Licensing Agreement: Definition, Example, Types, and Benefits

What Is a Licensing Agreement?

A licensing agreement is a legal contract where one party (the licensor) allows another (the licensee) to use intellectual property like patents, trademarks, or copyrights. These agreements set rules for how the property can be used, including royalties, time limits, and regions. Licensing can help a business reach new markets and earn money. But it also comes with certain risks, such as potential damage to the company's brand or reputation.

Deep Dive: How Licensing Agreements Work

Licensing agreements outline how one party can use another's property. While the properties in question can include a myriad of items, including real estate holdings and personal possessions, licensing agreements are most often used for intellectual property, such as patents and trademarks, as well as copyrights for written materials and visual art.

Licensing agreements should detail how licensed parties can use properties, including these parameters:

• The geographical regions within which the property may be utilized.
• The time period parties are allotted to use the property.
• The exclusivity or non-exclusivity of a given arrangement.
• Scaling terms, such that new royalty fees will be incurred if the property is reused a certain number of times. For example, a book publisher may enter a licensing agreement with another party to use a piece of artwork on the hardcover editions of a book, but not on the covers of subsequent paperback issuances. The publisher may also be restricted from using the artistic image in certain advertising campaigns.

Generating Income Through Licensing: An Overview

Licensing revenues, known as royalties, are a significant source of revenue for several publicly traded companies. For example, a major source of income for the publicly-traded company Dolby Laboratories is the licensing of its technology to consumer electronics manufacturers.

The license agreement outlines the royalty payment terms. The license agreement defines the limits and restrictions of the royalties, such as its geographic limitations, the duration of the agreement, and the type of products with particular royalty cuts. License agreements are uniquely regulated if the resource owner is the government or if the license agreement is a private contract.

Most license agreements set royalty rates as a sales percentage or per-unit payment. The many factors that can affect royalty rates include exclusivity of rights, available alternatives, risks involved, market demand, and innovation levels of the products in question.

To accurately estimate royalty rates, the transactions between the buying and selling parties must be willingly executed. In other words: the agreements must not be forced. Furthermore, all royalty transactions must be conducted at arm's length, meaning that both parties act independently, and have no prior relationship with one other.

Real-World Examples of Licensing Agreements

Many industries use licensing agreements. An example of a licensing agreement is a contract between the copyright holders of software and another company, allowing the latter to use the computer software for their daily business operations.

A McDonald's franchisee using the company's branding and marketing materials under a licensing agreement is an example. Toy manufacturers also routinely sign licensing agreements with movie studios, giving them the legal authority to produce action figures based on popular likenesses of movie characters.

How to Negotiate a Licensing Agreement

The product's nature influences the bargaining power of parties in a licensing agreemen. For example, a movie studio that licenses the likeness of a popular superhero to an action figure manufacturer might have significant bargaining power in this negotiation, because the manufacturer is likely to profit immensely from such an arrangement. The movie studio thus has the leverage to take its business elsewhere if the manufacturer gets cold feet.

Those entering into a licensing agreement should consult an attorney because there are complexities that may be hard to grasp for those without a deep understanding of intellectual property law.

Pros and Cons of Licensing Agreements

As mentioned above, licensing agreements are legal contracts that are written between a licensor and a licensee. Making sure there's one in place provides certain advantages to both parties but there are also some key downfalls, too. We've outlined some of the key benefits and disadvantages of these agreements below.

Advantages

Licensing agreements clearly lay out the guidelines, rules, and stipulations that cover the use of the licensor's brand, patent, or trademark. Both the licensor and the licensee are fully aware of what is expected and required of them. This includes when payment is due and how much, any additional royalties that may be due as a result of the relationship, the type of agreement, the length to which the licensee can use the property, copyright issues, and the contract's expiration date.

Setting up an agreement saves a lot of time, money, and hassles. For instance, if someone decides to use a trademark without a licensing agreement, they may be sued by the property owner, which could result in legal battles, court fees, and lost time.

Contracts give licensors can retain a great degree of control over their property and gives them access to other markets. For instance, a licensor can dictate how their property is marketed. And it allows them to enter new markets—through the licensee—without actually having to set up shop there.

Disadvantages

One of the drawbacks of having a license agreement is drawing up a contract with the wrong party. In some cases, licensors may want to get into a market so desperately that it doesn't do its research. This means a licensor may be stuck in a lengthy contract with a company whose ideals don't align with its own. The same principle applies to the licensee, especially when it thinks a new product or brand may work well in a certain market without doing its research.

Both parties risk losing brand power or reputation. For example, if one company commits a marketing faux-pas or is embroiled in a scandal, it can put the other party at risk as well. This means that both the licensor and licensee must conduct their business effectively.

Agreements can increase competition for licensors. The licensee, though acting for the licensor, competes directly with them. The licensee also loses out, too. That's because relying on someone else's product means that the licensee may cut down its own research and development (R&D).

Licensing Agreement FAQs

What Is a Licensing Agreement Example?

Entertainment companies like Netflix enter into licensing agreements all the time. The online streaming service obtains the right to broadcast content either exclusively or with other companies from the title/content owners. For instance, the company behind a major television series may enter into a licensing agreement, allowing Netflix to include the show among its titles for a certain number of years. In exchange, Netflix would agree to provide royalties to the content owner from fees it collects from its subscribers.

How Do Licensing Agreements Work?

Licensing agreements are legal contracts that are written between two parties—a licensor and licensee. The contract stipulates the type of agreement, the length of the relationship, payments and royalties that are due and when, and the extent to which licensing is allowed. Licensing also allows both parties to retain control over certain facets of the deal, including exclusivity and how a product or service is marketed. In essence, the contract lays out the expectations of what is required of both parties.

How Do I Create a Licensing Agreement?

The best way to create a licensing agreement is through a lawyer. By getting professional help, you lay out the proper foundation for a relationship with the other party. If you don't do so, you open yourself up to a lot of financial and legal hurdles.

How Much Is a Licensing Agreement?

The cost to draw up a licensing agreement can cost anywhere from a few hundred to a few thousand dollars. Going through a lawyer means you'll have to pay an hourly fee. A simple contract may only be a few hours, while a more hefty deal between parties means more details and revisions.

The Bottom Line

Licensing agreements let one party use or earn money from someone else's property, such as patents or trademarks. It’s important to define where and how the property can be used, for how long, exclusivity, and royalties to prevent disputes. Licensing can help businesses enter new markets and save time and money, but it also has risks like increased competition. Both parties should seek legal advice to make sure the agreement protects them equally.