or may include a sliding scale in order to provide some incentive to the licensee as a reward for performance. Royalty rates may vary from industry to industry and in some cases will vary depending on the licensed product’s stage of development. For example, in a typical merchandise licensing agreement, royalty rates range from 7 to 12 percent of net sales depending on the strength of the licensor’s brands whereas manufacturing royalty rates may be lower when the licensee will need to make significant capital expenditures in order to bring the product to the marketplace. In the biotechnology and medical device industries, the royalty rates may vary based on the stage of development of the product and its progression through the FDA approval process. A biotech or pharmaceutical treatment or compound that has already cleared Phase III approval may command royalties as high as twenty percent (20%) of sales, whereas a pre-clinical trial product or compound may only command a royalty rate of two percent (2%), depending on the likelihood of ultimate commercialization.

Quality control assurance and protection. Quality control standards and specifications for the production, marketing, and distribution of the products and services covered by the license must be set forth by the licensor. In addition, procedures should be included in the agreement which allow the licensor an opportunity to enforce these standards and specifications, such as a right to inspect the licensee’s premises; a right to review, approve, or reject samples produced by the licensee; and a right to review and approve any packaging, labeling, or advertising materials to be used in connection with the exploitation of the products and services that are within the scope of the license. Certain types of licensors may also want to consider the placing of a ceiling on the allowances for returned merchandise, perhaps in the three percent (3%) to five percent (5%) range of total goods sold. This helps prevent the licensee from producing a significant amount of substandard product which could dilute the board, damage the technology or otherwise expose the licensor to harm or potential liability.

Insurance and indemnification. The licensor should take all necessary and reasonable steps to ensure that the licensee has an obligation to protect and indemnify the licensor against any claims or liabilities resulting from the licensee’s exploitation of the products and services covered by the license. These provisions should address any minimum insurance coverages (naming the licensor as an additional insured) as well as discuss an exclusion from liability or ceilings on the responsibilities of the licensee.

Accounting, reports, and audits. The licensor must impose certain reporting and record-keeping procedures on the licensee in order to ensure an accurate accounting for periodic royalty payments. Further, the licensor should reserve the right to audit the records of the licensor in the event of a dispute or discrepancy, along with provisions as to who will be responsible for the cost of the audit in the event of an understatement.

Duties to preserve and protect intellectual property. The obligations of the licensee, its agents, and employees to preserve and protect the confidential nature and acknowledge the ownership of the intellectual property being disclosed in connection with the license agreement must be carefully defined. Any required notices or legends that must be included on products or materials distributed in connection with the license agreement (such as the status of the relationship between licensee and licensor or identification of actual owner of the intellectual property) are also described in this section. The agreement should also be clear as to which party and at whose expense and control will any disputes regarding the ownership of the intellectual property will be handled.

Technical assistance, training, and support. Any obligation of the licensor to assist the licensee in the development or exploitation of the subject matter being licensed is included in this section of the agreement. The assistance may take the form of personal services or documents and records. Either way, any fees due to the licensor for such support services which are over and above the initial license and ongoing royalty fee must also be addressed.

Warranties of the licensor. A prospective licensee may demand that the licensor provide certain representations and warranties in the license agreement. These may include warranties regarding the ownership of the intellectual property, such as absence of any known infringements of the intellectual property or restrictions on the ability to license the intellectual property, or warranties pledging that the technology has the features, capabilities, and characteristics previously represented in the negotiations.

Infringements. The license agreement should contain procedures under which the licensee must notify the licensor of any known or suspected direct or indirect infringements of the subject matter being licensed. The responsibilities for the cost of protecting and defending the technology should also be specified in this section.

Termination. The license agreement should provide some guidance on the licensor’s ability to terminate the rights granted in the event of material breach (such as nonpayment of royalties), change in control, insolvency or other default of the licensee. The notice and procedures for termination should be discussed as well as the “wind-down” or “phase-out” periods following termination.

About Gerbsman Partners

Gerbsman Partners focuses on maximizing enterprise value for stakeholders and shareholders in under-performing, under-capitalized and under-valued companies and their Intellectual Property. Since 2001, Gerbsman Partners has been involved in maximizing value for 52 Technology, Life Science and Medical Device companies and their Intellectual Property and has restructured/terminated over $770 million of real estate executory contracts and equipment lease/sub-debt obligations. Since inception in 1980, Gerbsman Partners has been involved in over $2.2 billion of financings, restructurings and M&A transactions.

Gerbsman Partners has offices and strategic alliances in Boston, New York, Washington, DC, San Francisco, Europe and Israel.

Gerbsman Partners
211 Laurel Grove Avenue, Kentfield, CA 94904
Phone: +1.415.456.0628, Fax: +1.415.459.2278
Email: Steve@GerbsmanPartners.com
Web: www.gerbsmanpartners.com
BLOG of Intellectual Capital: www.boic.wordpress.com
Announcements & White Papers
Events
Wireless 2.0
Press
The BoIC Talks
© Gerbsman Partners 2016