Product Licensing Agreement: Key Terms and Strategies

Key Takeaways

• A product licensing agreement allows one party to produce, market, and sell a product owned by another in exchange for royalties or fees.
• Licensing agreements can cover various intellectual property types such as patents, trademarks, copyrights, and trade secrets.
• The agreement should outline terms like scope, exclusivity, territory, duration, royalty rates, and termination clauses.
• Proper due diligence and a detailed agreement reduce the risk of disputes and maximize the commercial potential of a licensed product.
• Businesses often use product licensing to expand product reach, enter new markets, or monetize intellectual property without the costs of manufacturing.
• Both licensors and licensees benefit when the agreement aligns strategically with their goals.
• It's advisable to consult an attorney to tailor the agreement to specific business needs and protect legal interests.

A product licensing agreement is a key document you’ll need to protect your business interests. Licensed products are attributes that individuals exchange money for, not free giveaway items. In essence, your service or product has to pinpoint a certain demographic that will pay for your service or product. Also, you’ll have to get a license that ties into the preferences and lifestyles of your target audience.

When it comes to a licensing agreement, you must be aware of royalties and how to use them effectively. In most cases, you would get an advance royalty (a flat price paid to you upfront) and ongoing royalties (paid as a certain percentage for each sale). Advance royalties are guarantees that a licensor will get a portion of the money, even if the product does not sell. After, when and if the product sells, the licensor gets a percentage on the sale. You would usually get five percent of a wholesale price of every product that’s sold.

A licensor will decide the royalty, and the rates are set in stone. This is why you should know what the rates will be and how they’re detailed in the agreement to avoid any confusion. If you are unclear regarding the terms of a licensing agreement, you should contract a lawyer for further assistance. The assistance you receive will save you money in the long-run, so you can agree to a licensing contract that works in your favor. Also, if you’re turned off by the idea of royalties, you should know that all parties will benefit from the agreement.

From the licensor’s standpoint, the advantage is simple:

• By granting the person a license, marketing and manufacturing costs are cut for the launch of a new product, and the royalties yield direct profits. Moreover, the licensor has added value to a product that will turn into more sales.

Licensing Process

For an easier licensing process, you can use the service of a licensed firm or agent. A licensing professional helps with such matters as:

• Contract negotiations
• Packaging
• Merchandising
• Product development

If you go ahead with a licensing product agreement, you may discover that your business grows rapidly. The issue of where you seek a license largely depends on:

• Product type
• Licensing knowledge
• Prior experience

Key Elements of a Product Licensing Agreement

A well-drafted product licensing agreement includes several core components that help define the business relationship and reduce legal risks:

• Grant of License: Specifies what rights are being transferred, including whether the license is exclusive or non-exclusive.
• Scope and Territory: Defines the geographical areas and market segments in which the licensee can operate.
• Term and Renewal: Indicates how long the agreement will last and under what conditions it can be renewed or terminated.
• Royalty Structure: Outlines how and when the licensor will be compensated (e.g., fixed fee, percentage of sales, or tiered rates).
• Quality Control: Ensures that the licensed products meet certain standards to protect the licensor’s brand.
• IP Ownership and Use: Clarifies that the licensor retains ownership of the intellectual property.
• Audit Rights: Allows the licensor to inspect the licensee’s records to ensure proper royalty payments.
• Termination Clauses: States under what conditions the agreement may be terminated (e.g., breach, bankruptcy, mutual consent).

Target Demographic

To know the people you wish to market to, observe or talk to people within that demographic. You should also know the following qualities:

• How they spend their time
• What products they buy at a mall or store
• How they spend their time

Also, you should read newspapers and magazines, and search websites/blogs regarding your target market.

Benefits of a Product Licensing Agreement

Entering into a product licensing agreement offers several strategic advantages to both licensors and licensees:

For Licensors:

• Reduces costs associated with manufacturing, distribution, and marketing.
• Enables global expansion without directly managing international operations.
• Generates passive income through royalties.
• Enhances brand visibility and market presence.

For Licensees:

• Offers a faster time to market by using proven products or technologies.
• Reduces research and development (R&D) expenses.
• Leverages the credibility of established brands or patents.
• Helps penetrate markets where the licensor already has strong IP protection or brand recognition.

