Inventing for Money - Step 7
Paper: Negotiate and close the deal
Congratulations - you’ve made your presentation and they love your idea! Before you pop the champagne, it's time to make some important decisions about the subject matter of your license and to negotiate a fair deal.
You need a qualified attorney. However, it is best to handle the negotiations yourself and keep your lawyer in the background. It will cost you much less and it’s better if you are personally involved with the people who may help you to become rich.
During the negotiations, it is important to have thick skin and to remember this is business and not personal.
Talk to the company reps, but DO NOT sign anything until your lawyer has reviewed it. Do not give in to pressure or promises. If you are handed a piece of paper, you will say, “Thank you-I’ll get back to you.”
Some important issues to resolve with your attorney include:
- Subject matter: what is being licensed?
- Is this license exclusive or non-exclusive?
- What royalty rate is the company offering?
- What is the upfront amount?
- How long does the agreement last?
- What further obligations does the inventor have?
The Term Sheet
The first document that you may be asked to sign is the “term sheet.” The best way to define term sheet is in to compare it to a marriage between two people. The term sheet is like getting engaged. The contract is like getting married.
The term sheet is a two- or three-page document that outlines a proposed agreement. It has language that clearly limits the obligations of both parties. Here is the opening paragraph of a typical term sheet.
This Term Sheet contains the basic terms to be included in a future definitive License Agreement for the Technology described below. The parties are the Inventor, having an address at ____________________ and the Company, having an address at _________________. The proposed transaction is subject to (i) the acceptance by both Company and Inventor of the principal terms as finally negotiated, and (ii) the negotiation, execution and delivery of a definitive License Agreement and any other agreements related thereto.
It is understood that this Term Sheet does not constitute a binding contract, and that the parties do not intend to be legally bound, unless and until a definitive License Agreement has been executed by both parties (except as expressly provided below concerning Publicity and Confidentiality). Unless and until a definitive License Agreement has been executed by both parties, either party is free to terminate further negotiations at any time, with or without cause.
Notice that there are two binding components in this term sheet: confidentiality and publicity. The company does not want this negotiation, or even the fact that they are talking to you, to be revealed to the public or to competitors. It’s a very fair condition.
Among inventors, the saying goes that “Businessmen negotiate the term sheet, lawyers negotiate the contract.” You should hammer out the basics of a deal yourself—but be sure to let your lawyer look at the term sheet before you sign it, just to make sure there are no sneaky clauses or conditions. When you are happy with your term sheet, you ask your lawyer to do the final contract negotiations.
In contrast, the contract is lengthy, legalese-filled document that precisely defines each party’s rights and obligations. A contract must be negotiated by a lawyer, based on the provisions outlined in the term sheet.
Let’s review some of the issues you will need to review with your lawyer.
Although after months of letters, phone calls, dog-and-pony shows, call back demonstrations, market strategy and engineering tooling meetings of all sorts, you would think that there could be absolutely no question as to what the heck it is that you are offering to license to the company. But properly defining the subject matter is absolutely key to your sanity over the coming years.
This is because the company must be certain that your invention is truly your property and is truly protected by patent.
The company will want to define the subject matter of the license very narrowly and will attempt to limit the coverage merely to the claims of any invention covered by a US patent that may issue in your name. The reason for this narrow coverage is that in the event that your patent fails to issue or that the claims arguably fail to create a monopoly in the product, the company will not have to pay a license royalty under the contract.
You, the inventor, will want to broadly define the subject matter of the license to include patents, trademarks, copyrights, drawings, prototypes, trade secrets, and know-how that not only protects the product, but also will assist the company in successfully manufacturing and selling the product. With this broad subject matter description, the company will have received significant value and be obligated to pay royalties after the patents expire and even if patents never actually issue.
Along the same lines, the company will want to broadly define any products covered by these licensed rights to include not only the invention that you so effectively prototyped and demonstrated, but every conceivably related magnificent gizmo in your workshop junk closet, and every related creation you devise in the future. The reason for this broad definition is that they want to avoid your going to one of their competitors in the future to sell a related product that might compete in the market place with the gizmo that they have licensed. Fair enough; however, unless you want to be forever co-opted by this licensee and unable to develop future products for other companies, it is important to pay attention to the product description being licensed here.
An important threshold question that was discussed earlier in this book is whether the license to the company will be exclusive or nonexclusive to a single licensee. The reason that this is an early threshold question is that most companies will strongly desire an exclusive license to the product. This is especially true if the invention is an end product as opposed to an intermediate product.
For example, let’s look at the semiconductor equipment manufacturing business. A ubiquitous product made by several companies is the special tip of a wafer probe used for testing semiconductor wafers during the manufacturing process.
The inventor has developed an advanced probe tip having superior electrical and mechanical characteristics.
The first probe manufacturer he approached wanted an exclusive license. The inventor believed that the improvement was sufficiently important that if he signed up one company, he could ultimately get all of the probe manufacturing companies to use the improvement. So he held out for a non-exclusive deal. The first licensee caved in and signed. The other vendors soon fell in line to sign up.
