How to Negotiate a Business Contract
The aim of negotiating a business contract is a binding agreement where all parties win.
George Doyle/Stockbyte/Getty Images
- 1 Effective Negotiation, Confrontation & Conflict Resolution
- 2 Make a Contract Legal
- 3 Settle Business Partner Disagreements
- 4 The Disadvantages of Being Overconfident During Negotiation
Businesses buy and sell goods and services based on contracts with other businesses. These business contracts influence how well your business performs and how much time you have to spend managing your business relationships. An effective contract negotiation results in an agreement that is fair to the parties and distributes benefits and responsibilities equally. To negotiate effectively, you have to pay attention to five major aspects of business contract negotiations.
The preparation for contract negotiations includes studying the company and individuals with whom you will be negotiating. Identify their strengths and weaknesses and any strategies that you know they will use. On your own side, set limits to what you will accept and set out your aims for the negotiation. Identify factors that will cause you to walk away from the deal.
Make sure the terms and conditions are clear before proceding. Go through the responsibilities that the contract assigns to the parties and change the wording if you and your negotiating partners don’t agree on what it means. Make sure the financial terms are clear, both in the amounts that are due and when the companies will make the payments. Check the dates when the contract comes into force and when it finishes. Examine what happens when one of the parties doesn’t fulfill their part of the contract.
A good contract results from both parties feeling pressure to sign a fair agreement. Put your negotiating partner under pressure by referring to the alternatives open to you if there is no deal. Mention competitors or other markets and specify what will happen if you don’t reach agreement and the business opportunity is lost. Indicate what you will not accept in the contract and determine if a deal is possible. If not, you have to be prepared to walk away. If your negotiating partner does not call you back into the negotiations, a fair deal was not possible.
Once you determine that a deal is possible, you can offer concessions to make it happen. The contract negotiations to this point revealed what is important to your negotiating partner. The concessions most likely to promote an agreement are those which are of substantial benefit to your partner while not costly for you. Ideally, your partner will offer similar concessions.
When all major issues have been discussed, you have to decide whether to make the deal. Some experienced negotiators set up the closing at the beginning of negotiations by saying they have a plane to catch or have to be at another meeting at a certain time. This allows them to introduce the closing offer in a natural way. To close the deal, you have to make a proposal that is acceptable to the other side. If you don’t want to close, you can make an unreasonable proposal. Either way, these negotiations will have run their course and resulted in a fair contract or the realization that you have to explore all your options more extensively.
About the Author
Bert Markgraf is a freelance writer with a strong science and engineering background. He started writing technical papers while working as an engineer in the 1980s. More recently, after starting his own business in IT, he helped organize an online community for which he wrote and edited articles as managing editor, business and economics. He holds a Bachelor of Science degree from McGill University.
A licensing agreement is a legal contract between two parties, known as the licensor and the licensee. In a typical licensing agreement, the licensor grants the licensee the right to produce and sell goods, apply a brand name or trademark, or use patented technology owned by the licensor. In exchange, the licensee usually submits to a series of conditions regarding the use of the licensor’s property and agrees to make payments known as royalties.
Licensing agreements cover a wide range of well-known situations. For example, a retailer might reach agreement with a professional sports team to develop, produce, and sell merchandise bearing the sports team’s logo. Or a small manufacturer might license a proprietary production technology from a larger firm to gain a competitive edge, rather than expending the time and money trying to develop its own technology. Or a greeting card company might reach agreement with a movie distributor to produce a line of greeting cards bearing the image of a popular animated character.
Whatever the type of licensing arrangement, the formal licensing agreement is an important component in a successful venture. «While it is impossible to determine the future success of a product, much can be done in the earliest stages to ensure that a licensed product gets the best chance possible,» Teresa Salas wrote in Playthings. «One might even say that the entire future of a licensed product is laid out, at least in part, during the process of negotiating a licensing contract.»
ELEMENTS OF A TYPICAL LICENSING AGREEMENT
Because of the legal ground they must cover, some licensing agreements are fairly lengthy and complex documents. But most such agreements cover the same basic points. «In general, contracts contain the same provisions,» Salas noted. «Outlined clearly in the contract are such things as advances, royalties, guarantees, market dates, renewal options, length of contract, monitoring rights, procedures for quality control, inventory, and returns and allowances.»
