The best way to get a big picture understanding of how licensing works is to use the analogy of real estate.
Let’s say you have a property company which owns a condo building, and is renting the units out to tenants. A real estate agent has been hired by the condo owner to find tenants. When the agent finds a tenant, that tenant will sign a contract for one or two years, agreeing to a certain financial arrangement between the tenant and the landlord, as well as how the condo unit can, and cannot, be used. The agent who brokered the deal is paid a commission by the landlord (typically), which is generally a percentage of the financial arrangement that has been agreed to by the tenant and landlord.
Now imagine that we are talking about ‘intellectual’ property rather than physical property – such as a trademark – for instance, a protected/owned character. In this case, you still have an owner, an agent brokering the deal (unless the owner is selling directly itself) and a tenant or a “user” of the intellectual property.
Much like a rental agreement for physical property (like a condo), in an intellectual property licensing agreement, the owner gives permission to a user (3rd party company) to use the intellectual property for a period of time on its products and to sell said products and pay the owner of the intellectual property a royalty on those sales. Much as above, the owner will also compensate the agent who brokered the deal with a commission as a percentage of total reported sales by the user or licensee.
An intellectual property licensing agreement will also typically be defined by a number of other materials terms, including what territory the products can be sold in, specifically what products that licensee is permitted to produce under the agreement (usually divided by product category, such as apparel, or houseware, or toys and games, etc.), and additionally, the licensee will generally be required to ‘guarantee’ a minimum amount of sales against the agreement in the form of a minimum guarantee.
To put it another way, imagine a licensee – say a producer of ceramic mugs – coming to a licensor – let’s say the Superman shield – and saying, “If you let me produce mugs bearing the Superman shield and sell them in Indonesia, I will sell 1,000,000 units, which at a royalty of X% will generate revenues of “Y” for the Licensor. Then the licensor says, “Great, I will give you a license to do so, provided you guarantee a minimum sale of 800,000 units, which at X% royalty and Z unit price, will equal “A” which you will be required to commit as a Minimum Guarantee (MG), which your reported royalties will earn out against.
“If you sell less than 800,000 units over the term, you will still need to pay us this MG. If your sales exceed the 800,000 units, you will pay overages, or additional royalties, for those sales in excess of the MG”
In Part 2 of Licensing 101 we’ll go into more of the terms and conditions that typically define a Consumer Products Licensing Agreement.