This article is written by Shriya Pandey who is pursuing a Certificate course in Intellectual Property Law and Prosecution from LawSikho.
As an inventor, patenting your invention is not enough. Since patent acquisition is an expensive and time-consuming process, even without taking into account the R&D expenses involved in inventing a product or process, it is absolutely essential to have a clear idea of how you intend to monetize your patent. And the earlier you start the process, the better in some cases, it is recommended to start the process in the development stage of the invention itself.
Patent offices around the world suffer from some form of a backlog of patent applications and patent acquiring can take around 3-5 years or even longer in case there has been any opposition to such an application. For example, the Canadian Patent Office took more than 13 years to grant Amazon a method patent called one click.
In India, until recently that is 2019, the examination time of a patent application was 72 months. Even with the Government of India’s initiative in 2019 reducing the wait time and pendency of patent applications significantly with the lofty target of reducing it to 12-16 months in 2021, it will take a while for the process to become smooth and effective in practice.
The Patent Prosecution Highway is another positive initiative and development by the Government of India along with significant increase in the hiring of patent examiners. However, the buck stops with the inventors to ensure that the time lag from patent grant to patent monetization is not unreasonably long. A delay in monetizing patents can lead to the invention becoming obsolete and more effective technology or invention getting patented and entering the market.
Design patent applications experience shorter wait times than utility patent applications. In the US context, it is not uncommon for a design patent application that is judged worthy of patent protection to receive a notice of allowance from the USPTO in one to two years from the date the application is filed. However, notices of allowance for utility patent applications that are approved could be sent anywhere from one to five or more years from the date the application is filed. In general, keeping in mind all these long time lags involved in patent prosecution, it is advisable to have a strong patent monetization strategy in place. There are several ways in which you can monetize your invention. The first most obvious way to monetize your patent is by selling it. The second and most commonly used method especially for IT inventions is licensing.
Important things to remember while negotiating a Patent Royalty Agreement
In order to license one’s patent, one enters into a patent licensing agreement with the licensee party. This agreement is also called a Patent Royalty Agreement. In simple terms, a patent royalty agreement is a contract between a licensor and the licensee that lays down the terms under which a licensee must use the licensor’s product. The royalty agreement also mentions other specifics related to remuneration, method of using the patent etc. that are agreed upon by the parties during negotiation. As a practical practice, before even beginning the negotiation process, the licensor must clarify certain aspects related to the patent being licensed. Here are some of the important considerations: important things to remember while negotiating.
Appraising your patent value– The importance of accurately valuing your patent cannot be underscored enough. Patent valuation is an extremely complicated and nuanced process involving making judgments on a myriad of factors.
However, there are certain common methods one uses in order to accurately determine the value of one’s patent. Following are some of the commonly used tactics to arrive at a value of one’s patent:
Scope of Patent– Some patented inventions may only have an application in specific and limited industries. This may reduce their value as the scope of generating income from limited sources is narrow. Other patents may be more wide in scope and would enable the licensor to have multiple options to monetize it. They may even consider monetizing the patent themselves in one industry and license the rights to monetize it in a different separate industry or field if the projected value of the patent down the road will change.
Once you have ascertained the nature and scope of a patent, it will become easier for you to determine how much profit you can make in the event you sell or license your invention. Projected earnings from selling can in the reverse help you decide what value to assign your patent. The idea would be to maximise earnings and profits. For example, Kodak sold its portfolio of 1100 patents for a whopping $525 million. And Microsoft acquired patents from AOL for more than 1 billion. These are not outlying figures. In turn, Microsoft sold only 70 percent of those patents to Facebook for $550 million. The sales of pharmaceutical patents carry the highest returns.
Target Market– Patents that have a more niche application or involve a specialized technology would likely have a limited value. In contrast, patents that are applicable to a broader target market and has application in a variety of industries would be likely to generate bigger economic results. Both these factors will affect the value of a patent and must be taken into consideration by valuators.
Existence of competitor– Patents come with many different advantages and additions to existing technology. Some may be the first of their type and some may only be improvements upon existing products or technologies. The patents which are more exclusive meaning the first of its kind would have greater value than ones which are based on or are surrounded by similar technologies in the market or patents of competitors. As the prior art for patents which are one of a kind is limited, these patents become extremely invaluable from a licensing standpoint and would therefore be valued higher.