One of the most important elements of a licensing agreement covers the financial arrangement between the two parties. Payments from the licensee to the licensor usually take the form of guaranteed minimum payments and royalties on sales. Royalties typically range from 6 to 10 percent, depending on the specific property involved and the licensee’s level of experience and sophistication. Not all licensors require guarantees, although some experts recommend that licensors get as much compensation up front as possible. In some cases, licensors use guarantees as the basis for renewing a licensing agreement. If the licensee meets the minimum sales figures, the contract is renewed; otherwise, the licensor has the option of discontinuing the relationship.
Another important element of a licensing agreement establishes the time frame of the deal. Many licensors insist upon a strict market release date for products licensed to outside manufacturers. After all, it is not in the licensor’s best interest to grant a license to a company that never markets the product. The licensing agreement will also include provisions about the length of the contract, renewal options, and termination conditions.
Most licensing agreements also address the issue of quality. For example, the licensor may insert conditions in the contract requiring the licensee to provide prototypes of the product, mockups of the packaging, and even occasional samples throughout the term of the contract. Of course, the best form of quality control is usually achieved before the fact—by carefully checking the reputation of the licensee. Another common quality-related provision in licensing agreements involves the method for disposal of unsold merchandise. If items remaining in inventory are sold as cheap knockoffs, it can hurt the reputation of the licensor in the marketplace.
Another common element of licensing agreements covers which party maintains control of copyrights, patents, or trademarks. Many contracts also include a provision about territorial rights, or who manages distribution in various parts of the country or the world. In addition to the various clauses inserted into agreements to protect the licensor, some licensees may add their own requirements. They may insist on a guarantee that the licensor owns the rights to the property, for example, or they may insert a clause prohibiting the licensor from competing directly with the licensed property in certain markets.
Heicklen, Michael J. «Licensing Your Restaurant’s Name, Trademark.» Nation’s Restaurant News. June 29, 1998.
Salas, Teresa. «Building a Lasting Licensing Contract.» Playthings. October 1988.
Stodder, Gayle Sato. «License to Win.» Entrepreneur. February 1995.
Upton, Pat. Make Millions in the Licensing Business. Monarch Press, 1985.
Business Borrowing Basics — Negotiating A Loan Agreement
Cash is king for businesses, especially those just getting off the ground. It’s rare that a company can simply operate from cash flow without short-term borrowing from time to time.
Even if your business does not have a line of credit—or another type of loan with a bank or other professional lender (e.g. credit unions, non-bank asset based lenders, etc.)—it nonetheless borrows every time it buys on credit, defers payables or pays its employees in arrears.
Often, access to credit makes the difference in whether a business survives.
However, there is a cost to obtaining any credit facility beyond interest and fees charged. The terms of any loan and the restrictions it places on borrowers can often determine how much of a benefit (or burden) any loan facility places on a business.
How much borrowing is available?
What will the collateral be?
How much reporting must the company undertake?
What restrictions does the loan agreement place on running the business?
All these terms (and more) are often open to negotiation, regardless of whether your lender suggests otherwise.
“In a business loan, there is nothing more important than a flexible, positive relationship between borrower and lender, but circumstances change, as do the bank personnel, and the parties can only truly rely on the terms expressly agreed to in the loan documents.”
-Wade Kennedy, McGuire Woods
Business Loans: “Why Negotiate Detailed Terms?”
The short answer: If the details matter (and they always do), you should negotiate the best terms you can.
In most loan facilities, you can expect to see some or all of the following legal documents:
Loan and Security Agreement (may be two separate documents)
Guarantees (personal or corporate)
Stock (equity) Pledge Agreements
Reporting Documents (Compliance and Borrowing Base Certificates)
Account Control Agreements (giving lender control over deposit accounts)
Landlord Waivers/Access Agreements
Many lenders in the middle market offer loans documented on standardized forms. They use broadly restrictive terms and a “fill in the blank” structure.
This approach provides significant savings on legal expenses, but these standardized forms contain one-sided terms favorable to the lender.
Such terms might inadvertently saddle your business with covenants and representations you often cannot keep—and to which you should not agree. If your business wants or needs greater flexibility (and the prospect of more favorable terms), a negotiated set of nominally “customized” loan documents is the typical approach you should take with your lender.
