17 Nov Early Stage: Step 15 – A license to sell
Editor’s note: This is the 15th in a series of articles on developing start-up companies in the technology or biotechnology sectors.
Madison, Wis. – My most recent column discussed strategic partnerships, which to some extent are similar to the subject of this column: licensing arrangements. There is a key difference, however, between strategic partnerships and licensing arrangements and that is with licensing, the licensor retains ownership of the technology and gives the licensee rights to develop and exploit the technology.
A strategic partnership is really a partnership between parties who are jointly developing a business idea. In a licensing arrangement, the licensor is the owner of the core technology or business concept. The licensee does the real work of developing an actual product or services, while the licensor is permitting the licensee to do it within certain legal and business constraints.
License agreements frequently involve technology developed or originating at a university or other research institution. In such cases, the inventors/developers of the technology are usually required to disclose the invention to the university, in particular if the invention or development was made using federal funds.
If the university chooses to claim ownership of the invention, the inventors must assign the invention to the university, or an affiliated technology-transfer entity, such as the Wisconsin Alumni Research Foundation. If the inventors wish to develop and commercialize the technology, WARF will often agree to negotiate a license agreement with the inventors, or a company, which they have formed.
For example: You are a University of Wisconsin-Madison professor or researcher who has developed a certain technology in your UW lab. You believe this technology has commercial application and you wish to commercialize this technology. You then disclose this technology to the UW. If the technology is patentable, you work with WARF to prosecute and obtain a patent. WARF patents the technology and you form a new entity, which will license the technology from WARF.
The following are some of the important issues likely to arise in the negotiation of a technology license agreement. The discussion of these issues does not relate to any particular transaction, but is based on the experiences of the author and his law firm over the years in representing inventors and their new entities in license agreement negotiations with WARF and other technology-transfer organizations.
1. Definition of technology. The license agreement must define the scope of the technology. This often is related to the patent and the scope of the patent. If the technology is the subject of a patent application or an issued patent, it is usually sufficient to cite the serial number of the application, or the number of the issued patent. If the technology is not patented, then it must be carefully defined and described so as to include only the licensed technology and nothing more.
2. Patent costs. The parties must agree on who is going to pay for the expense of prosecuting an application for a patent on the invention. Sometimes the new entity assumes responsibility for all patent expenses; more frequently WARF pays the initial patent costs and recovers this expense over time from the new entity in the form of royalty payments.
3. Field of use. Licensors such as WARF often license their technology to multiple licensees, with each licensee being granted the right to use the technology for a different purpose, or “field of use.” For instance, a biotechnology patent might be licensed to multiple licensees for fields of use, including human therapeutics, drug discovery, research products, animal health, and agricultural uses. In negotiating the field of use provision, it is crucial that the description be broad enough to be adequate for the licensee’s purposes.
4. Licensor equity. Technology transfer organizations such as WARF frequently seek to take an equity interest in the entity to which they are licensing the technology. Of course, granting equity through the licensor dilutes the founders’ equity in the company, and reduces the amount of equity available for future investors. On the other hand, the fact that a licensor such as WARF thinks highly enough of the company and its technology to take equity stake may be a selling point when the company seeks additional financing. We have seen a variety of equity relationships with licensors, ranging from no equity to 10 percent depending on circumstances.
5. Royalties. Royalties are usually calculated either as a percentage of the price of each product sold using the licensed technology, or as a percentage of periodic (quarterly) gross or net revenues from sales of the licensed products. Royalty rates for biotechnology, material science, and other technologies are typically in the 5 to 10 percent range. Royalty discussions usually involve several other issues. For instance, the licensor may wish to require a minimum annual royalty, even before the licensee company has actual product sales.
Another issue is whether the royalty will be calculated on the basis of the sale cost of the entire product, or only on that portion or component using the licensed technology. “Royalty stacking” also may be an issue because complex products can require technology from multiple sources. The need to pay royalties to multiple licensors may make in uneconomic to develop the product. Where multiple technologies are involved, a royalty-stacking clause serves to limit the aggregate royalties paid to all licensors.
6. Infringement. Patent litigation is expensive, complex, and time consuming. Technology license agreements typically include provisions regarding responsibility for defending the patent should the validity of the patent be challenged, should it be infringed, or should a third party claim that products made using the licensed technology infringe on claims of the third party’s patent. The parties also need to agree on the responsibility for legal and other costs of prosecuting or defending infringement actions. These arrangements vary. Typically, WARF initially pays the defense costs. WAFR also hires legal counsel and works with the inventor/new company to defend or prosecute infringement claims, or defend the patent’s validity.
Crucial creative license
Negotiating a favorable license agreement can be key to the success of a new, technology-based company. Negotiating a suitable license agreement requires the resolution of a number of potentially complex issues. The significance of a license agreement extends beyond the licensor and licensee. It may be scrutinized closely by grant-funding organizations, potential future investors, and other companies with whom the entity may choose to partner.
In other words, a well-drafted license agreement can be crucial to a start up company’s successful exploitation of its technology.
Previous Early-Stage articles by Joe Boucher
• Joe Boucher: Early Stage, Step 14: Strategic partnerships require legal protections
• Joe Boucher: Early Stage, Step 13: The advantages of leasing real estate
• Joe Boucher: Early Stage: Step 12 – Alternative forms of business finance
• Joe Boucher: Early Stage: Step 11 – Other forms of finance
• Joe Boucher: Early Stage 10: The nuances of federal laws
• Joe Boucher: Early Stage, Step 9: Raising capital in the securities landscape
• Early Stage, Step 8: Misclassifying workers brings risk
• Joe Boucher and Bonnie Wendorff: Early Stage 7, Part I: Just what is an employee?
• Joe Boucher: Early Stage: Step 6 – Taxes, taxes, taxes!
• Joe Boucher: Early Stage: Step 5 – Forming the entity
• Joe Boucher: Early Stage, Step 4: Cautionary trademark tales
• Joe Boucher: Early Stage, Step 3: Naming the entity
• Joe Boucher: Early Stage Step 2: Choosing a domain name
• Joe Boucher: Starting a tech business? Step 1 is minding the intellectual property
The opinions expressed herein or statements made in the above column are solely those of the author, and do not necessarily reflect the views of Wisconsin Technology Network, LLC.
WTN, LLC accepts no legal liability or responsibility for any claims made or opinions expressed herein.