Should I give a time window in which a third party can exclusively license my patent?

QUESTION:

I would like to commercialize an invention of mine in the field of photovoltaics through a corporate partner. The challenge with my idea and field are that A) the invention does not have any obvious applicability to other industries; and B) the solar industry is so competitive nowadays that I suspect a corporate partner will demand a high level of exclusivity in order to make a deal. Under these circumstances, do you have any advice about the best way to set up a partnership that maximizes the potential upside to my startup, yet keeps intact a sufficient degree of downside protection (i.e. ensures that all is not lost if the partnership does not go well)?

One idea I thought of along these lines is to give the partner a time window in which they can exclusively license the patent. If the time limit is reached and the partner has not paid a contractually-defined amount of royalties on the patent, the partner would lose its exclusivity. Have you seen a deal structure like this succeed in practice?

ANSWER:

by Ethan Stone, Stone Business Law

First, a quick but important clarification: I’m not your lawyer and this answer doesn’t establish a lawyer-client relationship. I’m giving a generic answer to a generic question to educate the users of this site. The information below is general in nature and should not be understood as a substitute for personal legal advice.

I’ll start by emphasizing that, although I’m happy to give you a few strategic thoughts, if you’re serious about this, you’re going to need to hire a lawyer. Licensing is not as easy as it looks. In my experience, people who think they can save money by doing it themselves end up spending much more to clean up the mess they’ve created (if it can be cleaned up at all). Especially in a situation (like yours) where you are in serious danger of getting trapped into an exclusive deal that doesn’t work for you, the details are very important.

That said, here are some thoughts:

Do You Want to Develop a Business or Monetize a Technology?

First, you need to ask yourself if you’re trying to start a business or monetize an invention. They’re different endeavors. If you have one relatively narrow invention, especially one that is valuable mainly as part of a capital intensive manufacturing process, it’s often wiser to focus on monetizing the invention, rather than starting from scratch as a manufacturer. There are two reasons for that.

First, you don’t have any great ideas about most of the manufacturing process. You might not even have many good ones. Contract manufacturing and outsourcing can fill in some of the deficit. But if you mix something you’re really good at with a lot of things you aren’t, you risk serious dilution (if not destruction) of value. Second, a huge amount of effort and risk is involved in gathering and deploying the capital needed for a significant business (e.g. to build a large and sophisticated factory or a global sales and distribution system). Again, you might do much better leaving those tasks to someone who’s already done them or is good at them (or, at least, thinks they are).

Options for Building a Business

That said, if you want to build a business and your plan is to give an OEM exclusive rights to your core technology in its core application, there’s really only one way that can work: Your business plan has to depend on developing other technologies, using the team, facilities and money generated by the development of that core technology. In that case, the key is to negotiate an agreement with the partner that defines narrowly what is licensed exclusively (or at all) to the partner. That’s really not easy. It requires careful drafting, tough negotiations and a lot of care during development to make sure you clearly delineate between licensed and unlicensed technology.

If you’re trying to build a business on the basis of the invention you’ve got now, an exclusive license to one industry player won’t do it. But there are other ways to get strategic investment. An industry player might be willing to invest cash for equity on a VC-basis (more or less). You can also come up with some mixture of equity (often in the form of warrants to buy your stock), combined with a supply agreement or non-exclusive license. That way, the partner is assured access to the technology it helped develop and it will also be able to profit if its competitors start using it.

Many large companies are willing to proceed on a pure equity basis. Many, in fact, have in-house “venture” funds for this purpose. You need to be very cautious about them, however, because strategic investors have interests and motives that purely financial investors don’t. This is important because equity investments of this kind will generally give the investor a set of approval and governance rights (e.g. to nix a proposed sale of the company or a proposed round of new VC money). In the worst case scenario, a strategic investor might use these rights in ways that work to its interest as an operating company (i.e. to exploit your technology and keep it from competitors) even if they hurt its interest as an investor (decrease the value of its stock). Roger Ehrenberg recently wrote a very good post, advising against such deals. Read it carefully before going in this direction: http://informationarbitrage.com/post/2165834986/is-it-wise-to-take-strategic-investment-as-a-start-up.

