Step 6: Negotiating The Licensing Agreement
To succeed in negotiation you must know what you need. If you do not know what you need, then you will never be ready to accept a licensing offer. As discussed above, it is extremely important for you to be honest with yourself and determine a deal value that would make you happy. This value must be based in reality. If you seriously consider your alternatives and have a clear-eyed view of what it takes to develop, manufacture and distribute your invention, then you should end up determining a deal value that will not only make you feel good, but also enable you to conclude a deal with a licensee.
On the other hand, if you determined a deal value honestly, and that value cannot be met by a licensee, then you can feel good about walking away from the deal. Knowing that you can walk away is a strength that will serve you well throughout the negotiating process.
With a deal value in mind negotiation becomes a matter of coming up with creative ways to achieve and exceed that value. It is more fun and far less stressful. Every deal is unique. There are common guidelines, but no rules.
Royalties are generally paid in the range of 1% to 5% for consumer products. Specialty products that enjoy higher profit margins enable higher royalties. Knowing the range of standard royalty rates for your industry is obviously important. Remember that royalties come from profits. If you cannot find standard royalty rates for a given industry, take a look at the profits earned by companies in that industry. You are most interested in the average profit for an average product. The more your invention exceeds the average the higher the possible royalty.
High quality professional advisors are critical to success. Ideally you should have a lawyer with experience negotiating licensing agreements for your particular industry AND a business advisor with experience in that industry. Legal and business perspectives often differ, and it is worthwhile to have both types of input. Regardless of who advises you, remember that you are the one in charge – only you know what is right for you.
If you cannot afford a lawyer/advisor to accompany you at every step of your negotiation then you should, at the very least, have one review the final contract prior to signing it. Even if you totally trust the people you are licensing to, even if they are family members or close personal friends, you should get the benefit of outside counsel.
Basic Structure of a Licensing Agreement
A Licensing Agreement is like a marriage contract. It details the duties of each party and provides a mechanism for divorce if one of the parties does not live up top its side of the contract. Licensing Agreements typically have following elements:
The Black & Decker Negotiations
The B&D stapler team needed management approval to proceed with WorkTools’ design; they required our working prototype four more times to get that approval. Even though we had a confidentiality agreement in place we decided that they could only review the prototype for one day at a time. Every time they requested the prototype I flew it out personally – night flight from Los Angeles to Baltimore – drop off to B&D headquarters at 8am –check into a hotel and sleep - pick up at B&D at 4pm – fly home. We wanted B&D to never lose sight of the fact that this was WorkTools’ invention and that B&D had no rights to it until a licensing deal was signed.
After six months of reviewing prototypes and doing a great deal of internal development, Black & Decker decided that it wanted to license WorkTools forward action staple gun. B&D called Worktools and set up a specific time and place for negotiations. The big question was how much they would pay for it. The place for negotiations was a conference room at an Embassy Suites hotel outside of Towson, MD. Towson was B&D’s home turf. The Worktools team would fly in from Los Angeles. One day was set aside, there were four people on the B&D team (including a lawyer) and there were three of us (including lawyer/partner Brad Golstein).
Prior to flying out for the meeting I spoke with B&D’s team leader Gary. “Gary,” I said, “before we spend a whole lotta money flying out for this meeting I want you to understand that we’re looking for a royalty of 5%. If that’s way off base then please tell me now. We’ll walk out in a heartbeat if you can’t meet our number.” Money was seriously tight and we couldn’t afford the luxury of a practice negotiation. “Mike,” came Gary’s reply, “Everything will be fine. I’m sure you’ll be satisfied with our offer.”
So out we flew. On the first morning of negotiations the B&D team told us how wonderful our invention was and all of the great things they were going to do with it. It would be an “icon product”. It would be featured in TV commercials. Then they made their first offer. It was something on the order of a buyout for $250,000 or a royalty of 1.5% of net sales. I turned to Gary and said, “I told you what we were looking for. This is insulting.” Then Brad, Joel and I walked out of the conference room, across the lobby, into an elevator, down a hallway and into our suite. “Well,” I said to Brad and Joel, “I guess that’s it.” A couple of minutes later Gary called, “let’s get together again in an hour.”
An hour later we went back to the conference room and talked some more. The offer was improved, but not nearly enough. Deciding it was hopeless, we thanked everyone for their time and walked out again. It was the end of the day and we were getting ready for dinner and a morning flight home when Gary called again. “Let’s try one more time tomorrow. I don’t know if we have any more to give, but let’s discuss some possibilities.”