Most lenders are willing to negotiate a package of loan documentation, so long as the process begins with a set of base “forms” with which the lender is familiar. A borrower can obtain significant benefits and concessions from most lenders beyond the basic economic terms of the loan (interest rate, term, security and fees). The ability to negotiate these terms depend on:
the creditworthiness of the business;
the presence of competing lenders; and
the market conditions.
Borrowers should keep in mind that lending institutions are like any other business, because they need customers . If more than one lender is willing to loan to your business, then you have some leverage.
Business Loans: “When Should I Start Negotiating?”
The short answer: Immediately
A proposal letter (or commitment letter) and term sheet are typically the first documents a lender will ask a borrower to sign, but likely the negotiation of the deal has already begun with phone calls and emails.
Also, the term sheet will be the first document that goes beyond the basics of pricing, tenor and fees. It delves into terms relating to scheduled payments and prepayments, collateral, closing deliveries, financial covenants and events of default—and that is when negotiation should begin in earnest.
A lender will hold you to the terms set out in an agreed term sheet, and that is when a borrower should engage counsel. Begin thinking all the way through the transaction, as well as its documentation and structure.
“There is nothing wrong with accepting general terms that are “market” for similarly situated borrowers. A smart lender will not present terms it knows a borrower has no reason or ability to comply with. It can be a financial (and sometimes strategic) mistake to try to negotiate every provision in a loan document.”
— Wade Kennedy, McGuireWoods
Negotiate the Most Important Provisions
Legal counsel can help guide the borrower through the loan documentation and point out those provisions that typically are most important to the company.
In many instances, the term sheet outlines these very effectively, but the detailed terms must “work” with the borrower’s business and operating requirements. You should be able to ask and answer many questions including,
Can I borrow money and get the proceeds when and how needed?
Can I provide the financial reporting with the frequency and detail required?
Do the covenants prevent me from entering into transactions I know I need?
If the answer to these and similar questions is “no,” then that is likely an area for negotiation. Everything else probably falls into the “nice to have” category, but is not worth going to the mat over.
One corollary to all this is that it always makes sense for a business owner actually to read the loan agreement they are signing. This may sound obvious, but skipping over “boilerplate” or relying too much on legal counsel to review business terms often results in documentation contrary to how an individual business runs.
This is what you want to avoid.
So, a strategy which focuses on the most important provisions tends to be the most cost- and time-effective. Business owners can save a lot of money on attorney fees by limiting the negotiation to a few key items, and this strategy also cuts down on time to close.
Engaging an experienced attorney in the type of loan you seek—and one that is willing to take some time to learn about your business—goes a long way to creating an efficient approach to negotiating and closing a loan.
General inexperience, not knowing the “market” for your specific type of loan or simply wanting to appear to be doing an effective job, can all result in “over-lawyering.” To avoid this, ask questions of your attorney both up front (such as “Have you negotiated many of these types of deals recently?”) and throughout the process (such as “Why do I need this provision?”).
Good counsel will always happily explain their expertise (careful here, though) and the reason for and importance of the specific terms to which you agree.
Common Provisions to Negotiate
As noted above, the term sheet sets out many of the most important terms of a loan transaction, including the maximum amount to be borrowed, interest rates, repayment terms, fees and costs payable, collateral, key financial covenants and certain defaults.
The actual documentation provides more detail, but the usual points of critical interest to a borrower include the following:
Borrowing mechanics (when and how borrowing notice is given, and when do you get your money);
Calculation of the borrowing base (for asset-based loans);
Eligibility requirements (and discretion to exclude) accounts receivable and inventory from the borrowing base;
Cash dominion (controlled accounts and cash sweep provisions);
Calculation of EBITDA for financial covenants and related definitions;
Affirmative covenants (actions the borrower agrees to take in the future); like
giving notice of adverse event,
delivery of financial information,
allowing lender to enter and inspect it premises and records, and
comply with laws and maintain insurance
Negative covenants (what the borrower agrees it won’t do in the future); like
incur other debt,
make dividends, and
dissolve or wind up the business
Terms that are important (i.e., they have to “work” with the borrower’s business) but are not necessarily negotiated heavily (mainly because they are fairly standard or “market”) include the following:
Yield protection and tax provisions
Representations and Warranties (what the status of the business is at closing)
General payment provisions
Waivers (jury trial, etc.)
