Patent Attorney and Founder
Hi, everyone! I’m J.D. Houvener. Welcome to the Bold Today Show, where you, the inventor, entrepreneur, or business owner, get your daily dose of inspiration to make the world a better place.
All right, we’re here in our series talking about patent licensing, and yesterday we talked about the first part, right? The first part of moving that transaction forward, which is the upfront payment. Today we’re going to talk about the types of agreements that come to mind that are most familiar with people when they think about licensing, and that’s royalties being received based on sales.
Before we get to that, I want to put a bold challenge out there for you as we listen to this series on patent licensing. This is an essential part of the way you’re gonna be able to follow and track with this in your industry. Of course, I’m thinking about the industry that you’re moving forward with your business or your inventions. Think hard about the top two to three players, who are the big-name players out there in your market. Think about the players that you wouldn’t mind if you couldn’t move forward with your business but you wouldn’t mind licensing your invention to companies that you think are reputable, that move the market, have built-in supply chains already, and you’d be proud to see your product being offered on their shelves. Once you identify those two, two, three, that is a goal. So, put that in mind and put it into your business plan as a potential outcome for your innovation. Think about that as we move forward and talk about royalties and putting a contract in place that might make you a lot of money over time. Let’s dig into it a little bit.
This is patent law. We’re talking about licensing, and even within licensing, talking about the royalty agreements. This is the section of the contract that talks about when you receive payments. So, there’s a few things to think about here. If it’s being based on sales, you’ve got to know that there could be quite a bit of lag time between when you actually complete the contract, give up your rights to either make, sell, or import your invention to this other party, the licensee, and when they actually sell it. Make sure you put in there, as we talked about yesterday, an upfront lump sum, whether it be cash or through stock or through stock warrants. Lots of different options. But make sure that you get payments or this compensation right upfront because there could be a long time for further research and development. It could be quite a bit of time between when it gets manufactured, tested, and any government regulations, as with pharmaceuticals, for example. That’s when it actually gets into consumers’ hands and the licensee receives compensation. So, put that timeline in place and make sure you’re considering all of that with your business analysis when you do your contract.
Now, let’s talk about what sales mean. You can’t just say sales in the contract. You’ve got to put other terms, such as net sales or gross sales. Now, gross sales, based on gross receipts, is the easiest way to do it. That means that there’s no funny business, there’s no accounting or bookkeeping going on. It’s truly the amount of money that they receive from compensating others with their goods. If you pay two dollars for a can of soda, the gross receipts for that company have two dollars. There’s nothing else to think about.
Now, if you’re looking at net sales, it gets a whole lot more confusing because you’ve got to subtract out things like operation taxes, excise tax, use tax, any tariffs that are on the product. This could include things like insurance or shipping fees, distribution, lots of things that could come in to add on to make up the cost of doing business. So, my recommendation, if you want to keep it simple, base your royalty on gross receipts, not net. This is going to provide you the easiest way to calculate and forecast what your cash flow will look like.
The next major section of royalties is, of course, when the payments will be coming in, the installment period. As most licensees are looking for more frequent, the better. You want to be able to generate this sort of steady stream of income just like you would for any other investment, much like a rental property or even outflow from an annuity from a retirement account. It’s having a good expectation to be able to build that into your cash flow management. You know, whether it’s every year or even once a quarter, the amounts can tend to spike and have ebbs and flows. It’s hard to predict when those amounts are coming in, and further, it’s harder to deal with when it comes to filing taxes. So, look for higher frequencies with royalty and think about net payment. They want net sales when you’re looking at royalty contract terms.
As you can tell, we’ve just kind of scratched the surface of this clause and, of course, just scratching the surface of the whole License Agreement as a whole. It’s important to have an attorney, especially a patent attorney, that can understand the nuances of the technology as you begin to craft your license agreement. So, please get ahold of us if you have any further questions about your potential technology and how you might license it or any other question related to patent law. We’d be happy to chat. Our website is boldpatents.com, and feel free to book a free 30-minute consultation. We’d love to chat. I’m your host J.D. Houvener of the Bold Today Show. Have a great day. Go big, go bold.