This can happen, but the reality is that most deals with independent inventors are exclusive. This is not necessarily a disadvantageous relationship. Exclusive deals help create more of partnering bond between the company and the inventor. Often, on exclusive deals, as a kicker the inventor’s lawyer is able to negotiate some level of paid consulting work for the independent inventor (discussed more completely, later) to keep income flowing during the period following the payment of the advance prior to payment of the first royalty check. This type of arrangement is much harder to pull off with a nonexclusive license, since the inventor will be viewed as more of an adversarial party. Within certain industries, nonexclusive licenses are often thought of as “tolls to trolls”-payments that have to be made to inventors for the privilege of keeping up with competitors in a market, the way medieval travelers had to pay a toll to the munchkin who owned the only bridge across the river. Oversight and enforcement of non-exclusive licenses is a much more time consuming process as we will see in the final chapter of this book.
At first blush, the subject of royal rate would seem to be all about negotiating a number. Is it 4%? 8%? And the number is indeed important, and you need to know how to arrive at a fair rate. But there is more to the royalty term than the percentage rate, and quite frankly, some of these others factors will have a lot more impact on how much money you actually get to put in your pocket.
First of all is the question that we all learned to ask by the fourth grade: “Percentage of what?” There are at least three definitions that occasionally get tossed around when dealing with royalty; it’s critical to keep your eye on the ball here.
- Licensee Gross Sale Price. This definition is usually pretty easy to understand. The royalty rate is paid on some percentage of the total sale price that the licensee receives for the product.
- Licensee Net Profit. This term, when used, is almost always defined at the beginning of the contract in a section called Definitions. The reason a special definition is required for this term is that it is usually impossible for two lawyers to agree on what the word profit means unless they are using the exact same dictionary. When licensees try to base a royalty rate on profit, watch out, you could end up paying for golf tournaments and all sorts of unexpected marketing costs.
- Licensee Net Sale Price, which usually is defined to mean the Net Price charged by the licensee on the sale of products, after subtracting certain costs. These certain costs might include taxes, shipping, advertising, promotional, and a variety of other costs and charges. If you see the word “Net,” you know you need to call your lawyer pronto.
The bottom line is that the royalty rate should be based on the Licensee Gross Sale Price, not including actual shipping costs to the customer, and any taxes that are collected and must be paid to the government. This is very simple and easy for everyone to understand. If the licensee sells a bike containing your invention for $100, and you are entitled to a 5% royalty, you get five dollars. If the company collects taxes or charges for shipping, you are not entitled to a royalty on those two extra charges.
What Rate to Charge?
This is a subject that you will want to discuss with your attorney. Your goal is to get the maximum possible monetary value from your invention. At the same time, you do not want to demand a price that the licensee is unwilling to pay. Check these resources:
- There are many law review articles and damage award treatises on this subject.
- Search lawsuits for company an industry.
- Work through the numbers. Does the requested rate leave a reasonable profit?
- And, of course, ask the licensee to make you an offer.
Change of Rate for Failure of Patent
Your licensee wants full legal rights to your product. They do not want to be sued for infringement by a competitor, nor do they want to discover six months from now that your patent application has been denied.
Prior to agreeing to invest in a royalty-bearing invention, the potential licensee will try to get some feel for the likelihood of a monopoly being created. This due diligence might consist of performing a patent search on the prior art with respect to the invention, reviewing patent examination papers that might have already been generated by the patent office, and perhaps even consulting a patent attorney for an opinion on novelty and patentability.
Licensees might also try to include language in the license agreement that will reduce or eliminate license royalties on the product in the event that the licensor/inventor fails to secure appropriate monopoly protection. Such a royalty termination clause may not be fair to the licensor, since the company may continue to make and profit from the product and has now legally cut off royalties to the inventor. Furthermore, this solution introduces a disincentive for the company to support the licensor’s effort to secure a patent for the technology.
Here is an example of how a company can thwart an inventor’s efforts to secure a patent. It occurs when such an agreement exists between an individual inventor and a large-company licensee. The inventor files a patent application and then shortly thereafter enters into a licensing agreement with this licensee. Royalties are paid on schedule for about a year, and the licensee’s product is selling well.
A downturn in the economy results in a management change at the licensee company, and the new administration decides that they are not happy with the size of the royalty checks going to the inventor and the burden that these checks were placing on profitability. As part of the license agreement between the parties, a clause stated that in the event the patent application failed to mature into an issued patent, the royalty rate would drop from 5% to 1%.
The licensee, feeling that it had the market tightly locked up for the product, began to meddle with the patent application in an attempt to keep the application from issuing. How can they do this? One of the duties of a patent applicant is to keep the patent office appraised of any “prior art” that the inventor knows about that will be material to the examination of the application. So the licensee hires a law firm to dig up all of the prior art patents, technical papers and other publications. Having amassed a stash of prior art patents, the company mails these papers one at a time to the inventor. Each time the inventor receives one of these references, he or she is forced to read it with the patent attorney and submit it with the proper disclosure statement to the patent office.
The cost and time burden on the inventor can be debilitating.
Other Inventor Obligations
A consulting contract typically consists of a monthly retainer with a not-to-exceed-hours provision, if the inventor is actually called upon for assistance. For example, the contract might call for company to hire the inventor as a consultant for the six months following the acceptance of the agreement in order to assist in the manufacturing and marketing of the product. The consulting fee might consist of a monthly payment of $2,500 per month, and the inventor will make himself reasonable available to company, but not to exceed 20 hours per month. Additional hours may be mutually agreed upon at a rate of, say, $125 per hour.
Many companies really like the idea of having access to the inventor, to help solve problems as they develop. Others are willing to pay for the consulting, even though they do not expect to need the help, since as a consulting fee this payment is often viewed as a startup investment, rather than an actual inventor payout or license fee.