Applicable law and consent to jurisdiction
The Benefits of Negotiating
The ability to trade for or modify terms
Major upside with relatively little downside (the worst they can say is “no”)
You ensure that the agreement is thought-out and vetted thoroughly
Potential Pitfalls of Over-Negotiating
Both sides may incur additional costs (including time spent)
Possible to begin banking relationship on a sour note
Even if you negotiate successfully, some items may never come into play
Thorough vetting may leave out wiggle room or space for interpretation.
Balancing Business vs. Legal Considerations
The main issue is one of cost and necessity.
Let’s compare it to buying a car.
You can get the base model (the one in the ads), with stock four-cylinder engine, no options and only the most basic safety and convenience features.
You may save money, but risk being really unhappy when you realize air conditioning, anti-lock brakes and a back seat were options you didn’t get.
Or, you can find a mid-level model on the lot with the special features you need (i.e., integrated child seat if you have kids; four wheel drive if you drive off road, etc.). It’s considerably more expensive, but your vehicle better suits your needs.
The final option is to have a car built for you from the ground up. You can dig into the nuts and bolts of every aspect of the vehicle—from engine size to upholstery to pin striping and racing foils. It may be the car you always wanted, but did you really need spinning rims, a 24-speaker sound system and underbody fluorescent lights?
So, back your loan facility.
For some borrowers, a form “fill in the blank” loan document is perfectly acceptable.
This has minimal changes to reflect the correct name and corporate structure of the borrower (and its subsidiaries and affiliates).
You still need a lawyer to review and explain the document, but with minimal time and expense (probably less than $2,000, depending of the attorney’s hourly rate).
But beware, this type of loan may contain onerous and narrow restrictions on how the company can run its business and, most importantly, provides maximum flexibility for the lender to withhold credit or declare a default—and withdraw the line entirely if any conditions change.
The other extreme is a truly customized loan agreement.
Here, you negotiate the scope and content of every provision (whether or not you really expect to have a critical need down the road). The main issue is asking permission from the lender to deviate from the restrictions in the agreement. Detailed negotiation can provide greater exceptions (carve-outs) to general prohibitions in the off-chance you need them in the future. This, however, takes time and creates expense for both you and the lender (remember you will be paying the lender’s legal fees as well as your own) . This risks you address only have a small probability of arising.
So, for most businesses, a better approach is to stick to the “floor model.”
Ask for the things you really anticipate needing (“We need more time to deliver monthly financial statements, and we need more availability in the fall when production ramps up.”) but leave the rest to a “market” approach (i.e., if you don’t foresee needing a lot of additional capital for acquisitions, don’t ask for an pre-agree incremental facility increase and a detailed definition of permitted acquisitions).
Just remember: You do only get what you pay for. Expect some time and expense while your attorney fights with lender’s counsel over what special terms you need and how they work. Getting these details right at the outset avoids time and expense (and lender fees) down the road.
Pros & Cons of Ambiguity in a Loan Agreement
Obviously, some terms in a loan agreement require certainty and precision.
Exactly how much can I borrower?
When exactly is the loan due?
What exactly is the interest rate I will pay?
What is the cost of the loan and what fees will the lender be entitled to?
These are all questions that should be readily answerable. Other terms are more ambiguous—whether by necessity or choice. Even questions about financial calculations are part “art” and part “science.”
A few such examples in loan documentation include:
Timing of Deliveries and Notice – “promptly” versus “within 3 business days”
Compliance – “in all material respects” and “material adverse effect”
Borrower Discretion – “reasonable business judgment” and “ordinary course of business”
Lender Discretion – “sole discretion” and “permitted discretion”
Events of Default – “Material Adverse Change”
Look for those areas in which you may be hamstrung by imprecise terms. If negative covenants only permit an action taken “in the ordinary course of business,” the borrower should be comfortable making that call. If the lender enjoys wide discretion in excluding collateral from the borrowing base or determining if a default has occurred, the borrower should ensure it has a good working relationship with the lender.
