Licensing happens when a company permits another to manufacture its product for a guaranteed amount. In such a relationship, the two companies must create and agree in terms of licensing beneficial to both parties. A licensing agreement presents itself as a document for a clear understanding of what each party intends to do. Learn more about licensing agreement, along with its definition and other relating information from the article below.

What Is a Licensing Agreement?

A licensing agreement refers to a legal and written contract between two companies that states the property owner permits another company to utilize their brand, patent, trademarks, copyrights, and other intellectual properties in exchange for a fee or a percent of revenue. The agreement set between the two parties, namely the property owner (licensor) and the permitted party (licensee), holds details regarding its type, terms of use, and compensation. Licensing agreements also help alleviate any form of disputes relating to sales, quality control, and royalties. It also allows the licensor to control their property, expand, and enter markets without releasing some money. It is also safe to point out that making these deals may cause problems if not done correctly. Establishing relationships with the wrong company may tarnish the property owner’s reputation.

According to an article published in dated August 2020, the Walt Disney Company ranks at number one, reporting 54.7 billion US dollars in annual retail sales of their licensed consumer products for 2019.

Components of a Licensing Agreement

Upon a business owner’s decision to enter into a licensing agreement, be prepared to negotiate and discuss various terms and conditions relating to the use of the intellectual property. It also depends on the use of the license, whether it is for merchandising, manufacturing, and other terms. In such cases, the composition of a well-written licensing agreement is as follows:

Scope of the agreement: It is necessary to put the desired extent and subject matter of the intended use of the license. Restrictions about the territory use, exclusivity, permitted channels of trade, sublicensing agreement, expansion of the brand line, and guarantee of sales must reflect and set in this section. Term and renewal: The start date, duration, conditions, and processes of renewals and extensions are present in this section. It also holds information on the grounds of termination, including the licensee’s obligations after the termination of the agreement. Performance standards and quotas: Considering that the royalty income depends on calculating the licensee’s net income and revenue, the licensor has the right to maintain and demand minimum levels of performance regarding sales, advertising, marketing events, and human resources relating to the exploitation of technology. In cases where there is refusal on the licensee’s end about performance standards and quotas, the property owner must compromise the situation by asking for a minimum level of royalties, regardless of the licensee’s performance. Payments to Licensor: Every licensing agreement requires an initial fee and ongoing royalty charges to the licensor. Royalties vary depending on the gross sales, net sales, net profit, fixed sum per sold product, or an agreed-upon minimum payment by the licensee and licensor over a given period. The property owner can also grant an incentive as a reward for the permitted party’s performance. Quality control, assurance, and protection: The licensor has the right to set quality control standards and specifications for production and manufacturing, including marketing, distribution, and other services covered by the license. Procedures allowing the property owner to enforce these standards and specifications must also show in the agreement. It includes the inspection of the licensee’s premises, review, approve, and reject samples, packaging, labeling, or advertising brochures connected to the marketing of products and services within the scope of the license.Insurance and indemnification: The licensor must take all necessary, precautionary measures to ensure the licensee has no obligation to protect and indemnify the licensor in cases of claims or liabilities that result from the licensee’s exploitation of products or services permitted under the license agreement.Accounting, reports, and audits: Imposing specific reporting and record-keeping conditions and procedures on the licensee is the licensor’s right to ensure an accurate accounting when it comes to periodic royalty payments. The licensor must also reserve his right to review the audits made by the licensee in the event of disputes and disagreements. It must also set a provision on which party shoulders the cost of audit in the event of an understatement. Preserving and protecting intellectual property: It is advantageous to clearly and thoroughly define the obligations of the licensee, its agents, employees to conserve, protect, and respect the confidentiality of the intellectual property of the licensor. The agreement must also describe any notices and legends included on distributed materials or products connecting with the license agreement.Training, support, and assistance: The section describes the obligation of the licensor to assist the licensee relating to the development and distribution of the property licensed. The support given by the property owner can be in the form of personal services, documents, or company records. Related fees to these assistances, over and above the initial license and ongoing royalty fee, must be specific and written for a clear understanding.Warranties: A prospect licensee can demand the licensor to provide specific representations or guarantees included in the agreement. These may relate to various things of intellectual property, including the absence of any infringements of patents or restrictions relating to the owner’s ability to license the property or guarantee that present technology has the features, capability, and characteristics as stated on the license agreement.Infringements: The license agreement must contain specific procedures for notifying the licensor of any suspect or known direct or indirect infractions relating to the scope of the license. The responsibility of shouldering the cost of protecting and defending the property must also be defined and made known in this section.Exclusivity: The term exclusivity applies to a territory, an application of technology, or a method of production of goods coming from the technology. It may or may not pertain to the licensor, granting sublicenses or cross-licenses to third parties not covered by the agreement. Exclusivity in itself is conditional, for a limited period, on the continued employment of the technical staff of the licensee.

