A licensing agreement gives a licensee rights to use a product that the licensor already owns. Numerous items can be part of a licensing agreement, including a trademark, a patent, or even branding. The rights of the licensee are fully outlined in the agreement for the license, which may allow them to sell items, use a trademark, or take advantage of a specific brand message.
The licensee is able to keep the profits earn by their use of the licensed items. In return, the licensor receives an agreed-upon royalty out of those profits for the ongoing use of their items. Most licensing agreements include a one-time upfront payment for access to the desired items as well.
There are advantages and disadvantages to licensing for both parties to consider before finalizing their agreement.
List of the Advantages of Licensing
1. It creates an opportunity for passive income.
If you are the owner of an intellectual property, then licensing it is an opportunity to create an ongoing stream of passive revenues. You don’t need to do anything to generate those revenues either. Just sell licenses after developing the IP and you’re good to go. As long as the licensees are making money, then you’re going to be making money too and you don’t risk losing your ownership rights. These payments could last for several years without interruption.
2. It creates new business opportunities.
A licensee can benefit from this type of arrangement because it requires less money from them to start a business opportunity. They can purchase a license instead of outright ownership, then begin to make profits right away. It takes less upfront cash to pay for a license. When a licensee can improve upon a product, they can make even more money off their venture. Even if the item wanted is a trademark or brand name, the new business benefits from the reputation and consumer awareness of the information.
3. It reduces risks for both parties.
Licensing is designed to reduce the risks involved in doing business for everyone involved. From a licensee standpoint, there are fewer risks in product development, market testing, manufacturing, and distribution. From a licensor standpoint, there are fewer risks in the selling and service of what is being offered. Neither party is required to throw their own money in these areas to earn profits, which creates a win/win situation for everyone involved.
4. It creates an easier entry into foreign markets.
When a licensing arrangement is in place, then the licensor is able to get their product into new markets much easier than if they were doing the work on their own. It is much easier to enter foreign markets in this manner, as the license allows for the intellectual property to jump border requirements. That means tariff barriers to entry can be avoided because a domestic company is using the IP, just as the licensor might be using the IP domestically.
5. It creates self-employment opportunities.
Licensing allows people to go into business for themselves. They get to experience all of the advantages of self-employment, such as setting their own hours, while you get the benefits of having someone invested into your IP. From a licensee standpoint, there is the opportunity to gain a monopoly over a product or service in a specific territory at a lower investment rate that going alone. For the licensor standpoint, personal IP carries the same advantages as well.
6. It offers the freedom to develop a unique marketing approach.
A licensee knows their market much better than the average licensor. That knowledge allows an intellectual property to be marketed in a way that is more attractive to the average consumer. It is a chance to expand the reach of a message, product, or concept without actually needing to invest into them fully. Even when certain elements of the arrangement are pre-planned, there is still a certain level of freedom and control given to the licensee in the management of their business.
List of the Disadvantages of Licensing
1. It increases opportunities for IP theft.
Once you begin to license your intellectual properties and products, you are exposing yourself to higher levels of exposure. There will be more opportunities for theft, piracy, and misuse because you don’t have full control over how the licensee conducts operations. You can police how your IP is being used to some extent, but you can’t see everything that is being done. One slip-up is all it takes for your items to be distributed illegally, which means you don’t see the royalties on the profits being made.
2. It creates a dependency upon the licensor.
When a licensing agreement is signed, then the licensee is taking on all the risk in the arrangement. They are dependent upon the quality of the IP being used to make their own profits. If they do a great job and earn plenty of cash, the licensor might ask for a renewal that costs more than the initial license. There is also no guarantee of exclusivity with many licenses, which means multiple businesses could be competing in the same marketplace, using the same tools and products, to generate revenues.
3. It creates added competition in the marketplace.
Many licensors have found that their licensees eventually become competitors in their own marketplace. That creates a difficult situation, as one company or the other stands to lose from the process of selling IP in the same way. For that reason, many licenses include geographic barriers to protect against a needlessly competitive marketplace. With internet access growing around the world, however, an e-commerce platform makes it easy to be competitive without intending to be.
4. It is offered for a limited time.
Most licenses are only offered for a limited time. Although that time period may be 5-10 years, there is an expiration date which must be considered by the licensee. Is it worthwhile to invest time, effort, and cash into the promotion of goods or services that may not be available to them at the end of the licensing period? Is there a guaranteed renewal rate for the license, especially if the expiration date is fewer than 5 years? There must be a balance struck between royalties and revenues which makes sense for everyone involved.
5. It could damage the reputation of both parties.
When one element of the relationship is mismanaged with licensing, then both parties can see a reduction in the brand reputation of the IP involved. If multiple licenses are offered, then the reputation may suffer globally, affecting multiple businesses who are not involved in the situation. The only way to resolve this potential management is to have good quality management practices in place. That is why many license agreements include a series of best practices to follow, creating consistency within the brand across all licenses.
6. It is not a guarantee of revenues.
There is no guarantee that a licensing agreement will generate cash. You could agree to a specific royalty rate with a licensee, then never see anything because the licensee is unable to generate any sales. Many products don’t get licensed either, even when they are offered at discounted rates, because there is no interest in the product. You might face returns of damaged merchandise as a licensor as well, which reduces your overall profits as well.
7. It takes time for royalty payments to arrive.
In a franchising agreement, royalties might be paid weekly out of the sales that are generated at the register. This can be an automatic process, withdrawn directly from a bank account or the batch sales created. For many licensing agreements, however, the royalty payments are offered just once per quarter. That means it could be 5-6 months before you see your first meaningful royalty payment as a licensor, even when your product is doing well in other markets.
8. It may lead to royalty litigation.
One of the biggest issues that licensors face with licensing agreements is a refusal by the licensee to validate royalty statements. They may not let you audit their statements at all for accuracy. This does allow you as the licensor to take legal action, but that tends to get very expensive, very quickly. For that reason, arbitration clauses are becoming a common component of licensing agreements. Some are even requiring ongoing royalty statement audits as a condition of the license continuing.
The advantages and disadvantages of licensing can be managed when due diligence by both parties is performed before agreeing to anything. A licensing agreement can be beneficial because both parties get the chance to earn profits. It can also be detrimental if a license is over-extended or one of the parties acts in bad faith.