Crafting Effective Terms in a License Agreement (Patent/Copyright)

Crafting Effective Terms in a License Agreement (Patent/Copyright) Dr. Mark Reeves Oak Ridge National Laboratory Nashville, Tennessee May 2, 2011

2 Agenda Where to start Intellectual property valuation and financial consideration Exclusivity, fields of use, license duration Termination R&D prior to product sales Sublicensing Gross sales vs. net sales Diligence provisions Leveraging (licensing + sponsored research) Some Rules of the Road Questions

3 Disclaimer! The course will: - Describe approaches to working through common stumbling blocks in technology licensing - Provide tips on what has worked for me - Share ideas that might be helpful - Help you avoid the effects of misinformation or lack of information

4 Disclaimer! (Cont.) What is presented here is NOT the only way I want to learn, too so offer your past experiences as well Please speak freely disagree, offer alternatives, ask questions

Agenda Where to start Intellectual property valuation and financial consideration Exclusivity, fields of use, license duration Termination R&D prior to product sales Sublicensing Gross sales vs. net sales Diligence provisions Leveraging (licensing + sponsored research) Some Rules of the Road Questions 5

6 Where to Start Develop a Formal Licensing Strategy Performed when you have a technology or portfolio in hand for which you are seeking licensees Good way of recording data about the technology portfolio and the institution s goals in licensing Offers a way to allow management and inventor participation/approval in developing the strategy - Keeps everyone on the same sheet of music - Could be very useful if future internal disputes arise Will be a living document (many updates as new data are gathered)

7 Where to Start (Cont.) Develop a Formal Licensing Strategy (Cont.) An internal formal document, with management approval or buy-in Documents the: - State of the intellectual property/technology - Market - Competition - Fields of use - Candidate licensees - Pricing parameters - Other key factors Begin with technology-based, move to company-based More on strategy document in Tools section of course

8 Where to Start (Cont.) Finding a Partner and Cultivating Leads Inventors - Contacts through conferences, academia, journal articles, etc. - CRADA partners Previous licensees in similar industry sectors Financial sources Internet Market analyses Cold calling Ask contacts for leads

9 Where to Start (Cont.) Finding a Partner and Cultivating Leads (Cont.) Inventors - Other than inventing the technology, the most important function in the licensing process is the principal investigator (PI) creating a candidatecompany technical champion - Creates a salesman inside the candidate licensee company; much more effective than the licensing executive s sales efforts - All other sources of licensing leads pale in comparison to what inventors can provide (in my humble opinion)

Where to Start (Cont.) Qualify the Partner Use a license application/questionnaire or some other form of formal, expressed interest in licensing License application provides several things - Essential data for filling in license agreement - Contact information - Indication of ability to perform Formulate a term sheet based on license application (i.e., outline of proposed license agreement) More on license application and term sheet in Tools section of course 10

11 Where to Start (Cont.) Qualify the Partner (Cont.) Diligence on prospective licensee(s) - Dun & Bradstreet reports - Company website - SEC filings (http://www.sec.gov), Yahoo! Finance, Motley Fool, etc. - Google them! - Income statement & balance sheet

12 Where to Start (Cont.) Qualify the Partner (Cont.) Diligence on prospective licensee(s) (Cont.) - Formal market opportunity analysis - Proprietary databases - Market reports - Etc. - History on new product introduction - Technology licensing history - Dirt? - Stable market player Reference librarians are a superb resource!

14 IP Valuation and Consideration State of the invention ( time to revenues ); indicates degree of technology maturation required, as well as value to licensor - Conceptual (licensor value +) - Proof-of-principle experiment (licensor value ++) - Prototype (licensor value +++) - Production scale (licensor value ++++)

15 IP Valuation and Consideration (Cont.) State of the IP rights - Who has rights, sole or joint ownership? - Divulgations, publications, bars, etc. (foreign rights impacts) - Can broad commercial claims be obtained?

16 IP Valuation and Consideration (Cont.) Degree of improvement to state of the technology - Minor enhancement? (licensor value +) - Leapfrog existing technology? (licensor value ++) - Revolutionary? (licensor value +++) - Disruptive? (licensor value ++++) Level of commitment of inventor(s) - Significant part of value to laboratory may be in sponsored research vs. royalties

17 IP Valuation and Consideration (Cont.) Culture in the licensed industry Consumer perspective/receptivity How have similar products fared? Economic climate/marketplace economics - Robust/tech boom - Stagnant - Recession

