When parties enter into a licensing agreement the overall scheme of the agreement is simple: the licensor grants the licensee the right to sell or otherwise exploit its technology, which may be patented or otherwise protected as a trade secret, and the Licensee pays royalties to the licensor. What is not so simple is determining a fair royalty rate.
Patent licensing revenue has grown from an estimated $15 billion in 1990 to $150 billion in 2003 - this well may reach $500 billion by 2015. This represents the largest share of intellectual property licensing revenue, thus an improper valuation could cost a licensor millions of dollars in royalties. So how we value a brand new product based on a new patent is one of the first things to tackle and possibly the most difficult.
Because of the uniqueness of intellectual properties placing a value on intellectual property assets, especially new patents, is not an exact science. There are many variables that attach to each asset and they must be analyzed on a case-by-case basis. The particulars of each business situation will often determine how these valuations translate to royalties. A trend that has developed because of this difficulty in ascertaining a fair royalty is to include an equity stake as part of the deal and accepting a lower royalty. Here are a few factors to keep in mind when deciding whether to aim for royalty rates that are in double digits or are a mere fractional percentage:
Once these factors have been satisfactorily defined the next step is to come up with an appropriate value and the royalty figure.
The most commonly utilized valuation approach is commonly referred to as the market or sales approach. It is premised on the notion that transactions for similar assets in the market will yield similar prices. To do this properly we must gather data of similar sales and licensing transactions. Keep in mind, however, that many patents are unique to themselves and thus there may not be suitable comparisons. Another valuation method is based on the projected income to be derived in the future- this is then converted to present value.
In attempting to put together a licensing proposal for an existing patent that has a sales history, royalties are easier to figure. The majority of licenses use past sales as the royalty rate base - usually a net sales figure; a lesser are based on units sold. This is the reason that Universal Licensing often encourages its clients to manufacture and begin to sell their product - even on a very limited basis. This provides some statistical data upon which we can rely when preparing for a royalty negotiation.
Once there is a meeting of the minds regarding royalties, a licensing agreement may be prepared and executed by the parties. The following are the most essential sections of any patent licensing agreement.
Definitions - Just so everyone is on the same page and especially if one of the parties is new to patent licensing terms used in the normal course of business, such as:
Finally, it should be understand that each agreement needs to be drawn based on the particular patent. Further, because of the complex nature of these agreements, it is recommended that a potential licensor utilize an experienced attorney to assist with the preparation of a licensing agreement.
In order to gather more information on patents and royalty rates, books and periodicals are available. One of the most helpful books is Battersby & Grimes yearly addition of "Licensing Royalty Rates", published by Aspen Publishers. Sample licensing agreements are also available on the world wide web.