Licensing intellectual property (IP) can be a game-changer for a company’s commercialization, whether creating research and development opportunities, opening new markets or gaining access to complementary technologies. When negotiating a licensing deal, the difference between success and failure may be failing to consider the different ways in which revenue flows between the owner of the IP (the licensor) and the licensee.

Upfront Payments

An upfront fee is a one-time fixed payment made by the licensee to the owner of the IP when the license starts. An upfront fee is often recommended—even if the IP owner does not need an immediate capital injection—as the payment marks a tangible first step in the collaboration. However, the more the IP owner demands as a no-risk upfront fee, the more reasonable it could be for a licensee to demand a lower royalty percentage.

Milestone Payments

Milestone payments are fixed payments made by the licensee to the IP owner each time the licensee is able to successfully use the IP to get closer to a product that can be commercialized. These types of payments are commonplace in the life sciences industry where the outcome of clinical trials will determine if a therapeutic will be approved by, for example, the U.S. Food and Drug Administration. If the licensee does not make it through the predetermined milestones then the licensee does not have to pay the milestone payments. Milestone payments can be a good way of de-risking a licensee’s investment to license the IP while still providing some early revenue to the IP owner.

Royalty Payments

Royalty payments are the most well-known way that revenue flows through a licensing arrangement. Commonly, a licensee will pay the IP owner a percentage of either gross revenue or net profit gained from the sale of a product based on the IP. Clients, and their counsel, should work to create win-win royalty structures that go beyond simple formula and help align the parties. An IP owner may consider demanding a fixed minimum annual royalty payable regardless of product sales, incentivizing the licensee to make efforts to market the product. On the other hand, licensees can demand a cap or downward adjustment of royalties when sales meet certain thresholds allowing the licensee to hold onto more of the revenue when product sales exceed expectations.

Cross Licensing or Other Non-Cash Consideration

An IP owner may ask a licensee for consideration other than, or in addition to, cash in return for a license. This could include lab space, access to certain development resources or a license to the licensee’s own IP (a cross license). These do, however, add a layer of complexity and may force the two parties to actively collaborate on a long-term basis. As such, it is highly advisable for everyone around the table to consider whether the parties (and their respective teams) will be a good strategic fit for the whole life of the license.