18 IP Valuation and Consideration (Cont.) From the license application and associated pro forma financials, calculate a proposed financial compensation structure: - Upfront fee (perhaps equity?) - Minimum annual royalty/license maintenance fee - Royalty rate (% sales) - Patent cost reimbursement? - Perhaps sponsored research (full cost recovery) Calculate the potential profits and use the 25% rule More on IP valuation in Tools section of course

19 IP Valuation and Consideration (Cont.) Develop and send a term sheet Determine upfront fee proposal from NPV on THEIR financials Base the term sheet consideration on THEIR financials, where possible THEIR financials often more favorable than what you might develop Builds trust

21 Exclusivity Consider exclusivity in light of prospective licensee s ability to exploit IP, then tie to diligence - Diligence Product development, capital investment, marketing efforts - Sales milestones Quantify to retain exclusivity (or license) - Demonstrated ability to satisfy demand

22 Exclusivity (Cont.) Where to start - Inventor - Patent claims analysis - License application Generally speaking - Small market <$25M, and/or niche technology grant exclusive license - Large market >$100M, and/or platform technology assure licensee ability to satisfy demand; best approach may be multiple nonexclusive licenses and let the market choose the winners

23 Fields of Use Why employ fields of use? - Few licensees can or will exploit all fields of use - License various companies in different fields of use - Allows exclusive and nonexclusive licenses for a single technology - Allows licensor maximum market exposure when fields of use are easily deleted if not used Takes considerable time and effort to draft license with proper fields of use

24 Fields of Use (Cont.) Always tie exclusivity to fields of use, where possible - Nonexclusive with limited field(s) of use - Exclusive - Exclusive with limited field(s) of use - Anything in between Generally speaking and where possible use limited field(s) of use Take all you want, but eat all you take

25 Fields of Use (Cont.) Examples Lighting Technology RFID - Use Interior, exterior, residential, commercial - Size Wattage - Application Automotive, aircraft, machinery, biological growth - Asset tracking - Highway traffic management - Personnel monitoring Also consider geographic fields of use

26 Fields of Use (Cont.) IMPORTANT: Write separate, parallel diligence requirements for each field of use - R&D and marketing expenditures - Sales Require annual minimums for each field of use For fields of use where the diligence is not achieved or minimum annuals are not paid, have the deficient field(s) of use automatically withdrawn from the license CAUTION: Crafting fields of use usually must keep in mind use of IP by licensee, not use of products by end user

27 Fields of Use (Cont.) Sample Retention Language Retention of these Fields of Use shall be contingent upon 1) the payment by Licensee of the Royalties and Minimum Annual Royalties specified in Exhibit B, and 2) satisfying the diligence milestones specified in Exhibit C for each Field of Use. Should Licensee fail to make said payment or perform the diligence milestones for each respective Field of Use, such Field of Use(s) will be deleted automatically from the License

28 License Duration License or fields-of-use duration can be limited by: - Time - Diligence metrics (level of investment, etc.) - Production or sales metrics - Timely payment of financial obligations

29 License Duration (Cont.) For Licensee head start - Grant first licensee a nonexclusive limited field-of-use license - Then agree not to license any other licensee in the limited fields of use for a set time (limited nonexclusive) Licensor agrees not to grant any other party rights in the field of use of??? until January 1, 2015

30 License Duration (Cont.) Generally, license duration extends until last patent (or other IP protection) expires, or until diligence milestones are not met or other breach Copyright licenses will almost surely be terminated before IP protection expires (but if exclusive may not remain so after 5 years) Licensee or Licensor may terminate with appropriate notice - Licensee for loss of interest in commercializing the technology - Licensor for recovering rights when licensee has failed to commercialize or meet diligence milestones

32 Termination Licensor always needs to retain the ability to recover licensed IP from licensee - In case of failure to commercialize (not meeting diligence milestones), or - In case of breach of terms of license agreement

33 Termination (Cont.) Licensee needs to be able to terminate in a timely fashion if company s strategic directions change, or market conditions turn unfavorable for commercialization of licensed technology Termination is preferred to convert to nonexclusive - Unilateral action vs. bilateral action - If originally exclusive, can always negotiate new nonexclusive license post-termination

34 Termination (Cont.) Example Language This Agreement may be terminated by either Party for any material breach of the Agreement by the other Party. Such termination will be effective sixty (60) days after written notice specifying the breach to the other Party. If the specified breach is cured before the effective date of termination, the Agreement will not be terminated.

35 Termination (Cont.) Example Language (Cont.) In the event Licensee either (1) fails to make payment to Licensor of Royalties or other consideration in accordance with this Agreement or (2) fails to satisfy the requirements of the Commercialization Plan in Exhibit C, Licensor may, at its sole discretion, terminate this Agreement with respect to specified Licensed Patents or Fields of Use. There will be no reduction in any of the payments due from Licensee, including but not limited to Royalties.

