The Inventor's Cut
Q: I'm a designer and have come up with an idea that will require a partnership with a manufacturer. They have the production facility as well as an experienced marketing team with the knowledge required to make and sell this product. If they produce, warehouse, distribute and market the product, what is a fair monetary arrangement for me?
A: If an inventor comes up with an idea and a manufacturer does the production design, manufacturing and selling, it's most common to license the invention, that is, to have the manufacturer pay the inventor periodic royalties based on a percentage of the net factory sales price of the product. There are no standard royalty rates-they can range from less than 1 percent to more than 30 percent, but most hover around 5 percent. The actual percentage depends on various factors and your negotiating skills. As noted business author Chester Karass said, "In business, you get what you can negotiate, not what you deserve."
Here are some of the factors an inventor can use in negotiating a higher rate:
- The established reputation of the inventor
- A high anticipated sales volume
- A high selling price
- A high anticipated profit margin
- A product with great ingeniousness and novelty
- A large licensed territory (for example, the inventor has filed for foreign patents)
- The inventor furnishes materials and services (consultation)
- The field of the invention has respect for patents
- The patent has great anticipated strength and breadth
- The invention provides significant manufacturing cost savings
- The industry is one where royalty rates are high (for example, medical inventions earn more than toys)
- The inventor has a lot of experience in design and development
- The product has a long anticipated market life
- The license is exclusive (rather than non-exclusive)
- The invention pervades the product (for example, the inventor of a novel transistor will obviously earn a higher royalty on the sales price of the product than would the inventor of a TV volume control)
On the other hand, the following factors tend to decrease the royalty rate:
- A lot of anticipated competition from other sources
- Difficulty in making an agreement
- High start-up costs to design and manufacture the invention
Another way of compensating an inventor is for the manufacturer to pay a percentage between 10 and 50 percent of the manufacturer's profit. Suppose the item sells out of the factory for $10 and it costs $7 to make it, including materials, labor, overhead, insurance, administrative costs and so on. If the inventor can get one-third of the profit, he or she would be entitled to a royalty of $1 per item. While this method is less common, I favor it since it compensates the inventor more directly for what he or she has actually done for the manufacturer.
An inventor can also sell an invention outright for the present value of the anticipated stream of royalty payments over the life of the product or the life of the patent. Lump-sum payments are rare, however, because of the amount of capital required and the difficulty of estimating the product's life and sales.
David Pressman, a practicing intellectual property attorney, is author of the bestselling bookPatent It Yourselfand the interactive software program Patent It Yourself, both published by Nolo Press. Formerly an electronic engineer, David has more than 30 years' experience in the patent profession-as a patent examiner, a columnist for EDN Magazine and a patent law instructor at San Francisco State University. Patent It Yourself can be obtained in bookstores (brick-and-mortar and online), from the publisher (www.nolo.com) and through David's Web site (www.PatentItYourself.com).
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.