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Patent Valuation Techniques
This technique essentially considers the value of a patent to be its replacement cost. It takes into consideration the cost of creating an invention that is similar to the patent including expenses, risks etc. If a substitute technology can be easily created without additional risks and lost sales, then the patent will have significantly less value compared to a situation when it is difficult to create a substitute.
This technique considers the potential earnings that the patent will bring the company owning the patent. For example, a company that has patented a process that will improve its cash flow through sales of the. Now, the actual or expected amount that the company evaluates it will earn through such a patent will become the value of the patent.
The market evaluation technique considers the value of a patent that is similar to the existing patent in the open market. This information could be gathered from direct patent purchases, licensing terms, among others etc.
Preparing for worst case scenarios
Once you have properly evaluated your patent is when you can approach a party for licensing. When drafting and negotiating a royalty agreement with a party, you must start with asking yourself about worst case scenarios of what-ifs situations. These questions could be along the lines of what are the consequences for licensees if they fail to pay the royalty and what would be the economic loss to the licensor in case they don’t.
Answering this question will enable you to put forth an argument for having a stronger consequence in place in case of non-payment of royalty. This preparation will ensure the other party knows that you are aware of the legal pitfalls. Or consider the question what are the consequences of non-monetization by the licensee. How long can he be allowed to sit on the invention and how to avoid that, what happens in case of a potential infringement-what could the possible enforcement costs and therefore who will have the responsibility under the terms of the agreement to take care of enforcement or litigation actions.
What are the mechanisms for dispute resolution that are more advantageous to the licensor, etc. Consider a scenario in which an inventor approaches a company for monetizing their patent. The inventor has not asked the above questions. The company offers terms and sends back an agreement listing them. One of the clauses mentions that the company will file the patents on the inventor’s behalf and that the patents would be wholly assigned to the company. If you are an attorney working for the inventor, this is a huge issue as the inventor would not have the right to enforce his/her parents. It’s advisable for the inventor to own the patents and license them to the company. But since the inventor didn’t consider the what if questions, they were saddled with unfavorable terms by the other party.
In negotiation, it is best to have an upper hand and be the first to move with your conditions. For example, setting a royalty percentage does not guarantee that a licensee will receive that income. If a licensor negotiates and states the licensing agreement to state that that licensor will receive a percentage of the income from sale of the invention. Now if the license makes no sales, the company will end up making no income. However, if before negotiations you had considered this possibility, you could include a minimum guaranteed royalty.
Similarly, it is inadvisable to make royalty rates dependent on net profits as the companies may make deductions and overhead that will impact the actual profit that is the net profit. Royalty rates should always be off gross profit, not net profit. Finally licensing agreements should always include “get out jail free” terms such as termination in case of non compliance on certain essential terms.
Pre Negotiation Analysis and Due diligence
Before you even begin negotiating you need to have a great idea of the value you bring for the other party. This involves investing more R&D in developing their patents, conducting competing surveys into the needs of your potential licensing partner, how best your patent will help them and building reputation and publicity for your invention such that the licensee will be compelled to buy its value.
Due diligence also involves studying the prior art associated with the patent. The reason for this is because a strong prior art search will mean a stronger provisional patent application and therefore more negotiating power. It is inevitable that licensees will need clarifications regarding prior art. Only if you know the advantage of your invention over the existing prior art, the market for your invention will you be able to sell your invention and get the best price for it during negotiation.
A prior art search along with market search will also give you an inkling into the demand for your invention. If you can prove demand at the negotiating stage, companies will be less wary of making substantial investment in your invention or paying high royalties. A proof of concept along with potential costs involved and ways to reduce said costs in developing or manufacturing the invention for the licensee also helps to ensure a speedy negotiation process.
Terms of Contract
A patent royalty agreement contains some standard and some specific terms that involve negotiation. Each will have a different outcome based on desires of each party. Let’s consider the terms below:
Types of License– The type of license that the licensor is willing to license is an extremely important consideration of a license agreement. An exclusive license has a high value, because it ensures that the licensee is the only party who can make, use or sell the patented technology. If you want more value for your patent and are willing to hand over rights for your patent completely for a limited period of license you may consider an exclusive license.
