From the July 1997 issue of Entrepreneur

Learning the finer points of negotiating

I've received many letters from readers entering the negotiating gate in the race to sell their great ideas. They're both excited and scared--excited because their dreams are within reach and scared because their plans could go up in flames if negotiated poorly. Well, move over, Monty Hall: You're about to learn the basics of "Let's Make a Deal."

Negotiating is an art. I'll never forget the first deal I negotiated by myself. A buyer wanted the TV rights to my product but wanted to negotiate without using attorneys--the argument being the savings in attorneys' fees. Well, I took the bait, and the contract ended up in litigation. What became clear to me during this expensive legal fight was that our contract was missing some standard language that would have made the intentions of the agreement clear and concise. Lesson learned: Pay now--or pay later.

Your first step in negotiating should be to find
an attorney experienced in business contracts. A good attorney is expensive, but this is one of the most important negotiations you'll be involved in.

Don't assume the attorney can and will do everything for you, however. He or she is only as good as the information you supply. Therefore, you must be personally involved in the negotiations and thoroughly understand what is being agreed to.

Here are some of the basics that should be included in a contract with a potential buyer:

 

  • The granting clause defines in precise language what is being licensed or sold, to whom, for what purpose, for how long, and under what kind of conditions. For example, if you grant a license to a corporation, you should define whether the parent company or its subsidiaries also get to use the license. If there are improvements made to your idea, who will get the rights to them?

If your idea is patented, trademarked or copyrighted, or if you have developed specific know-how that is required to demonstrate how to use the product, you need to address that in the granting clause. Reference any trademarks by name and list patents by number; you need to leave as little to the imagination as possible.

 

  • The royalty clause defines how you will be paid. It should be written precisely and indisputably, include the royalty amount, and have a specific payout schedule.

 

  • Many licensing agreements also include a minimum royalty payment provision. This guarantees you a minimum royalty payment regardless of how many units your licensee sells. This is helpful because it gives your licensee incentive to get out there and market your idea--or pay a price for doing nothing.

 

  • Also important is a reporting clause. When calculating royalty payments or unit sales, buyers use their own records. If you want to verify reported amounts, you'll need access to those records. A reporting clause outlines the record-keeping details you require and allows you access to the buyer's records.

 

  • Include a default provision in the event the buyer doesn't pay you. The typical default provision requires you to serve a notice of default to the buyer and then provide a time period in which to "cure" or fix the default.

 

  • Your agreement should also contain an indemnity provision. Indemnity means security against hurt, loss or damage. Such a provision ensures the buyer will pay if you are sued for something he did in selling your product. Conversely, if you are the owner of the patent or trademark listed in the agreement, you'll likely need to indemnify the buyer should someone sue them for patent infringement.

Make sure the rights revert to you if and when the contract terminates and that the buyer no longer has the right to make, use or sell your product after this point.

Sell vs. License

Between a rock and a hard place is where most entrepreneurs find themselves when faced with the decision of whether to sell or license their great ideas. Following are some points to consider before making that choice.

If you plan to sell your idea outright, you can probably expect to receive some sort of lump-sum payment for it. This is the quickest route to getting some return on your efforts. The downside is whatever you negotiate as the price will likely be all you receive from the idea--even if it's a huge success.

A licensing strategy usually provides you with more money in the long run. Points to be determined in a negotiation include deciding exactly what will be licensed, for how long, how much you'll be paid, and how and what rights each party has if things go awry.

Many times a licensor wants to turn over "patent pending" rights to a licensee so he or she can finish the patent process. This is a common practice because many inventors can't afford the expense associated with obtaining a patent. If you turn over the rights to any patent, make sure your license agreement provides for royalties on any improvements made to your idea so you get income on future products your invention generates.

Also, give some thought as to whether to grant an exclusive, nonexclusive or sole license. An exclusive license gives exclusive rights to your idea to the licensee for a specified territory. A nonexclusive license allows you to license your idea to more than one licensee in a specified territory. A sole license allows you and only one licensee to make, use or sell your idea, and prohibits you from granting any other licenses for that idea.

Royalty Rules

Royalties determine how you get paid when you license your idea. The royalty amount depends upon myriad factors, including patent and prototype status, industry standards and more. It's fairly common for the licensee to advance some upfront payment against future royalties.

There are two royalty options:

1. Lump sum: This is when you sell your license for a onetime payment. This less common form of payment is usually used to compensate an inventor for releasing his or her rights to the idea.

2. Usage royalty: In this arrangement, payments are tied to the ongoing use or sale of the licensed idea. This is a more common payment method. With this type of royalty, the upfront payment to the licensor is usually smaller or nonexistent because of the uncertainties of future use or sales.

If you plan to let the licensee market your idea, royalty payments are usually calculated based on the number of units the licensee sells. There are several ways to determine this.


*You may choose to receive a percentage of the net selling price. This is known as the percent-of-sales method. This is a good solution if the net selling price is hard to determine upfront or if there is a possibility the product price will change. This method gives you an advantage in times of rising prices. Be sure to define how the net selling price will be calculated. Are commissions, discounts and shelf costs deducted when the amount is determined?


*Another way to calculate royalties is the fixed-amount method. A fixed amount of money is paid to you for every unit sold. This method is easy to calculate and implement. However, if the selling price is difficult to determine at the outset, you may be selling for a smaller amount than you need to. A benefit to the fixed amount method is that it insulates you against price decreases.


*The third way is the profit-sharing method. You and the licensee agree to split the profits from each unit sold. This approach is rarely used because it means you are subject to the whims of the licensee's accounting practices.

Clearly define the variables in your royalty calculation, but be open to as many selling opportunities as possible. For example, if you invented a new rubber compound for tires but your product could also be used in rubber hoses, you wouldn't want to limit the royalty payments to the sale of tires; you'd want to define your royalties subject to anything containing your compound.

Royalties are typically payable quarterly, usually within 30 or 45 days after the end of each quarter. In most cases, the licensee prepares a report detailing the royalty calculation.

The last but most important element to consider when you're negotiating is whether you can live with the terms of the agreement. Don't feel you must win on every point; only insist on the ones that are most important. The best deal makers always let the other side feel like they scored, too. Any contract is like a marriage. If you want it to work, you have to be flexible.

Selling Points

When you begin negotiations with a potential buyer or licensee, keep the following six points in mind:

The ultimate price you agree on will be the result of your negotiation.

The licensee or buyer will want to limit your idea's selling price to an amount less than the extra profit he or she will make.

You want the profit to be no less than the amount you lose by foregoing other opportunities, such as selling the idea yourself.

Don't give away more than you need to get a signed licensing agreement.

Contracts are an art, not a science. If they were standard, there would be no need for attorneys.

There is no exact method of calculating a price. Every deal is unique.