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https://www.epo.org/fr/node/1204815

Dealing with companies

To deal effectively with a company interested in your idea, it helps to start by understanding what companies look for in new product ideas.

Their dream invention is one that gives them an enormous profit for no risk. They know they are unlikely to find such an invention, but they will definitely want ideas with as few costs and risks as possible. They will never look at your invention and say: ‘This is so good that we must do it, no matter what it costs us!'

Before risking any of their resources on an invention, they will want answers to key questions. These include:

  • The product
    Does it fit in with our longer-term business plans?
    How much more development does it need?
    Can it be manufactured cost effectively?
  • The market
    How many units can we sell?
    How much market advantage will it give us?
    How much will it cost us to enter the market?
  • The intellectual property
    How valuable is the IP?
    How strong is the IP?
  • The cost
    How will the whole project be financed?
    Will the cost pose a significant risk to the business?
  • Risk
    How soon will the product go into profit?
    How long will that profit last?
    What if we say no to the invention but a competitor says yes?

  Further points for inventors to think about include:

  • Rejection of an idea does not necessarily mean that the company thinks your idea will not succeed. It means they think it is not right for them.
  • Do not expect the company to do everything correctly. Smaller companies in particular may have relatively little experience of innovation.
  • For that reason, consider offering your own expertise or resources to the company if it helps persuade them to license the invention from you.
Companies and your prototype

An interested company may want to keep your prototype for a period of evaluation. If you have only one prototype, this can limit your ability to approach other companies. Your prototype is your property, so to help you to stay in control of it:

Do not leave a prototype behind at first visit. Insist that the company first sign a legally binding agreement on conditions of loan, drafted by your solicitor or patent attorney. It should cover most of the issues raised below. (Feedback from inventors suggests that such agreements are necessary. If the company refuses to sign, it may be too risky to have any further dealings with them.)

  • Establish who will be responsible for the safe keeping of your prototype, and that they agree to compensate you for any damage or loss. 
  • Specify the length of the loan period and an end date.
  • In most cases a month will be long enough. Do not loan your prototype for a longer period without some form of payment. The company should also pay if it insists that you do not approach other companies during the loan period.
  • Payment should depend on the potential value of the IP. Your patent attorney can advise you on this.
  • Ask for payment in instalments and make it clear that if any instalment is not paid on its due date, the loan agreement is immediately void.
Negotiating a licensing agreement

Assuming the company has evaluated your invention and wants it, the next step is negotiating a licensing agreement.

You must have professional representation if you are not confident of your own negotiating abilities or if any licensing agreement is likely to be complex - for example, if it covers several countries. Ask your patent attorney for advice on representation.

Most licensing negotiations take a long time to complete - often many months. They can also become a source of conflict as you and the company will almost inevitably disagree about the value of your invention.

To be a good negotiator you must be able to:

  • Know at all times what you want from the negotiations.
  • Understand the company's position.
  • Demonstrate personal and professional integrity.
  • Find the courage to end negotiations rather than accept poor terms.

You must be prepared to be flexible . For example, there is no point insisting on financial terms that the company simply cannot afford. Most licensing agreements emerge from a process of compromise during which both parties find mutually acceptable ways of getting what they want.

However, negotiations can be psychologically complex. If the human chemistry is badly wrong, there may be no possibility of an acceptable agreement. You should therefore plan what you can do to remain in control. Ultimately, the only way to keep control may be to withdraw from negotiations if you see no advantage in continuing them. (There is a lot of truth in the saying that ‘He who can walk away from a deal controls it'.)

Royalties

Many inventors fail to understand that a royalty percentage does not guarantee a royalty income.

Your royalty percentage is the agreed share of the company's income from your invention that you will receive under the terms of the licensing agreement. But your royalty income depends entirely on sales. You might have negotiated a high royalty percentage but if the company makes no sales, you receive no income.   

It is quite possible for a company to acquire a licence from you but not make or sell any product. Your licensing agreement should therefore include a guaranteed minimum income (see later).

It is also possible for an inventor who accepts an extremely small royalty percentage to become much richer than one who negotiates a high royalty percentage. The difference depends on the number of units sold. For example, the inventor of the drinks can ring-pull got only a tiny royalty percentage - but he is reputed to be the world's wealthiest inventor.

Royalty percentages

The maximum royalty you are likely to get is about 25 per cent of the company's gross profit from sales of your invention.

Gross profit is the company's ‘factory gate' price per unit minus the cost of production and selling, multiplied by the number of units sold per year. You can predict the company's gross profit with reasonable accuracy if you know:

  • The company's sales forecast for your product.
  • Its proposed selling price.

If the company will not or cannot tell you what these are, meaningful negotiation will be almost impossible.