At the end of the day, negotiating excruciating detail into the loan agreement will be expensive and the borrower should decide if that is worth the cost.
To a certain degree, accepting a loan from a lender is an act of trust—for both parties. The lender entrusts the borrower to comply with the agreement (the lender’s faces limited options once you finalize the loan, and enforcement is expensive and time-consuming). The borrower entrusts the lender to be reasonable and flexible in managing the loan (there are always many discretionary “hooks” upon which to hang a default or limit credit, should the lender so choose).
«Getting the critical terms agreed too early avoids costly adjustments in documentation and structure down the road and sets core expectations at the outset. It also doesn’t hurt to let your lender know you mean business and expect thoughtful terms. They can’t just throw in the kitchen sink and expect that you will agree. It says ‘I want a market deal here and I’m willing to work for it.’”
Negotiating the Sale of Your Business
You have found the perfect buyer for your business (that is, a willing person, who will take good care of your business, and who has the cash or loan money to make the deal happen). Now it’s time to negotiate terms. To help you sort out the general flow of the process, here are some possible questions that you and the buyer will need to deal with.
Most business sales are complicated transactions, and they require the help of several advisors for both parties. Get a good CPA to look over the financials and the tax implications of the sale, and, most of all, you will need an experienced attorney to make sure the terms of the deal are what you want.
Begin by Gathering Information
The party with the most complete and accurate information has an advantage in a business negotiation. You may think because you’re the seller that you have all the information about your business, but make sure you know everything that the buyer could bring up as an issue. For example, what liabilities and lawsuits could derail the deal?
Don’t Forget Negotiation Strategies
Selling a business is usually a once-in-a-lifetime event. Even if you think you are a shrewd negotiator, take some time to review negotiation strategies, like knowing your «bottom line» ahead of time and having a
Negotiate Selling Price
This sounds like it should be a simple number to arrive at, but the selling price is the most difficult part of the negotiation. As you discuss selling price with a potential buyer, keep in mind that the selling price may be separated into several sections:
The price of business assets. What’s the value of these assets? Is the value based on fair market value or an appraisal? Or are the assets of so little value that they are at liquidation (sell-off at a loss) value level?
A purchase price for buildings and land owned by the business. The land and building should also be appraised, and comparable values.
The more outside valuation information you can get on the assets, the easier it is to make your case for the value of the business.
A purchase of shares of stock owned by the owner and other shareholders
Compensation for a non-compete agreement. In many cases, the buyer will ask the seller for an agreement not to compete against the new business (see below). To be fair, the seller should be compensated for giving up potential income for a period of time.
The «Basket» of Business Price
As you can see, the selling price is not just one number. It’s a «basket» of different possibilities, depending on how the buyer and seller can come to terms.
For example, the buyer might say, «Your equipment is worthless. I’m going to have to bring in all new equipment.» And the seller might respond, «That equipment will do the job for years.»
And on and on, around and around, until both parties have come to an agreement on the basket, including all of the elements of the sale.
But we’re not done yet.
Decide on Contingencies
Contingencies are those conditions which must occur before the sale is complete. Contingencies might include:
- Favorable review (a financial audit) of your business financial records
- Receipt of escrow or earnest money deposit by the buyer
- Qualification of the buyer by a lender
- Acceptable transfer of building or office lease
- Acceptable bank financing for buyer
Consider Covenants (Promises)
Covenants are promises (sometimes called restrictive covenants) made by the parties to each other. The seller may receive special compensation (part of the «basket» described above in return for one or more of these agreements:
- A covenant not to compete with the new owner. not to set up shop near the new owner and steal current customers.
- An agreement not to solicit employees or customers away from the current business.
In addition, the current owner may be required to make a «business as usual» promise, especially during the sales process. The current owner promises to keep running the business «as usual,» not making any new or unusual agreements, taking on new products or serices, maintaining the same business hours and inventory levels, and continuing to provide the same level of customer service.
Review Other Agreements and Promises
Warranties are promises made by the parties to each other. In a business sale, these warranties might include:
- An audit of the financial records of the business that shows the records are true and complete
- Inventory of goods and products is correct
- The seller has full authority to sell assets and is not in default on any contracts
- All leases are in good order, all taxes have been paid, all liabilities are current, and there are no liens against any assets that have not been disclosed.
