A licensing agreement is a legal contract between two parties, known as the licensor and the licensee. In a typical licensing agreement, the licensor grants the licensee the right to produce and sell goods, apply a brand name or trademark, or use patented technology owned by the licensor. In exchange, the licensee usually submits to a series of conditions regarding the use of the licensor's property and agrees to make payments known as royalties.
Licensing agreements cover a wide range of well-known situations. For example, a retailer might reach agreement with a professional sports team to develop, produce, and sell merchandise bearing the sports team's logo. Or a small manufacturer might license a proprietary production technology from a larger firm to gain a competitive edge, rather than expending the time and money trying to develop its own technology. Or a greeting card company might reach agreement with a movie distributor to produce a line of greeting cards bearing the image of a popular animated character.
Whatever the type of licensing arrangement, the formal licensing agreement is an important component in a successful venture. "While it is impossible to determine the future success of a product, much can be done in the earliest stages to ensure that a licensed product gets the best chance possible," Teresa Salas wrote in Playthings. "One might even say that the entire future of a licensed product is laid out, at least in part, during the process of negotiating a licensing contract."
ELEMENTS OF A TYPICAL LICENSING AGREEMENT
Because of the legal ground they must cover, some licensing agreements are fairly lengthy and complex documents. But most such agreements cover the same basic points. "In general, contracts contain the same provisions," Salas noted. "Outlined clearly in the contract are such things as advances, royalties, guarantees, market dates, renewal options, length of contract, monitoring rights, procedures for quality control, inventory, and returns and allowances."
One of the most important elements of a licensing agreement covers the financial arrangement between the two parties. Payments from the licensee to the licensor usually take the form of guaranteed minimum payments and royalties on sales. Royalties typically range from 6 to 10 percent, depending on the specific property involved and the licensee's level of experience and sophistication. Not all licensors require guarantees, although some experts recommend that licensors get as much compensation up front as possible. In some cases, licensors use guarantees as the basis for renewing a licensing agreement. If the licensee meets the minimum sales figures, the contract is renewed; otherwise, the licensor has the option of discontinuing the relationship.
Another important element of a licensing agreement establishes the time frame of the deal. Many licensors insist upon a strict market release date for products licensed to outside manufacturers. After all, it is not in the licensor's best interest to grant a license to a company that never markets the product. The licensing agreement will also include provisions about the length of the contract, renewal options, and termination conditions.
Most licensing agreements also address the issue of quality. For example, the licensor may insert conditions in the contract requiring the licensee to provide prototypes of the product, mockups of the packaging, and even occasional samples throughout the term of the contract. Of course, the best form of quality control is usually achieved before the fact—by carefully checking the reputation of the licensee. Another common quality-related provision in licensing agreements involves the method for disposal of unsold merchandise. If items remaining in inventory are sold as cheap knockoffs, it can hurt the reputation of the licensor in the marketplace.
Another common element of licensing agreements covers which party maintains control of copyrights, patents, or trademarks. Many contracts also include a provision about territorial rights, or who manages distribution in various parts of the country or the world. In addition to the various clauses inserted into agreements to protect the licensor, some licensees may add their own requirements. They may insist on a guarantee that the licensor owns the rights to the property, for example, or they may insert a clause prohibiting the licensor from competing directly with the licensed property in certain markets.