A license agreement is a contract between two parties in which the owner of an intellectual property (IP) asset (the licensor) grants another party (the licensee) specific rights to use some aspect of that IP. The licensee usually pays certain fees to the licensor in return for these rights and must agree to a series of conditions regarding the use of the asset. The licensee refers to the license agreement as an inbound license, whereas the licensor refers to the agreements as an outbound license. Startup companies may license IP from other entities for many reasons, such as to obtain a license to use or to integrate certain software or technology in its product development, to obtain a license to use or to display a licensor’s brands as part of a marketing relationship, or to settle an ongoing patent litigation through the plaintiff granting the defendant a license to use the IP in dispute. This piece discusses five factors that entrepreneurs should consider when entering into an inbound license agreement. The list only seeks to highlight some of the most important factors, and is not an exhaustive list of issues that will arise.
Under an exclusive license agreement, the licensee has exclusive rights to use and exploit the IP, but such exclusivity is usually limited to a certain parameter. For example, a licensee may enjoy exclusivity in a limited geographic area, a specific field of use (such as a specific production method or distribution channel), or within specific channels of trade. These exclusive rights can generally be sliced as thin as the parties would like, such as to be exclusive only with respect to a potential sub-set of licensee types. Exclusive licenses often (but not always) exclude the licensor from exercising these same licensed rights. The licensee must consider what scope and field of exclusivity, if any, to ask for during the negotiation. A completely exclusive license will give the licensee a broad range of rights, but it will also come with a higher financial price. When a licensee is obtaining a license to use certain IP that will provide a competitive advantage in a specific field of use, the licensee will often only seek exclusivity against competitors in the relevant territory. In such case, the licensing parties might also need to consider whether antitrust legal issues arise as such a restriction could be seen as a prohibited hindrance on competition if drafted too broadly. If in doubt, seek antitrust and competition legal advice before finalizing the exclusive licensing arrangement.
The financial terms of license agreements can vary greatly based on the particular transaction. A license agreement can be structured as a one-time up-front payment, fixed license fees to be paid at set milestones, or recurring royalties calculated against a certain base (such as net sales of any product that integrates the relevant IP), or a combination of some of these methods. If royalty payments are involved, a startup licensee may consider negotiating for a sliding scale royalty rate, so that the rate decreases as the licensee expands its operations and generates higher sales revenues. Investors and acquirers may perceive a license agreement that encumbers a startup licensee with a high ongoing royalty attached to its core software products as a material issue. Additionally, a startup licensee should be prepared for minimum guarantees a licensor might ask for, which requires a payment of a minimum amount from the licensee if the sales, and in turn royalty payments, do not reach a certain level.
A startup licensee should ideally have the right to terminate a license agreement with or without cause (for convenience) upon prior written notice to the licensor. As mentioned above, if the licensed IP does not provide as much benefit as the startup licensee expected, the ability to terminate the license for convenience will be helpful as the licensee can stop spending excessively on the license. To convince the licensor to agree to such termination right during the parties’ negotiation, the licensee can point out that the licensor is merely granting the licensee a right to use an asset the licensor already owns and operates, and that the termination of such grant will not cause the licensor to lose any asset.
Increasingly, software-as-a-service (SaaS) models are replacing a typical licensing model. In a SaaS model, the software being made available is not actually downloaded on the customer’s devices or equipment, but is instead accessed as a remote service that is hosted on the licensor’s systems. SaaS agreements are often written as license agreements and include many of the same concepts as would be found in a traditional license agreement (although for legal reasons we don’t need to get into now, a “license” may arguably not even be needed in a SaaS agreement versus a right to use the software in question). However, startup customers negotiating a SaaS agreement should pay increased attention to issues around data security and privacy, as the SaaS provider will now be storing and processing all of the data generated by the startup’s use of the software service on the provider’s systems. Such a concern may not be present in a traditional software licensing arrangement, in which all relevant software and usage data remains stored on the networks of the customer licensee. If the underlying data includes personal, financial, or other types of sensitive data, certain regulations such as the European GDPR mandate that such an agreement include specific clauses regarding how the SaaS provider can store, transfer, and otherwise process the underlying data.
The parties should expressly state in the license agreement whether the licensee has a right to grant sublicenses in the underlying IP. A sublicense is a license that a licensee grants to a third party, extending some or all of the rights that the licensee enjoys under a license agreement. A licensee may wish to sublicense to its supply chain partners, such as distributors or resellers, other business partners or affiliates. Often, license agreements will contain strict controls or outright prohibitions on sublicensing. A licensor will likely want to do this in order to control how its underlying IP is shared and used, including to ensure that all such sublicensees pay their own license fees for use of the underlying IP. A licensee that knows up front that it will need to share and sublicense the relevant IP with third parties will have much more leverage negotiating a carefully tailored sublicense clause at the outset of the negotiation, as opposed to seeking consent long after an agreement is signed.