Even if you’re pretty sure you’d prefer monetization, it can be useful to keep up the pretenses that you might want to pursue a go-alone model during negotiations over monetization. The partner may think that it’s much better situated, objectively, to commercialize your technology than you are. If it isn’t sure you believe that, however, it’s likely to extract a lower “charge” for taking on commercialization.

Options for Monetizing a Technology

That brings us to the monetization approach. In that case, it’s really a question of how much you’re going to get paid and what risks you have to take along the way.

The easiest option, of course, is to sell the invention for cash now. That involves no risk, but the payment will be discounted for the difficulty and risks of commercializing the invention. That’s not only an economic issue, it’s also an emotional one. It’s worth considering whether you’ll be forever bitter if your partner makes billions on your technology and you only got a few million. Personally, I could live with the millions and not suffer lots of regret. It would eat some people alive. Make sure you know who you are. Assuming that you’re inclined to take some risks to get more of the “back end,” the cash out option is always there and you should have a rough idea of how much money you could get in an outright sale in order to maintain perspective as you consider other options.

Assuming you aren’t going to sell now, there are several ways you can get paid. You’ll probably want to use some combination.

First, you can get an upfront license fee or a set of fixed payments over time that don’t depend on milestones, sales levels etc. That assures you something for your efforts and gives the partner a sense of investment from the beginning. If the deal is that you will be footing the bill for some or all of the technology development, of course, you should try hard to get at least enough money to cover your expected costs pledged without contingencies.

Second, you can get paid on achieving technical milestones. Whether that makes sense depends on whether you and the partner can agree right now on a few unambiguous measures of progress. You don’t want to get into a fight about whether or not you achieved a milestone. If you can’t come up with something that can be verified objectively with little or no room for argument, you should think long and hard before agreeing to milestone payments. Also, even if the milestones are clear, you need to consider whether you will be relying on your partner to achieve them (for example, providing money or technical assistance). Remember, you want money, not a lawsuit. The ideal situation for milestones is where the markers of progress are clear and they don’t depend at all on your partner’s cooperation. Aside from the difficulty of finding good milestones, this kind of arrangement suffers some of the problems of an outright sale: Since the payment doesn’t depend on actual sales (let alone profits), it’s likely to be discounted for the possibility of commercial failure. That means you don’t take the risk of failure, but you also won’t get paid for astounding success.

Third, you can get paid based on some measure of sales or profits. As a rule, you should avoid any measure that involves profits. As the old saying goes, profits are an opinion, cash is a fact. Almost any measure of profits can be gamed to drastically reduce or eliminate profit, no matter how good the true economic situation. Even if the measurement for royalties is cash revenues, you need to think about all the ways the partner might be able to exploit your invention profitably without showing direct cash flow from it. Those vary a lot by industry and product, but your measure should depend on something that isn’t easy to manipulate.

You’ve rightly pointed out the risk that a partner whose royalty obligations depend mainly on volume might just sit on your invention, either because it’s lost interest, because it’s waiting for your license term to run, or because it’s waiting for you to get desperate enough to renegotiate. Your idea is certainly viable and is often done. You can also provide for the license to lapse altogether (not just exclusivity). Another variation is to require minimum payments (regardless of volume) or to give the partner the option to “reup” exclusivity (or the license as a whole) periodically by making a lump payment.

There are endless variations and combinations on the basic approaches discussed above. Which one makes sense for you and your partner depends on your preferences and the particular circumstances. It is important, however, to keep an open mind during negotiations. If you identify the specific concern that’s holding things up, it’s often possible to address it with a relatively minor tweaking of terms (sometimes one that makes a difference to your partner but not to you). If you think in terms of discrete types of arrangements, you can miss these opportunities.

I hope that helps. Good luck!