The value of your invention

Most companies will not want to give you anywhere near 25 per cent of their gross profit. They will tend to undervalue your invention in order to reduce the royalty percentage payable. For their part, many inventors tend to overvalue their inventions and ask for an unrealistically high royalty percentage.

To help determine a fair value, answer these questions as objectively as you can:

  • What is your contribution to the product? If you have given the company a highly developed product, that may justify a royalty of 15 per cent or more. But if the company has done all the redesign and development, a fair royalty percentage may be 5 per cent or less.
  • Who is taking the risk? If the company is investing heavily in production and marketing resources for an invention that is unproven in the market, it may be difficult to justify a large royalty if your own exposure to risk is small by comparison.
  • How special is the product? If there is no close competition and the company can charge a high price, you deserve a high royalty. But if competition will keep profits low, your royalty percentage will also be low.
  • In what quantity will the product sell? The more units sold, the lower will be your royalty percentage. Profit margins shrink as customers place larger orders but insist on lower prices. However, even at a lower percentage your income may increase dramatically if sales increase.

You should also consider gross profit per unit and market size. Simply multiply the gross profit per unit (which you know) by the number of units the company estimates it can sell in a year (which you also know). Then look at the size and sustainability of the market. Will your invention sell well for only a few years, or for many years?

Overall, the bigger the potential gross profit per unit and the bigger and more sustainable the market, the higher the value of the invention.

Bidding for a percentage of gross profit

The story so far is:

  • You know that 25 per cent of gross profit is probably your maximum royalty percentage, and that a company will almost certainly want to give you far less.
  • You know what 25 per cent of gross profit ought to be worth in money.
  • You know the relative value of your invention - low, medium or high.

You should now have enough data to convert the value of your product into a percentage of net sales price that you can justifiably ask for.

Converting gross profit into net sales price

Gross profit is the most accurate way for an inventor to calculate a realistic level of reward. But it is standard business practice to express royalties as a percentage of the product's net sales price - that is, the ‘factory gate' price minus all taxes. The terminology changes but the amounts of money do not.

Converting a percentage of gross profit into a percentage of net sales price is straightforward once you appreciate that one (gross profit) is a percentage of the other (net sales price). For example: 

  • Your figures show that the company will make 40 per cent gross profit on sales of your product in one year.
  • Based on your valuation of your invention, you decide that you want 15 per cent of gross profit as your royalty.
  • That now becomes 15 per cent of 40 per cent...
  • ...which is 6 per cent of net sales price - a smaller figure but exactly the same money as 15 per cent of gross profit.

Renegotiation of royalties

As sales rise, the company's profit margin may fall as large orders are conditional on a lower unit price. It might therefore help your cause to suggest a sliding scale of royalties based on total royalty income. For example: seven per cent up to €20,000 per year of total royalty income, reducing to five per cent between €20-50,000 and to three per cent when your total royalty income exceeds €50,000 per year. This demonstrates your willingness to be flexible in everyone's best interests.  Furthermore, by taking a smaller share of higher sales, your licensee has an incentive to sell more products.

Traps to avoid

  • Your royalty should apply to all sales, so never let a company stop paying you royalties if sales exceed a certain level. (A possible exception is if you accept a royalty ‘ceiling' in exchange for a substantial guaranteed minimum royalty income.)
  • Never agree to royalties based solely on net profit, as sales figures can easily be manipulated to show no profit at all. For example, it may be claimed that manufacturing and distribution costs and promotional discounts negate any net profit.
  • Some companies may try to reduce your royalty income by selling product at an artificially low price to an associate company. To avoid this risk, insist in your final agreement on royalties based on arm's length transactions - in effect, on a fair market price.
Reaching agreement

You (and the company) must remember at all times that the object of negotiation is not to win but to reach agreement.

If one side wins the other loses. The loser (not always the inventor) may then start behaving in ways which prevent the agreement from working properly. It is therefore far better for the company and the inventor to aim for an outcome that satisfies both parties.

A licensing agreement usually involves two rounds of negotiation, each leading to the signing of an agreement.  The first level is heads of agreement, the second full agreement.

Heads of agreement

This is essentially a preliminary agreement documented in plain language. Its purpose is to identify the figures, terms and conditions that you and the company are broadly happy with.

Before you start negotiating, you must know what kind of a deal you want and be able to justify it. The tactic of some inventors - simply saying ‘Not enough' to every offer - is likely to bring negotiations to an early end!

Though heads of agreement talks tend to work best without formalities or legal representation on either side, you should rely on the ‘off-stage' advice of your patent attorney and other legal representatives throughout the process. It may help to have other members of your team present for some of the time.