- All permits, licenses, and certifications are current and valid
Discuss Transition Issues
Other discussions between buyer and seller may include transition issues, such as:
- In-progress inventory or customer work.
- Dealing with ‘hidden’ liabilities that might show up after the sale has closed.
- Contact with customers — how and when that will be handled, and by whom.
- Current employees — will they stay or go?
- Contracts with credit card vendors, other vendors, and how/when to notify these people.
Finally, take a look at these tips for avoiding the 5 biggest mistakes business sellers make.
How to Negotiate Your Own Licensing Agreement
What to Expect and How to React When Companies Want to License Your Product >February 23, 2020
For the past few months, I’ve been describing what is needed to license simple ideas for new products. Designers pride themselves on their execution. But the licensing model requires you to be willing to relinquish some control. There are enormous benefits — and self-employment is freeing.
To briefly summarize, if after you’ve studied a market and done a prior art search; determined your product idea is indeed novel; made a list of potential licensees; filed a provisional patent application; and begun reaching out to said companies over LinkedIn or by calling their corporate office… one day soon, you’ll get a response! Which may surprise you.
Know that smaller, more aggressive companies will get back to you quickly. Predictably, large companies move more slowly. They may need to bring a larger group of people together before replying, which could take between five and 10 days. My best experiences have been with m >
You’ll say to yourself, «Shit, this actually works!» Now you’re in the game. I try to get my students in the game as quickly as possible so they know this is for real, and I advise you to do the same. Polishing your design may be satisfying, but it won’t help you secure a licensing agreement.
Don’t overthink it.
The licensing process is actually pretty straightforward. It’s always made sense to me on a very practical level in that way. If your marketing materials are good, companies will be able to quickly decide if they want to discuss your idea with you further. Yes or no.
The challenge really lies in finding the right partner — the perfect match for your concept. The closer you get, the sooner you’ll hear back.
Remember, companies today are stretched thin as it is. Getting them to do something new is damn near impossible. You need to show them something that is just different enough. Of course, some companies do take chances on products that fall outside their typical purview. But those who do are most often small companies, which by definition have access to fewer resources.
Soon enough, you’ll land one. (If not, you may be approaching the wrong companies.) And just like that — the time to dance has begun.
Keep in mind… this is a slow dance. Finalizing a deal will take longer than you expect. No matter. Your attitude is everything. Be explicit, and continue to tell the company that if they’re interested, you can get a deal done. Make it very clear that you’re happy to be working with them — that you’re optimistic, excited, appreciative, and looking toward the future. Setting the right tone is extremely important; I cannot stress this enough. Look at every interaction you have as an opportunity to keep setting the right tone. When things move more slowly than you want, don’t let your emotions get the best of you.
You don’t want to step on anyone’s toes and you don’t want to unnecessarily throw up any red flags. Be patient.
Early on, most of your conversations will be through email. That creates a paper trail, which is great.
But after a few exchanges, get on the phone. You need more information, and having a phone conversation will provide some in more ways than one. Everything from what is said to how much time on the phone your contact spends with you will shed light on their level of interest. I previously wrote about the value of sending each company on your list a unique link to your video. This allows you to track when and how often they click that link. Have they been watching? If they’re playing it cool, but they’ve watched your video 12 times… draw your own conclusions. The party with the most information usually wins.
After you get some initial interest, continue reaching out to other potential licensees. Don’t assume it’s a done deal! Deals falls out all the time.
Keep the momentum you’ve got going. Time is money! Having multiple companies interested in your product is never a problem. (Not because I think you can leverage one against the others, per se. That’s unrealistic, although it does happen.) The bigger picture is, continuing to reach out to other potential licensees is a form of protection. If you’ve filed a provisional patent application, your patent pending status is a ticking 12-month time bomb. So make haste!
Because if you disclose your idea publicly and don’t move quickly enough, you may end up having to make an expensive decision when those 12 months are up — meaning file a non-provisional application. Filing a non-provisional patent application on your own, with no interest? That’s more risk than I want to take on. I prefer to get my licensees to pay for a patent to be written in my name, of course, and so do other licensing experts like Gene Luoma, best known for inventing the drain-clearing tool Zip-It. «The hardest part is keeping it simple,» Luoma likes to say. I agree.