36 Termination (Cont.) Example Language (Cont.) Licensee may terminate this Agreement for any reason if Licensee provides Licensor with sixty (60) calendar days prior notice of its intent to terminate and pays Licensor all patent reimbursement fees owed at the time or termination, if applicable, and all Royalties due or the pro rata portion of any Annual Minimum Royalties due in, or at the end of, the year of termination under Exhibit B, whichever is greater.

37 Termination (Cont.) Example Language (Cont.) This Agreement will not be terminated for any breach that is the result of an act of God, acts or omissions of any government or agency thereof, compliance with rules, regulations, or orders of any governmental authority or any office, department, agency, or instrumentality thereof, fire, storm, flood, earthquake, accident, acts of the public enemy or terrorism, war, rebellion, insurrection, riot, sabotage, invasion, quarantine, restriction, transportation embargoes, or failures or delays in transportation.

38 Termination (Cont.) Example Language (Cont.) Neither Party will be relieved of any obligation or liability under this Agreement arising from any act or omission committed prior to the termination date. Upon termination, Licensee will execute any documents necessary to achieve the transfer to Licensor of all rights to which Licensor may be entitled under this Agreement.

40 R&D Prior to Product Sales Almost all licensees will have a need for further R&D/maturation on the IP prior to product sales Where R&D is for an extended period (greater than 1 year) and licensee can t or won t pay entire upfront (execution) fee, consider: - Including an R&D grant clause for a limited period of time for a portion of the initial fee - Followed by an option for licensee to convert to a commercial grant clause for the remaining portion of the initial fee

41 R&D Prior to Product Sales (Cont.) Sample Language Licensor grants to Licensee the exclusive right and license to utilize the Proprietary Rights of Exhibit A solely for research and development purposes. This right will expire on January 1, 2016. No right to commercial manufacture, sell, or offer for sale Products is granted to Licensee

42 R&D Prior to Product Sales (Cont.) Sample Language (Cont.) Should Licensee desire to expand the scope of the grant of this research and development license to a grant of an exclusive license to commercialize the Exhibit A, Proprietary Rights, Licensee will first notify Licensor of Licensee s desire to so expand the scope and to be bound by the payment schedules for such a license as set forth in Exhibit B, Execution Fee Royalties and Minimum Annual Royalties

43 R&D Prior to Product Sales (Cont.) Sample Language (Cont.) Licensee will also submit to Licensor, with such notification the balance of such Execution Fee Upon receipt of the notice and payment to Licensor, the research and development license will then be expanded to a grant to Licensee of an exclusive license within the field of use of??? to commercially manufacture, have manufactured for Licensee, use, sell or offer for sale Licensed Products

45 Sublicensing Usually acceptable for grants of exclusivity Make the licensee ask for it; entry position for licensor on 1 st term sheet should be to deny right to sublicense (negotiation tactic get something in return for granting the right to sublicense) Structure where there is net benefit for both parties - Careful examination of sublicensing fees/consideration - `No pass-through licensing

46 Sublicensing (Cont.) Examine whether to allow Licensee s sublicensee to grant further sublicenses USUALLY NOT Bona fide sublicensor or technology broker? Usually not acceptable for grants of nonexclusivity, except for software shrink-wrap licenses Consideration to licensor should not be significantly less, if at all, than if sublicensee had licensed directly from licensor Ask for right of approval of each new sublicense In the event of termination, sublicensees should become licensor s licensees

47 Sublicensing (Cont.) Sample Language Licensee will have the right to grant sublicenses but sublicensees will not have the right to grant further sublicenses. Licensee will have the right to sublicense in the Field(s) of Use All sublicenses must be approved in writing by Licensor in advance of execution by Licensee. Such approval will not be unreasonably withheld by Licensor.

49 Gross Sales vs. Net Sales Gross Sales means the sum of all invoices Licensee sends to purchasers for Products sold (example only) Gross sales no exclusions - Simple - Easily auditable Net sales many exclusions - Leads to negotiation - After both negotiating parties are gone, leaves open to interpretation - Keeps auditors and maybe lawyers in business at YOUR expense!!!

50 Gross Sales vs. Net Sales (Cont.) If licensee insists on net sales, licensor should insist on a higher royalty rate than on gross sales For my money, a lower rate on gross sales is preferable to a higher rate on net sales Some argue gross sales violates statute; charging royalty on commissions, etc.