Heads of agreement are not final and legally binding, so you must never let the company exploit or ‘work' your IP in any way until a full agreement is signed.

What should be in a heads of agreement document?

The following list of items is for guidance only and is not comprehensive. It merely indicates the considerable range of topics which must be discussed. You must seek advice from your legal representative on what should or should not be included in your own heads of agreement document.

  • What is being licensed?
    List and describe all the IPR on offer.
  • How exclusive is the licence?
    Will only the licensee (the company) be allowed to manufacture and sell the product, or will there be limitations which allow others (perhaps including the inventor) to manufacture and sell?
  • Which countries will be covered?
    Note that you cannot control activity in countries where you have no IP protection.
  • Which markets will be covered?
    You may be able to negotiate separate licences with separate companies for different markets.
  • The basic agreed royalty rate
  • What can the licensee deduct from the value of sales?
    You must specify which costs are deductible. If you do not, some companies will claim every imaginable deduction in order to reduce your royalty payment.
  • Guarantee of payment
    You need some guarantee of payment to prevent the company acquiring a licence and then being either slow to work it or doing nothing at all with it.
  • Right of termination
    The licence can be terminated if the licensee fails to meet agreed minimum royalty levels, or fails to perform some other agreed obligation.
  • Confidentiality clause
    This requires the licensee to safeguard all disclosures.
  • How long will the licence last?
    A term of one to five years with renewal options may be best, as that makes it easier for you to get rid of a poorly-performing licensee.
  • Who owns improvements?
    If the company develops ‘your' technology over time, who owns the IP in any improvements?
  • Who challenges patent infringers?
    Fighting legal challenges can be expensive and stressful. It may be worth accepting a lower royalty in return for transferring this risk to the licensee.
  • Standard clauses
    There can be many of these, dealing mainly with operational detail such as royalty payment dates, scrutiny of accounts, how disputes will be resolved etc.

As negotiations progress, discuss with your legal representatives the possible effect of every clause. Ignore any pressure to reach a rapid agreement. If any clause is unclear, insist on renegotiation until it is clear. But do not forget that the purpose of negotiation is to reach agreement - so do not expect every clause to be written entirely in your favour.

Advance or guaranteed payment

It is part of the mythology of invention that every inventor deserves a large advance payment from the company. This is highly unlikely to happen unless the payment is for some contribution to the development of your invention that the company would have had to pay for anyway.

If you demand an advance payment, you risk damaging your prospects of a licensing agreement.  Most companies will take the reasonable view that your reward and theirs can only come from sales of your invention. Many smaller companies may argue that developing your invention is a large enough cost already, and that they simply cannot afford an advance payment.

A compromise may be to negotiate for a guaranteed minimum monthly income deductible from future royalties. This should perhaps be a small proportion - 25-30 per cent - of your agreed royalty on predicted annual sales. Even if this income starts several months before production begins, it may soon be recovered from royalties if sales remain as forecast.

Buy-out

Alternatively, a company might offer to buy you out entirely for a fixed sum instead of royalties. The company will be gambling that your invention will be worth far more to them than they pay you. But the gamble may fail if the product does not sell as well as expected.

A buy-out may or may not be to your advantage, so seek professional advice if made such an offer. The company's aim will be to buy you out cheaply, but cash is always tempting and no one can predict the future. For example, one inventor was offered a choice of €1.5m for a buy-out, or a guaranteed minimum royalty of €90,000 a year. He chose the latter - but sales were much poorer than predicted and after two years the product was withdrawn.

Full agreement – and beyond

The next stage of the licensing process is to convert the heads of agreement into a full legal agreement.

This will be such a complex and lengthy document that responsibility for it must be left to your legal representatives. Only they can ensure that the final agreement is consistent with the heads of agreement. 

Do not regard the full agreement as an opportunity to renegotiate! We can only repeat once again that the purpose of negotiation is not to win but to reach agreement. Some of the clauses may not be as advantageous as you wanted, but any attempt to alter what has been agreed (other than errors identified by your legal representative) is more likely to ruin the agreement than improve it.

Then one day, at long last, you have your licensing agreement. Congratulations!

But this is not the end of your involvement. You and your legal representatives must continuously monitor the way the licensing agreement operates. You need to ensure that you receive your royalty payments and that the licensee is making a good job of selling your invention.

You need to watch what competitors are doing, as some may be tempted to infringe your IPR. Others may improve their products, requiring you to improve yours.

You may also want to explore other ways of using your IPR to generate other licensing opportunities - perhaps in collaboration with your first licensee, or perhaps as an entirely independent business activity.

One way or another, your work as the owner of valuable IPR will not be over. But successful inventors rarely complain about that!