Helpful Tips in Creating a Licensing Agreement

Creating a license agreement requires a thorough process and requires an understanding between two parties. The licensor and licensee must come into accord with the terms and conditions of each other to lessen and prevent misunderstanding and disputes. Here are tips to consider in creating and engaging in a licensing agreement:

Tip 1: Establish Ownership and Be Ready For Potential Disputes

In terms of intellectual property, make sure the ownership of the product or services is clear. Ensure that no other company is using your asset and that it is properly registered. It is better to do meticulous research before engaging in a licensing agreement. It also helps to prepare for potential disputes in terms of ownership. For example, another company or individual claims copyright over a property you have the right to license. It is essential to know the course of action if and when the situation arises, especially if it involves plagiarized work under the license.

Tip 2: Emphasize Monitoring Processes and Quality Assurance

Before mass producing any product, it is necessary to have an initial test sample of the product that must be approved. Observance of periodic quality checks is a must during the license term to ensure it is up to the property owner’s standards. There must also be an emphasis on product sales monitoring. It is also essential to determine which of the parties decides on the product price and if discounts and sales are available.

Tip 3: Be Mindful Of Definitions and Government Regulations

If you are ever left unsure of any part of the contract, it is beneficial to ask. Ensure that you understood each statement in the agreement to know what you are consenting to. It is also essential that the process and product descriptions are complete and coherent to avoid any misunderstandings.

Tip 4: Learn About the Other Party Through Due Diligence

Before getting into any licensing agreement, it is essential to learn about the other party. Know their views and opinions before engaging in an arrangement. It is also safe to check the company’s operations. It is where due diligence comes into play. Due diligence is the process and effort of a company to gather and analyze information before conducting or engaging in a transaction. It involves checking business credits and business resumes, asking for financial statements, and visiting the company office and manufacturing facilities. It is better to be safe than sorry.

Tip 5: Discuss Royalties and Learn About Taxes

In terms of royalties, the licensor must ensure a thorough discussion with the licensee, being that payment is the center of all licensing agreements. Discuss how the licensee pays off the royalties when different situations arise. It is also advantageous to pay attention and learn about taxes relating to the royalties. When the licensee pays for the royalties, it is a business expense on taxes. Royalties are also considered a form of income to licensors and must reflect on the IRS Form 1099-MISC. It is also advantageous to consult a tax attorney or lawyer to learn about tax royalties.

Tip 6: Prepare for All Possible Outcomes

While working with an authorized attorney on the licensing agreement, it’s beneficial to create a simple list of possible situations or circumstances you may face in the future. For example, what if one of the parties goes bankrupt? What if either or both parties cannot fulfill their obligations? What happens if there is a case of a breach of contract? It may seem absurd, but asking yourself these questions help with preventing these problems and finding solutions in the long run.


What is the purpose of a licensing agreement?

A licensing agreement ensures the licensee of legal permission to use or market another entity’s property. The creation of licensing agreements protects intellectual property, including patents, trademarks, and copyrighted materials (music, films, videos, art). Remember that the licensing agreement only gives the licensee the right to use the property within the parameters set by the licensor. It is essential to stress that the license agreement does not let the permitted party gain ownership of the licensor’s property.

What are the types of licensing agreements?

Licensing agreements based on intellectual property are as follows:

  • Trade Secret Licenses – Trade secrets are unique, and they are not known to the government. These are under the protection only of secrecy. Trade secret licensing agreements usually come with a non-disclosure agreement (NDA) stating that the party receiving confidential information cannot share any vital details.
  • Trademark Licenses – Trademark licenses are for commercial purposes, like brand names, logos, or slogans. The licensing agreement allows the licensee to use their intellectual property for trademarks and are commonly on commercial or consumer goods.
  • Patent Licenses – Patents cover science and innovation, and owners choose to license their patents for the licensee to manufacture and distribute in a larger market. These are the most complex as it involves every process from obtaining to maintaining the patent.
  • Copyright Licenses – Copyright involves art, including music, films, videos, and artworks. The most prominent copyrights focus on popular pop-culture characters. These agreements are usually found on commercial products and used for distributorship for movies or musicals.

What are royalties?

Royalties are the payments stemming out from licensing for the right to use someone else’s property. When an organization keeps the ownership of a property and gets royalties from the permitted party to use the licensor’s property, it is a form of licensing material. Royalties also increase the business’ income and protect the buyer from claims of improper usage of the property. Licensing a business’s intellectual property and getting royalties from the license is one way of developing the organization’s income. Royalties also appear in various industries and serve a similar purpose in all of these. The only way for a company to gain royalties is if they permit a business to use your property in exchange for income.

As a licensor, engaging in a licensing agreement is a big step for the brand and the business itself, and it is something that big companies do to promote themselves. As a licensee, it is an opportunity to increase your company’s profits while marketing into a big market. A licensing agreement is an arrangement to benefit both parties. At the same time, it protects the licensor and licensee when it comes to misunderstandings. The best way to ensure that the terms and conditions of both sides are fair, consult an impartial third party with sufficient knowledge about similar agreements. In the words of Francis Bacon, “A wise man will make more opportunities than he finds.” It means that it is in your hands to make things happen. Start to make your business known and engage in a term of license through a licensing agreement sample found above.