Look at it like this. The minute a marketing manager (or whoever else it is you reached out to) gets back in touch with you, the negotiation process has begun.
Expect to receive a response along the following lines. «Thank you for submitting your idea to us. Do you have time for a few questions?»
This is the ideal opportunity to gather as much information as you can about the company. You’re both checking each other out! So prepare to ask questions. Is this company the right fit for you?
You’ll be asked what you’re looking for. My answer: «I am not looking to manufacture; I’m looking to license my product. I’m looking for a royalty on each unit sold.»
At that point the first thing out of their mouth will be, «What royalty rate are you looking for?»
To which I respond, «If I understood your business a little bit more, I could come up with an appropriate royalty rate that works for both of us.»
Pulling a number out of thin air without knowing the potential revenue opportunity? That’s not smart. At this point, the tables will have turned a bit. Now, they’re selling you.
Ask them how many stores they have product in. Some people will readily share this information with you, but it’s more likely they’ll be vague. That’s okay. You can find out more on your own. If they tell you they’re in Walmart or Kmart, you can always Google how many retail outlets there are.
Assume each retail store sells one unit a week. (If not… your product is going to be kicked to the curb.) Now apply different royalty rates. How much will you make at a five percent royalty? Seven? Three?
Almost always, they will ask you for an exclusive. When you give someone an exclusive, you lose the ability to sell your technology to anyone else, meaning your royalty stream is finite. If your projected revenue is too low, you should walk away. If you’ve been granted a patent or have proven sales, you can negotiate a higher royalty rate, like between seven and 10 percent.
To be clear though, royalty rates are less important than how many stores they’re in and the minimum guarantees they’re willing to commit to. Remember, at this point, you’re still dating! You don’t want to ask any hard questions, which include minimum guarantees, yet.
Don’t be caught off guard when they ask you about your intellectual property fairly quickly as well. If you’ve filed a provisional patent application, then your answer is easy; tell them your concept is patent-pending. At that point they may want to see your provisional patent application, which is not a problem. But you might want to ask them to sign a non-disclosure agreement, given that you’ll be sharing confidential information with them.
Most likely, they will not sign yours, and will instead offer one of their own. There is nothing wrong with this, but make sure to examine their document very closely. Confidentiality agreements are written so that they protect both parties — what is known as a mutual non-disclosure agreement — or just one. If something doesn’t sound right, consult a patent attorney or a licensing attorney. Yes, this will slow down the momentum you’ve got going. But it also makes you look more professional. To be honest, I’ve never relied on confidentiality agreements to protect me. But from a public disclosure standpoint, they’re absolutely helpful. They can help you extend the length of your provisional patent application, for example. But please note laws regarding non-disclosure agreements differ between states. IPWatchDog.com has some good sample confidentiality agreements.
Once you’ve come to an agreement, send them your provisional patent application and any other information that might help them figure out whether your product is right for them.
Continue following up with your contact.
inventRight coach David Fedewa, who has licensed several of his ideas, puts it like this: «You want to stay on top of their pile — on their radar, in other words.» So Fedewa follows up with companies that are interested in his ideas every week and does so alternating between emails and calls. He focuses on how he can be helpful by literally asking questions like: How can I help? Do you need any more information?
«If you keep demanding, ‘Do you have a decision? Do you have a decision?’ then you’re likely to be thought of a pest. But if you offer a helping hand, they’re more likely to think of you as a resource. ‘Why not work with him?'» Fedewa explained.
If the company isn’t getting back to you despite your best efforts, you can always ask them pointblank as a last resort: Are you interested? In my experience, that’s usually enough to get people off a rock.
If they are interested, that’s when you should ask if you can put together a few terms that you all agree upon before moving forward. Technically, what I’m referring to is a term sheet, but you don’t have to call it that.
Next up, I’ll tackle what that term sheet should include, as well as negotiation dos, don’ts, and deal-killers.
Congrats — You’ve got interest!
Stephen Key is a lifelong product artist who has licensed dozens of his ideas. His bestselling book «One Simple Idea: Turn Your Dreams Into a Licensing Goldmine» has been translated into five other languages. He speaks, writes, and vlogs extensively about licensing, entrepreneurship, and intellectual property strategy.