What type of compensation in IP licenses?

Liliana Korosi [1]
ROBIC, LLP
Lawyers, Patent and Trademark Agents

This article aims to provide a short answer to the following question, which automatically arises when negotiating an intellectual property (IP) license agreement: what type of compensation should be stipulated in a license agreement?

Although the amounts in percentage on net or gross sales of products, usually called royalties, are the most common, the parties to a license agreement consider a wide range of different forms of compensation, in addition or in lieu of percentage royalties. We would therefore, like to invite you to surf with us, through the list below, the different forms of compensation that the parties to an IP license agreement may consider when negotiating:

Percentage royalties on product sales

This form of compensation is calculated by a percentage of net or gross sales of products incorporating the IP subject to the license agreement. The choice between the two bases of calculation is not however, an easy task and will depend, among other factors, on the complexity or simplicity of determining the deductions to be made (product manufacturing costs, discounts made on the product selling price, sales or import taxes, etc.) in order to arrive at the total net sales. It will also depend on the importance or the proportion held by the IP in the finished product.

Royalties as a percentage applied on the selling price or the manufacturing cost of a product unit

Less frequently used, this form of compensation targets the simple calculation based on the number of product units manufactured or sold, especially when the product encompasses multiple IP elements under one or more license agreements. In addition, royalties calculated on the manufacturing cost of a product unit are designed to eliminate discussions on the minimum or maximum limit of the licensed product selling price.

Minimum or maximum royalties

Usually provided in an exclusive license agreement in order to motivate the licensee’s commercialisation efforts, the minimum royalties may be combined with a penalty or loss of exclusivity clause as to a territory or field of exploitation in case the licensee fails to commercialize the product. In addition, when the licensor wishes to encourage the licensee to sell more products or provide more services, a maximum annual royalty is included in the license agreement such that, once the licensee reaches a certain level of sales, no further royalties are payable for the year.

Advance payment on due royalties

These advances are deductible from due royalties and may be paid at the beginning of the license agreement, annually or in consecutive instalments over the year.

Fees or license price

The license agreement may provide for (i) license fees, either in a fixed amount payable with a certain frequency (upon signature, and then annually, quarterly, etc.), corresponding to a certain percentage of any other amount received under the license agreement, (ii) a lump sum amount payable upon signature or annually, or (iii) a compensation payable (x) directly, by issuance of shares of the share capital of the corporate licensee, (y) by issuance of options to subscribe later on to a number of shares, or (z) by the issuance of promissory notes convertible into shares.    

Lump sum amounts based on the achievement of objectives or performance milestones

Fixed amounts may be set forth upon the achievement of major steps or important performance milestones regarding the development or the commercialization of the product, such as (i) obtaining certain regulatory certifications or approvals (particularly in the pharmaceutical industry) or (ii) attaining a certain level of net or gross product sales.

Sub-licensing revenues

The licensee may be required to pay a fixed amount, or a percentage of any income received from its sub-licensees.

Equity

Some of the amounts stipulated in the license agreement may be satisfied by issuance of shares in the share capital of the corporate licensee, by issuance of options to subscribe later on to a number of shares, or by the issuance of promissory notes convertible into shares. In such cases, additional documents are required, such as a shareholders agreement.

Reimbursement of patent costs

Usually found in the patent license agreement, this type of compensation requires the licensee to reimburse the licensor for part or all of the costs and expenses related to the patents (whether to maintain them or otherwise in connection therewith).

Reimbursement of advertising and promotion expenses

Used primarily in trademark license agreements, advertising and product promotion expenses incurred by the licensor are reimbursed in whole or in part by the licensee.

Cross-licensing

For example, the licensee grants, in turn, the licensor a license on its own IP but for a different field of exploitation.

Interests for late payment

The licensee pays an interest at a certain rate on any late payment.

Contractual practice in license agreements may provide for other forms of compensation, the ones mentioned in the above list being examples only.

For any question or additional information, we invite you to contact directly the members of the ROBIC business law team.