At MidCap Advisors we advise clients on the "transaction continuum" ranging from licensing, which represents a relateively low level of commitment by both parties, to the purchase or acquisition of a company, which represents the highest level of commitment.
The following is an exerpt from an excellent article on the pros and cons of licensing by attorney Bill Venema, a partner with the law firm of Epstein Becker & Green. This article describes the pros and cons of licensing from both sides of the table.
Generally, licenses are contracts that allow a person or entity (the "licensee") to use the property of another (the "licensor"). Licenses often involve intellectual property, and, when they do, their characteristics include the following:
- a limited right to use the intellectual property;
- little access to the knowledge source (i.e., the licensor); and
- the application of a "packaged solution," rather than a customized one.
In deciding whether to enter into a licensing arrangement, the parties should weigh the advantages of using licensing as a means of collaboration over the disadvantages and then use that analysis to compare licensing with the other ways the parties could collaborate.
THE LICENSEE'S PERSPECTIVE
For licensees, the principal advantage of a license (typically referred to as a "license-in") is that it allows the licensee to use proven technology in its business in exchange for paying the license fee, rather than incurring the full cost of developing and maintaining the technology. If the licensee's business is relatively complex and involves a variety of different technologies, which would be difficult and costly for the licensee to develop on its own, then the licensee will probably need a number of "licenses-in."
The principal disadvantage of licenses-in is that they can cause the licensee to become technologically dependent on the licensor, which could lead to a variety of problems when the time comes to renew the license. The licensor could use its leverage to negotiate better terms. Or, if another party has offered the licensor more money in exchange for an exclusive license, then the licensor might refuse to license the technology to the licensee. Even if the license-in is a perpetual license, which does not need to be renewed, the licensee is still at risk. The licensor could license the same technology to one or more of the licensee's competitors, thereby giving them the same competitive advantage that the technology provides to the licensee. In addition, the licensor could fail to maintain or update the technology, thereby diminishing its value.
THE LICENSOR'S PERSPECTIVE
From the licensor's perspective, a license is referred to as a "license-out." The principal advantage of a license-out is that it allows the licensor to realize a return on its technology without incurring the expense involved in actually manufacturing, marketing, distributing, and selling a product. If a licensor has technology that is unrelated to its core business, then it can use a license-out to realize some value from the technology, without being distracted from its core business. Licenses-out can also be employed with technologies that have little value by themselves and must be combined with other proprietary technologies in order to create a complete product.
The disadvantages of licenses-out depend upon how they are being used. If the licensor is licensing the technology in exchange for receiving a royalty based on sales of the products that incorporate its technology, then the licensor is, to some extent, dependent upon the licensee to make the sales and to be honest in reporting the sales revenue. To protect itself, the licensor can establish certain sales goals that the licensee must meet in order to keep the license and can include special audit rights in the license agreement to ensure that the licensee is accurately reporting its sales revenue. The licensor is also dependent upon the licensee to make quality products with its technology. To the extent the public knows that the licensor's technology is in a product, the licensor will want to ensure that the licensee adheres to certain quality standards so that the licensor's reputation is not damaged.
A full copy of Bill's article can be found at here.
Bill Venema is an experienced business lawyer in Epstein Becker & Green's Houston office. Bill focuses on mergers and acquisitions, IT contracts, outsourcing, licensing, joint ventures, and private equity. Bill is the author of The Strategic Guide to Selling Your Software Company: Essential Advice from a Veteran Deal Warrior, as well as numerous articles on a variety of business law topics. To understand all of your options, including whether a license, joint venture, partnership agreement, or outright sale is the best way to accomplish your goals, contact the MidCap Advisors office nearest you.