F|R Crib Sheet: Key Terms of a Licensing Agreement

People talk about “selling” technology products all the time, but they usually mean licensing them. Licensing is actually the most common way that technology companies generate revenue. A “sale” occurs when ownership of the product changes hands completely. A “license” is when some portion of ownership is held back. For example, Apple sells iPods, but licenses the software that runs them. The point of this technical distinction is that if you want to “sell” your software to multiple customers, you’ll need to retain ownership, otherwise your first customer is going to walk away with everything. When you license your product, you retain control over how your customers may use it.

License agreements come in a million flavors, but they all contain a few critical elements. Here is a Crib Sheet of 10 Key Licensing Terms you need to comprehend.

1. Scope: What restrictions do you want to impose? The main ones are field-of-use, geography, time and exclusivity. Field-of-use means a customer can only use your product within a specific market. Restricting a license to the automotive sector prevents a customer from using it in aerospace or retail (without paying you again).

2. Geography:
Predictably, this determines the physical area where a customer may use your product. Geographic scope is usually worldwide (though I have seen “throughout the universe”), but in some situations a tighter scope makes sense.

3. Time:
When pricing your license, you need to decide whether to charge a one-time perpetual fee or a renewable subscription. If renewable, choose an expiration date.

4. Exclusivity:
Your customer is the only person who can use your product within the parameters specified. Customers will ask for exclusivity if your product is somehow central to their business. Consider charging a premium for this, unless your product is a commodity (like Microsoft Office), in which case there is no value in negotiating exclusivity.

5. Representations and warranties:
This is where you give your customer assurances that the product is yours to deliver, doesn’t infringe on anyone else’s IP, and that you will stand behind it if anything goes wrong. These elements get negotiated frequently. For the warranty, simply find out what your competitors offer and benchmark to it.

Representation of the authenticity of your IP is more challenging. Practically speaking, it is impossible even for big companies to prove that a product does not infringe on existing IP “anywhere else in the world.” Some tips: (a) determine where your customer is likely to use your product and assess whether you need to worry about infringement claims from those parts of the world; (b) limit the scope of your warranty to registered intellectual property in all cases. Patents must be registered to be effective, but trademark and trade secret rights can exist without registration, making due diligence impossible to complete with certainty.

6. Indemnification:
If you breach a representation or warranty, and your customer incurs damages, this assures them you will cover the costs. IP claims are foremost in most people’s minds, but personal injuries and property damage (e.g. if your gear causes a fire) are other common grounds for indemnification claims.

7. Limitations on liability:
This is your opportunity to state that if any claims on your warranties are made, the maximum amount you will pay will be capped. Most licensors limit it to the fees they will receive from the customer. (Licensees, of course, will want no limits.)

8. Most favored nations:
Avoid this provision as much possible. It means that if you ever offer better terms to a new customer, you must give earlier lincensees the benefit of the same terms. Each business deal naturally involves a slightly different set of compromises. But if you give a customer an “MFN” provision, consider yourself warned: You’ll be required to give that person the best part of every deal you do in the future. also.

9. Jurisdiction and venue:
Jurisdiction determines the set of laws that apply to your agreement (e.g. California vs. New York). Venue determines where any subsequent lawsuit will be filed. Litigation is rough on startups; litigating long-distance, worse. Set the venue close to home if possible.

10. Attorney fees.
If there is a dispute, the loser pays attorney fees incurred by the victor. In my experience, where this provision exists, the parties stay at the negotiating table longer, resorting to court only if certain they will prevail. It can come back to haunt, however; there is always a risk that you could lose, no matter how good you think your claim is.

Disclaimer: This post is provided for general information purposes and may not be considered legal advice.

Jay Parkhill serves as outsourced general counsel to startups and growth-oriented companies, and writes on legal and business matters at his blog, StartupToolbx.


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