51 Agenda Where to start Intellectual property valuation and financial consideration Exclusivity, fields of use, license duration Termination R&D prior to product sales Sublicensing Gross sales versus net sales Diligence provisions Leveraging (licensing + sponsored research) Some Rules of the Road Questions

52 Diligence Provisions Why diligence provisions? - Ensure commercial exploitation of licensed IP - Promulgate the technology to the greatest extent in the marketplace - That which is not exploited will be returned to licensor Field of use License Individual patents Requires great care in drafting to be effective you don t want to be gamed

53 Diligence Provisions (Cont.) Milestones based on sales (invoicing, revenues, units sold, etc.) are the easiest to monitor Tie to fields of use if multiple fields of use are granted Also consider technical milestones if early stage Might use milestone payments instead of minimum annual royalties

54 Diligence Provisions (Cont.) Example Language Licensee agrees to invest in the development of technology and market for products by committing licensee s resources, at a minimum, to the following requirements: Milestone Due Date Working Prototype Demonstrated Date First Commercial Sale Date Annual Gross Sales of $? Million (per field of use) Date Annual Gross Sales of $?? Million (per field of use) Date Annual Gross Sales of $??? Million (per field of use) Date

56 Leveraging Ingredients Patentable technology with commercializable claims Embryonic patent-based technology needing maturation for commercialization; or Copyrighted software that might need productizing Licensee (preferably a limited field of use license) Licensee willing to use licensor s PI via Sponsored Research Agreement (THE subject matter expert!) Applicable to a minority of licensing deals

57 Leveraging (Cont.) Structuring the Deal Limited field(s)-of-use license with - Patent recovery costs - Upfront fee, minimum annual royalties and running royalty are preset Companion Sponsored Research Agreement (funds-in CRADA), where newly generated IP is incorporated into the companion license for the limited field(s) of use

58 Leveraging (Cont.) Sample Language Licensee agrees to provide Licensor, by January 1, 2015 at least X million U.S. Dollars ($X,000,000) for research and development to be undertaken in collaboration with Licensee under appropriate agreements and in support of Licensee s commercialization efforts relating to Proprietary Rights

59 Leveraging (Cont.) Sample Language (Cont.) Should Licensee fail to make any of the above research and development payments by January 1 of the respective year the grant of right in the field of use of??? will be immediately revoked and the grant of right returned to Licensor on January 2 of the respective year for licensing to third parties without written notice. Further, the provisions of this Agreement allowing Licensee the ability to cure within sixty (60) days will not apply to the above.

Leveraging (Cont.) Advantages Allows focused research directed to commercialization (not usually funded by government) Increases success - PI direct involvement (subject matter expert) Grows the body of knowledge and IP portfolio Develops out-fields of use for further licensing and possible leveraging with others 60

61 Leveraging (Cont.) Advantages (Cont.) Inherent programmatic benefits Increases private sector laboratory funding Good PR May lead to regional economic development success (company may locate near source of R&D/expertise) Can grant license to foreground rights developed at licensee s expense if licensee has already licensed background rights (same financial compensation terms)

62 Leveraging (Cont.) Example Language Adding Foreground IP Licensor agrees, for as long as this funding agreement (CRADA, WFO, etc.) remains in effect, to add any new intellectual property developed under this agreement to Exhibit A of Patent (Copyright) License Agreement XXX.

63 Leveraging (Cont.) Possible Disadvantages Focused research may lead to programmatic conflicts Expectations by the licensee/sponsor must be managed by PI and laboratory management Conflict of interest pitfalls, e.g., PI receiving royalty sharing Care in working with other private entities with same or related technologies Sponsor may believe they now own the lab Failure to commercialize may be unpleasant, or result in unfavorable PR

Leveraging (Cont.) Summary Leveraging is an excellent way to mature the technology - Usually the most focused research performed at a federal facility for commercialization Leveraging can be negotiated as part of a license - As a diligence provision Researchers love leveraging - They take ownership in the commercialization Not without pitfalls be careful! Usually only applicable to a minority of license deals 64

66 Some Rules of the Road Only the PI can create the technical champion in the candidate licensee company Always have a formal licensing strategy with management buy-in on any technology you seek to license Use a license application to qualify partner and value IP Using THEIR numbers is better than using YOUR numbers usually

67 Some Rules of the Road (Cont.) Base exclusivity decision on company s ability to perform, plus market factors Define fields of use and tie diligence milestones to FOU Get something in exchange for the right to sublicense Leverage license with sponsored research opportunity where possible Always maintain a mechanism for terminating the license in a timely manner and recovering IP rights

69 Followup/Questions??? Mark Reeves Oak Ridge National Laboratory reevesme@ornl.gov (865) 576-2577