License Meaning

The word license has two distinct meanings. There is the common usage (driver’s license, for instance), and another for commerce and business. A license is a permit from an authoritative body to use or own something. In a company, licenses are usually given by a business that wishes to bestow rights to another business in return for payment. Such rights pertain to making, selling, or using assets.

Examples of licensing include:

• Sports teams offer licenses to businesses that make products with a team’s name on them
• A movie company offers licenses to businesses who make products based on movie characters
• A business that patents a product does not wish to sell or make the product, so it sells licenses to make the products
• A business with a trade secret sells a right to use or promote the process to another business

For a business with a quality product, but no ability to create it, licensing is a good way to make that product. Essentially, licensing is the best way to get a return on investment and has the best chance of success.

When to Use a Product Licensing Agreement

A product licensing agreement is most effective when:

• A business wants to monetize its intellectual property without directly manufacturing or selling products.
• A startup lacks the infrastructure to scale production but owns valuable designs or patents.
• A company wants to expand into new regions or demographics by partnering with a local distributor.
• A brand wants to enter new industries without losing control of its core operations (e.g., a fashion brand licensing its name to a perfume company).

In all these cases, the product licensing agreement serves as a bridge between IP ownership and commercial success.

License Types

Copyright licenses entail the right to replicate and sell a copyrighted asset. The right to conduct the work publicly may then be under license. Patent licenses entail the right to distribute, export, use, or sell and export the product that’s patented. Trademark licenses mean the right to use trademarks on certain items, or in certain manners. Trade secret licenses mean the right to use trade secrets, at certain locations, and for a specific process.

Common Pitfalls in Product Licensing Agreements

Despite their benefits, poorly structured licensing deals can lead to disputes or lost revenue. Common pitfalls include:

• Vague Licensing Terms: Unclear definitions of what’s being licensed can lead to overreach or infringement.
• Lack of Performance Clauses: Without minimum sales or marketing commitments, a licensee may underperform.
• Inadequate Royalty Tracking: Without clear auditing rights, licensors may have difficulty verifying reported earnings.
• No Exit Strategy: Missing or weak termination clauses can trap parties in unproductive relationships.
• IP Misuse: Failing to set brand standards can damage reputation or dilute brand value.

Avoiding these issues requires clear language and foresight in the agreement drafting process.

Other License Types

Product licensing is a faster way to transform an idea into a product that’s ready to sale. To license a product, you must:

• Think of a good idea
• Safeguard your intellectual property via the United States Patent and Trademark Office (USPTO).
• License a company to distribute and manufacture your service or product
• Garner royalties

Steps to Create a Product Licensing Agreement

Here are the general steps to follow when creating a product licensing agreement:

1. Identify the Intellectual Property: Confirm that the product or concept is protectable and clearly defined.
2. Conduct Due Diligence: Evaluate potential licensees or licensors to ensure business compatibility and trustworthiness.
3. Determine the Licensing Model: Choose between exclusive, non-exclusive, or sole licensing.
4. Negotiate Key Terms: Cover royalty rates, payment schedules, performance obligations, and scope.
5. Draft the Agreement: Use clear, enforceable language. A legal professional should be involved.
6. Review for Compliance: Ensure the agreement meets regulatory and jurisdictional requirements.
7. Sign and Monitor: Once executed, monitor the agreement to ensure both parties meet their obligations.

If you need assistance navigating this process, you can find experienced licensing attorneys on UpCounsel who can help you draft or review a product licensing agreement.

Frequently Asked Questions

1. What is a product licensing agreement?
   A product licensing agreement is a legal contract allowing one party to use, produce, and sell another party’s product or intellectual property under agreed-upon terms.
2. How are royalties typically structured in a licensing agreement?
   Royalties are often based on a percentage of sales revenue, a flat fee, or a combination. The agreement should specify the rate, timing, and method of payment.
3. Can a licensing agreement be exclusive?
   Yes. Licensing agreements can be exclusive (only one licensee), non-exclusive (multiple licensees), or sole (the licensor licenses to one party but retains rights to use as well).
4. What should be included in a product licensing agreement?
   Key elements include the scope of license, royalty terms, duration, territory, IP ownership, quality control standards, and termination clauses.
5. Do I need a lawyer to create a licensing agreement?
   While not legally required, hiring an attorney is highly recommended to protect your rights, clarify obligations, and prevent future disputes.

If you need help with a product licensing agreement, post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.