What does it mean to license your invention for royalties?

If you are not familiar with the term “license”, think of it as a way of renting your invention as opposed to selling your invention.

A license agreement is when the inventor [licensor] agrees to let a third party [licensee] commercially use his or her invention for a period of time in exchange for some form of compensation, which is usually an ongoing payment called a royalty.  Typically, inventors would have some form of patent protection on their invention before licensing to a company, which is why many inventors look to patent the idea early in the process.  Filing a provisional patent application is a low cost option to move the inventor forward with the process.

Additionally, licensing the invention offers many key benefits to inventors, such as not needing to invest in the manufacturing and marketing of the invention, which is the most costly part of the invention development process.  Typically, the company who licenses the invention will be the ones to manufacture and sell the product on the market.

Also, when it comes time to actually enter into an agreement with a company, make sure you understand the key components of a license agreement.

At InventionHome we will strive to make the negotiation and contract process as smooth and easy as possible for inventors.  We have a complete and thorough license agreement template that we have developed over the past 15 years with hundreds of license deals.  Here are 3 important components of a license agreement that you should understand if you are licensing your invention on your own.

Definitions.  License agreements typically define key terms that are used throughout the document to ensure that there is no ambiguity.  Here are some typical definitions that you will see in license agreements:

LICENSOR – this is a term used to refer to an inventor, or the person/entity that is granting rights to the invention.

LICENSEE – this term refers to the company or party that is going to license your invention and pay money in royalties.

INTELLECTUAL PROPERTY RIGHTS – this term may refer to the patents, patent applications, trademarks, trademark applications, copyright registrations, etc.  Basically, it defines your ownership rights for your invention.

Royalty.  The top question on most inventors’ minds is “How will I get paid?”  Since a majority of our agreements have based the inventor’s compensation on royalty payments (not outright purchase of inventor’s assets, patent(s), etc.), let’s reflect on what that means in terms of how you would ultimately get paid.  A royalty is the amount of money paid by Licensee to Licensor for the use of the inventor’s intellectual property.  There are different ways that a royalty can be calculated and this can be a hotly-negotiated issue.  Some variations are:

Most commonly in our experience, royalty is based on a percentage of sales by the Licensee and will fluctuate based on circumstances like patent status, development stage of the invention, profit margin for the Licensee, etc.

Instead of basing royalty on sales, sometimes it is based on manufacturing cost, or even on profit.

Instead of computing royalty on a percentage, Royalty can be based on a flat dollar amount per unit, for example, $X per unit sold.

Advance Payment.  An advance payment is a highly desirable feature for a license agreement and something that we strive to include.  However, it is not uncommon for Licensees to resist the idea of offering an advance in light of the large investment that they are taking on by licensing.  Here are some of the expenses that the Licensee may face post-license:  design engineering, prototype development, tooling, samples, packaging design, inventory, warehousing, marketing/selling expenses, etc. It is important to have realistic expectations for what a company may be willing to pay up front.  Any advance payments would be defined clearly, along with timing for such payment, in the license agreement.