License to Grow: Licensing to Leverage Your Assets & Expand Your Business Without Soliciting the Equity Market Part 1

April 26, 2011

12:33 pm

This is the first part of a two part series focused on using licensing to grow your business, by guest contributors Blaire Jones and Aaron Horn.

Give me a lever long enough and a fulcrum on which to place it, and I will move the world. – Archimedes

There are a variety of reasons an emerging company may not tap into the equity market in its quest for growth. Equity capital is still thawing out from a lack of exits that has impeded funds over the past few years, and entrepreneurs may be facing increased difficulty in finding financing as a result. Even the rare and lucky companies that find financing may not be comfortable with the attendant costs. In either case, there are abundant growth strategies that use the current, non-monetized assets of a company to secure revenue without making the traditional sacrifices that capital infusion requires. Moreover, utilizing these strategies prior to tapping into the equity market can make your company more attractive and valuable to potential investors.

These growth strategies include franchising, joint ventures, alliances, co-branding, and licensing, among others. In an economy that increasingly values intangible assets, licensing can help a company make the most of what it has on hand. Licensing is a flexible growth strategy that can be tailored to your company's needs exactly.

How Many Uses Does a Paperclip Have? In the book One Red Paperclip, Kyle MacDonald chronicles the story of how, through a series of bartering trades over the course of a year, he turned a paperclip into a house. The moral of the story for the emerging company is simple enough: the value of an asset isn’t fully realized until the economic landscape has been surveyed and the asset has been creatively leveraged to its fullest potential.

The economic landscape has been shifting for some time towards intangible assets. As Aswath Damodaran notes in his paper Valuing Companies with Intangible Assets, “As we move from manufacturing to service based economies, an increasing large proportion of firms that we value derive their value from intangible assets ranging from technological capital to human capital.” Further, according to Damodaran, valuing emerging companies is something of a black art because it involves measuring assets that don’t yet exist for companies with little or no revenue or operating history, and it requires the value-setter to properly account for the very high mortality rate of tech startups.

For entrepreneurs looking to tap into the equity market, failing to accurately value their firm and its assets can seriously hamper interests from the start, compounding the loss of value that most outside-funded entrepreneurs encounter in the context of investor-leaning deal terms with a dilutive effect on founders equity and control.

However, the downside attendant to accepting outside capital can be bypassed, delayed, or lessened by employing licensing for growth.

Proof in the Pudding. Through licensing, companies like Dow Chemical and Hewlett-Packard generate hundreds of millions of dollars in annual royalties. The Louvre licensed use of its name to a museum in Abu Dhabi for $250 million. The Sharper Image emerged from bankruptcy, shedding its responsibility for managing stores, and using its name and a licensing strategy to effectively become a licensing company. Amazon has licensed “1 click,” a patented business process that stores online shoppers’ credit and shipping information securely so shoppers can purchase and “check-out” with just one click of the mouse, to many businesses, even including Apple.

For these companies and others, licensing means good money. According to a PricewaterhouseCoopers Technology Barometer Survey, small businesses that licensed out intellectual property received an average income stream equal to 26.2% of their total revenues.

Basic Training. Licensing can monetize intellectual property that you have already created. With a license agreement, you can trade the use of your intellectual property, but not ownership, for money–ideally, via multiple revenue streams flowing from non-competitors that offer a complimentary skill set, such as faster or less expensive market penetration.

More specifically, a license is a permission. The permission allows a licensee to do something that he couldn’t do lawfully otherwise.

How does a license work? The licensor transfers the use of specified intellectual property to licensees, usually in exchange for money. This brings revenue to the enterprise in the form of fees and royalties. The parameters for the relationship between the licensor and licensees are defined in a licensing agreement contract. The licensor sets the terms, and the customer’s use of the IP is conditioned on compliance with the terms.

Licensing intellectual property lets the licensor decide what the product is worth, who can use it, and what the conditions are. This provides a level of control that doesn’t attend accepting an outside investment.

What is intellectual property? Put very simply, intellectual property is two things—the fruit of its creator’s intellect and an intangible right to protect that fruit.

Intellectual property can be protected by the force of law with contracts, patents, trademarks, and copyrights, or as trade secrets, or–more rarely–as trade dress.

What are the critical components of my licensing agreement? A licensing agreement can contain whatever provisions the licensor can imagine.

It can be broad or narrow, and should at least include:

  • A very precise definition of what is covered by the license. The licensee gets nothing more than what’s described, so it’s important to make sure that everything the licensee needs to get the benefit of the intellectual property is covered. Give away the needed rights only, because you might want to license the rest of the rights elsewhere.
  • Parameters describing the scope of what the licensee may do with the software and where.
  • The duration of the license.
  • Measures for record keeping to facilitate royalty payments and reservation of the right to audit the licensee if there is a dispute on point.
  • Whether and what kind of technical assistance will be provided to the licensee.
  • Representations and warranties assuring the licensee that the license only covers rights the licensor may lawfully grant.
  • Performance standards for the licensee.
  • The responsibilities of both parties. For example it’s common for the licensor to promise to defend against third party claims on intellectual property rights involved if there is a suit against the licensee. It’s also common to require the licensee to use reasonable efforts to protect the intellectual property at issue.
  • Penalties for licensee’s underperformance or misuse of the product including loss of the license.

Choose carefully. One of the benefits of licensing is that you chose how your IP is used and by whom, and at what cost. In fact, it’s common for different licensees to pay different fees, depending on the value (as set by the licensor) the product offers them.

You may choose to license your IP only to non-competing firms, firms that are geographically distant, or firms that will use the software for research and development, or any combination of these and other types of uses.

Trust but verify. After determining the target licensees, its important to make sure that the licensee is financially secure and likely to stay in business, particularly if payment of royalties is at issue. Beyond that, it’s necessary that the licensee is sufficiently motivated and capable of generating revenues and royalties.

What is the catch? There are disadvantages to licensing. For example, putting your intellectual property out in the world opens the door to infringement. There is some policing involved in choosing licensees that are sufficiently stable and motivated to bring money to your firm, and in making sure they behave according to the terms of the license agreement. There is an administrative burden involved with servicing the licensees, too. And even though this can be limited within the license agreement, servicing your licensees can become a consuming business. Beyond that, your reputation, and the reputation of your product can be affected by the behavior of licensees.

In tomorrow's follow-up post, we'll learn more about whether you should license and what your strategy might be.

Image by Patrick Hoesly

Guest contributors Blaire Jones and Aaron Horn are the founders of the Georgetown Venture Law Society, an association of professionals and students at the Georgetown University Law Center dedicated to cultivating a greater understanding of the legal and financial issues facing emerging companies.

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Blaire Jones is a law fellow at National Public Radio, where she focuses on technology and intellectual property matters, and a new graduate of Georgetown Law. At Georgetown, Blaire discovered a special passion for helping startups leverage intellectual property and manage risk. You can follow Blaire on Twitter @VenEnthusiast.