The advantages of licensing agreement include increasing market share, lowering capital requirements, increasing the return on investment, and decreasing financial and legal risks.

Licensing and Licensing Agreements

A license grants a party the legal right to engage in specific acts. Many licenses are required for the safety of the public. For instance, physicians are licensed to verify clinical competence, and bars must be licensed to ensure that they are morally fit to serve.

In the business world, a license permits a company to use a property right, with some limitations, while the licensor retains ownership of the product. For example, a clothing company may grant a foreign manufacturer to use its specifications and designs to manufacture clothes under a U.S. licensing agreement.

For a license to be valid, a contract must be established between two or more individuals or parties. The contract must state the specific product rights that the licensor is agreeing to grant to the licensee. This type of contract is referred to as a licensing agreement. Licensing agreements have been around since the late 1700s, when the first patents and copyrights were issued.

A licensing agreement is a complicated legal document that provides details surrounding a contract. This may include specifications such as:

  • Identifying the parties of the agreement
  • Significant dates
  • Subject matter in question
    • Trade secrets and patents
  • Rights or provisions of the license
  • Constraints or limitations
    • Quantity or territorial restrictions
  • Termination, duration, and any key provisions of the agreement

Arrangements and licensing agreements must be mutually beneficial. The licensor provides the right to use a piece or pieces of property, and the licensee contributes its knowledge of the industry involved. The result is a relationship that resembles a partnership or joint venture.

There are many types of licensing agreements, including:

  • Trademark licensing
  • Copyright licensing
  • Patent licensing
  • Software licensing
  • Merchandise licensing

Generally, licensing is a key mode of entry for firms that are considering expanding internationally. Licensing agreements give a foreign company the right to produce and/or sell another company's products in its country. Sometimes an agreement may include production and sales in multiple countries. The licensee typically complies with a series of requests from the licensor with regard to the licensor's property and agrees to make royalty payments.

The licensee will take on the risks and responsibilities, including:

  • Making the investment in the facilities
  • Handling and manufacturing the goods
  • Managing supply chains
  • Delivering the goods
  • Selling the goods to the final consumer

Usually, the licensor does not make a large investment when granting a license. Licensing is generally viewed as an easy way to grow a company internationally. Licensing is becoming a common practice as a way for retailers and manufacturers to build their brands. Some of the major companies that grant licenses to retailers to manufacture and sell their products include:

  • Merck and Upjohn Pharmaceutical Company
  • McDonald's
  • KFC
  • Nestl√©
  • Anheuser-Busch

Releases of major motion pictures such as "Star Wars" also generate licensing agreements between licensors and mass merchandisers for games, toys, and clothing apparel. In order to take advantage of marketplace differentiation strategies, some retailers will go to the extreme of demanding exclusive agreements for licensed apparel.

Main Points of a Typical Licensing Agreement

Because of all the legalities that must be covered, licensing agreements can be very complex and lengthy documents. However, the majority of agreements encompass similar points, including:

  • Agreement scope
    • Territorial or exclusivity restrictions
  • Financial aspects
    • Royalty rates
    • Royalty calculations
    • Required advances
  • Minimum sales guarantee

  • Time schedules
    • Contract length
    • Renewal options
  • Monitoring rights
    • Quality control
    • Procedures to follow
  • Minimum inventories that must be maintained
    • Allowances and returns

One of the most significant parts of a licensing agreement is the financial provisions contained therein. Payments to the licensor are typically in the form of royalties on sales and guaranteed minimums. Depending on the licensee's level of expertise and the specific property involved, royalties normally range from about 5 to 11 percent.

Although many experts suggest that licensors ask up front for as much money in the form of fees as possible, not all licensors may require a guarantee to meet a certain threshold. Some licensors use guarantees as a way to renew a licensing agreement. For example, if a licensee meets or exceeds the minimum sales figures, the contract is renewed. If a licensee fails to make its numbers, the licensor may have the option to discontinue the relationship.

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