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5 Pitfalls To Avoid Before Signing A Licensing Agreement – Part 1

Are you currently a licensee (manufacturer) or licensor (brand owner) or contemplating entering a licensing arrangement? If so, you may have been weighing the business impact and exposure inherent in the definitions, requirements and terms stipulated in the licensing contract. If you have not read the contract language completely or understood it fully, you may not be aware of the obligations you have already committed, or are about to commit, your business to.

It is crucial to not only consult an attorney before signing a licensing contract but to also seek the advice of someone experienced in brand licensing, who can review and revise the specific language in a standard licensing contract. Traditionally, many of us relegate the negotiation of the business terms and language in our contracts to attorneys. The truth is that attorneys are trained and qualified to address the legal language – reps & warranties, indemnification, infringement – found in a contract. However, in many cases with licensing agreements, attorneys are not familiar enough with the business terms within the agreement – test protocols, authorized channels, approvals, and quality controls – to negotiate them properly on our behalf.

Unless you or someone on your team has experience negotiating licensing agreements, you will become an ideal candidate to fall into one, if not several, of the many business term pitfalls that are imbedded inside standard licensing contracts. Over the next two blog posts, I will highlight a few of the critical business pitfalls every brand owner and manufacturer should be aware of before they enter into a licensing agreement. To avoid falling into one of these pitfalls, it is important to understand all of the terms in a licensing agreement and their business implications.

Researching and reviewing sample licensing agreements can help as they show you what a standard agreement looks, what language to pay attention to, and what to watch out for.  I hope you find these useful.

Nets Sales:

This may be the most important definition in any licensing contract as the royalties owed are dependent on this definition. The definition of Net Sales contemplates that items such as returns, allowances and discounts should not be subject to royalty. However, it is critical that both the manufacturer and brand owner understand the definition and can live with it. Each party should pay particular attention to the deducted amounts, as often the amount is limited to a specific percentage of the gross sales. Also, it is critical for both parties to understand what items cannot be deducted from Net Sales. If the parties are unaware, the unplanned costs can turn out to be significant and if caught in an audit can be subject to penalty.

Royalties and Guaranteed  Payments:

Royalties are calculated by taking the Net Sales and multiplying them by the Royalty Rate. The Royalty Rate is the percentage of Net Sales to be paid by the licensee to the licensor. That is why the definition of Net Sales is so important to understand. Often licensing contracts stipulate that royalties are to be paid on inter-company as well as third party transactions. Guaranteed Periodic Minimum Royalty Payments (also referred to as Minimums) are calculated based on a percentage of the forecasted Net Sales and Royalties earned. It is customary for the Minimums to become fully earned upon execution of the agreement even if the agreement is legally terminated.  That is why it is critical that the licensee be prepared to make an investment in the license over the entire life of the agreement.

“If the Agreement is terminated for any reason, all Guaranteed Periodic Minimum Royalty Payments not yet paid by Licensee must be paid to Licensor within twenty (20) days after the effective date of termination.”

I hope you found these two pitfalls helpful. I look forward to sharing the other three pitfalls in part 2 of this blog post.