On the other hand, an exclusive license will be more appealing for the licensee if the patent is a particularly unique, in demand product or technology that is absolutely essential for their business. They would even consider paying more for such a license. However, if you have the ability to monetize the patent on your own and have a business plan and target market in place, you may consider a non-exclusive license that will allow you to provide the license to different parties and maybe even monetize in some markets yourself.
Term and termination– This refers to the duration of the agreement. The term can be perpetual or limited. It is advisable in case of an exclusive license where you are handing over all the rights in your invention to make the term of your license limited to a specific period. This will allow you to renegotiate more favourable terms after the expiry of the license based on the happenings during the patent term such as sales. In the case of termination clause, the circumstances under which a license can be terminated by either party are listed. These circumstances would include a breach of contract amongst other conditions.
Payment and Fees– A license agreement may involve a lump sum payment. However, if you have assessed that the invention has a long term chance of profitability, you might make the royalty amount dependent on the profits. A cap on the profits would be more profitable to the licensee if they are interested in cutting costs and are a small company with more limited interest in patent investment. Also consider any termination fees if the license is terminated prior to the expiry date.
The fees and payment to be negotiated also depend on these additional considerations such as significance of the technology and stage of development, competitive strength of invention, costs for licensees such as research and marketing, costs of enforcement, risks and liability etc.
Limitations– This refers to the restrictions that the licensor can impose on the licensee. These may be in the form of territorial boundaries, usage etc. If you are a licensee who is also a service provider, you must ensure the license allows you to sublicense to your customers if necessary.
Intellectual Property– Usually a licensor retains the rights in the licensed invention. If however, the license needs to be modified or enhanced in order to market, manufacture or sell it, the licensor may grant the licensee the right to make such modifications subject to ownership in such modifications residing with the licensor. These are called Grant Backs These grant backs may be exclusive assignments that are as stated above the licensor retains ownership in modifications along with the ability to sublicense while the licensee retains only a non-exclusive right to practice the improvement. However, while negotiating this term, keep in mind that a bigger licensee will be unlikely to allow the licensor a return on its investment.
Types of royalties to choose from- In order to get the most mutually beneficial license agreement, the parties can consider a variety of loyalties that best fit their needs. For example, step-up royalty rates which are more beneficial to a licensee which is a small company or startup. In this kind of royalty, a licensee pays a low royalty upfront and depending on a triggering event pays higher rates lower down the road. If you as a licensor are seeking to negotiate rates with a smaller party, this may be a good balance to stand on. In case of a minimum royalty, a licensee is required to minimum royalties irrespective if any earnings are made from the license.
In conclusion, remember that you only get what you ask for. And the same philosophy applies to negotiations during patent royalty agreements. In order to ask for the right terms you must have all the knowledge you can accumulate. As negotiating takes time, it only makes sense to have all the facts in place before you even begin negotiating. For example as a licensor, this includes facts regarding your licensee’s business, your licensee company’s strengths and weaknesses etc.
While you aim for getting the best deal and collecting relevant information to have the upper hand, aim for an eventual win-win outcome. As license agreements result in long term commercial partnerships, if the parties are dissatisfied they may be compelled to litigate which will demolish all the benefits the license agreement accrued in the first place.
One of the best ways to do that is creating a list of absolutely non-negotiable terms and ones where you are willing to give a leeway to the other side. Look at the bigger picture and discuss if you are agreeing on the more basic terms of contract like exclusivity, territories and royalty rates. Begin with these. It is likely that if these basics can’t be agreed upon, a partnership will be unlikely and there is no point for the parties to even discuss the bigger contract terms.
Research into the company you intend to partner with and license your patent to is also important because company’s attitudes around innovation vary. Due diligence about your company will give you an inkling into their past licensing deals and their outlook and stands on negotiating terms. Bigger companies are more risk averse and will need more effort from your end to convince your partner and to then negotiate terms to you as the licensor’s benefit. Ultimately a mutually satisfactory position and a hopefully long and fruitful partnership is the ultimate goal of a patent royalty agreement.
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