5 Key Considerations When Negotiating a License Agreement

License agreements can be a great way for a start-up company to generate revenue from sources other than the founders/funders. Start-ups can license their technology separately, or as part of a collaboration with another company. For example, two companies may decide to cross license technology so that each company has a better opportunity to commercialize their own technology. Although the complexity and scope of these types of arrangements can vary widely, there are five basic provisions most license agreements share:

Exclusive vs. Non-exclusive

An exclusive license is more valuable to the licensee (the party receiving the license rights) than a non-exclusive license because exclusivity enables the licensee to invest in the technology without others benefiting from the investment. But because exclusivity also creates more concerns for the licensor (the party granting the license rights), before granting rights to an exclusive license, consider the following:

Should you limit the exclusivity to a certain market/use or geography?
What other potential opportunities are you giving up if you grant this exclusive license to this licensee? Is it worth the risk? Remember: if you grant an exclusive license, it may preclude entering into other, more lucrative, licenses in the future, so do so carefully.
Will this exclusive license limit the value of your company to potential investors or purchasers?
Will you be able to terminate the license agreement (or convert an exclusive license into a non-exclusive one) if the licensee does not generate the revenue you are expecting?

Compensation/Royalties

There are many options for the licensor to receive compensation for a license. You may decide to offer the license for a fixed license fee, a royalty based on revenue generated using the technology, a combination of an upfront “license fee” and ongoing “royalties,” or the licensee may give the licensor equity in the licensee's company. To avoid surprises, consider:

How will the licensee generate revenue? What is an appropriate way for you to share in the revenue? Will the licensee be able to avoid revenue sharing by shifting revenue to other sources such as consulting fees? Is this "revenue" metric easily measureable?
What if the technology is combined with other technology or products and sold as a combined product?
Should you grant the licensee the right to sublicense the technology to another party? How will this affect your compensation?
Be sure to include the right to audit the books of the licensee to verify the revenue and the right to otherwise inspect licensee’s operations to ensure licensee’s compliance with the terms of the license agreement (including any restrictions contained in those terms).

Modifications/Enhancements

A licensee may want to modify the technology, so determining which party owns the modifications and the rights of use are important to consider:

Is the licensee willing to grant licensor ownership of any modifications made by the licensee? Should the modifications be carved out of the royalty base?
If the licensee owns the modifications, should the licensor have a right to use the modifications?

Term/Termination

When license agreements do not generate anticipated revenues, unhappy licensors may wish to terminate the agreement. With some advanced planning, licensors can be better positioned to deal with an agreement that is not meeting expectations. Consider the following:

A shorter term is generally better for the licensor since it preserves future options.
Provide for a right to terminate early if specified minimum revenue is not received. An objective standard for required performance will avoid future disputes.
Consider what will happen to end users of the technology when the license is terminated. Should the licensee be able to continue to support the end users after termination of the license?

Additional Risks

The licensee will want the licensor to have liability if the technology does not perform, or if a claim is brought against the licensee based on use of the technology. Licensors can limit this risk in the following ways:

Limit performance warranties – performance of technology is often based on many factors outside the control of the licensor
Limit intellectual property warranties, especially relating to non-infringement of patents
Include limitations of liability
Watch for broad indemnification provisions

With care consideration of the terms, new companies can generate licensing revenue, limit risk, and protect future options.