Brad, Joel, and I had arrived at the B&D meeting with a number in mind. That number was $1 million a year in Royalties if/when B&D achieved 50% market share – we assumed that to be roughly 2 million units a year. Whether B&D paid X dollars a unit, a percentage of net sales, whether the Royalty started high and went low, or vice were all “points of indifference.” Our secret number was $1 million a year at 50% market share. The formula for achieving that number was completely flexible. And that flexibility was why there remained hope in continuing negotiations.
We began the next morning by making a proposal to B&D. We said we could accept a Royalty that began at 5% for the first 500,000 units sold each year and dropped to 2.5% for all units sold for the rest of that year; each year would have the same sliding scale (we estimated this would pay out at roughly $1.5 million if 50% market share were achieved). We did not get a flat “no”, so we talked around the point some more. When things were ready to fall apart again, we dropped our proposal to 4% and 2.5%. After more discussion on how this might work, and why it was fair, we came to a standstill. This time B&D was ready to walk. It was very disappointing because we had come a long way and we were awfully close to an agreement.
I was fixated on the Royalty starting high and going low because I assumed B&D would prefer that structure. It was a structure that bet on success beyond 1 million units a year… something that WT certainly believed would happen. I was so fixated on this structure that I could not imagine inverting it. Joel thought of that.
Joel suggested, “how about each year starting at 2.5% for the first 500,000 pieces and then going to 4% after that?” Everyone stopped talking and the kind of silence that speaks “maybe” filled the room. The B&D team asked us to leave so they could discuss the concept in private. When we returned more discussion ensued. B&D agreed that this would work. We were on our way to closing a deal.
Eventually, a final deal emerged. Each year B&D would pay WorkTools a royalty of 2.5% of net sales for the first 500,000 units sold for that year and then 4% of net sales for units sold beyond 500,000 for that year. WT would also receive an advance of $140,000 of which 50% ($70,000) would be refunded via royalty deductions. B&D would advance the cost of patent filings too; that cost would also be refunded via royalty deductions. The maximum royalty deduction would be 50% for any given payment period. We shook hands, went out for a celebratory dinner and had a group photo taken.
However, we did not have a deal yet. The President of the B&D Accessory division needed to sign off on the deal to make it official. We gave him 30 days to do that. It seemed like a formality at the time. 25 days later the deal was still unsigned. I called Gary to remind him of the deadline. He said he did not think the deal would be signed in time. “Why?” I wanted to know. Gary hemmed and hawed with embarrassment and said, “He won’t sign off on the deal until we have a final ornamental design.” In other words until the B&D team finalized what the new staple gun would look like, the President would not sign off, and there would be no deal. Exasperated I said, “But you have total control over what the thing looks like.” “I know,” sighed Gary. “So what are you going to do?” he asked. “Well,” I answered, “if our deal isn’t signed by Friday (this was on a Wednesday), I’ll be talking to Stanley on Monday.” Gary said, “We’re going to continue working on this and hope we can still put something together later on.”
As soon as I was off the phone I called an acquaintance named John at Stanley Tools. John was responsible for Stanley’s staple gun program. I told John that we had a new staple gun and that I would like to see him that coming Monday. John lived in New England. We set up a meeting in Boston. If B&D came to its senses I could always cancel the meeting.
On Friday, I called Gary and asked if we would be getting a signature. He answered no and asked what we were going to do. “We’ll see” I replied. On Monday I met with John in Boston. John liked our staple gun a lot. We gave him a prototype to show to the folks at Stanley.
At the start of the National Hardware Show in Chicago that August things stood as follows: Stanley was evaluating the CounterPoint prototype and preparing to give us an answer; B&D was trying to finalize a housing design and sign the agreement we negotiated two months before. We did not want B&D to know we were talking to Stanley or vice versa. This was difficult, since all of the players in this story were staying at the Palmer House Hilton and there was only one prototype available for both Stanley and B&D to review.
In the event, B&D came to its senses and said it was ready to do a deal. At the same time Stanley decided against the radical new design. WorkTools was left with only B&D.
Back to the negotiating table we went. “Have you disclosed the invention to anyone else?” B&D asked. “Yes,” we answered honestly. “Who?” they wanted to know. “We can’t tell you because of confidentiality,” we lied. B&D postured, “Since you’ve disclosed the invention to someone else it’s now worth less to us and we need to change the terms of the deal we negotiated.” “You’ve got it all wrong,” we replied, “now there’s another interested party (there wasn’t since Stanley had said “no”), and it’s worth even more. You’ll need to give us something extra to sign the deal.” They reluctantly agreed to increase the annual minimum to maintain exclusivity from $125,000/year to $145,000/year. This gave us a moral victory and didn’t hurt B&D’s ability to proceed with the deal.
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