IP Licensing: An Alternative to Investor Funding?

The start-up ecosystem in India is a recent phenomenon in comparison to the start-up ecosystems of developed western economies. However, akin to the telecom and the internet sectors the start-up ecosystem in India is also maturing quickly. To provide start-ups with the necessary impetus and support the Government of India (GoI) has introduced various initiatives; primary among them being the Start-up India initiative. As part of its ambitious vision to develop an innovation driven start-up ecosystem, the GoI endeavours to set up multiple incubation centres and technology hubs, provide grants for research, funding for research labs in educational institutes etc.

The green shoots of this approach have begun to appear with a number of interesting innovations being reported from across India. A few examples of these are, ‘low cost wind turbines’, ‘solar power tree’, ‘biodegradable plastics’ etc. While the general start-up ecosystem in India consists of internet companies based on aggregator models or business service providers, there are a clutch of technology / product innovators, developing interesting patents. These innovations probably go unnoticed by the mainstream media, because neither do they attract multi-million dollar valuations, nor are they able to raise large amounts of institutional investor capital. While these innovators do require investor capital to develop their inventions and commercialise the application, the chances of them raising institutional investor capital are remote. A probable cause for this could be the absence of longer term investors better suited for investing in patented product innovations (IP Innovations). The existing investor fraternity largely comprises of investors with an exit horizon of 5-7 years, with only a few institutional funds having longer gestation periods. These investors are not structured to provide capital to IP Innovations given their constitution and investment strategies. Hence, for Indian product innovators to try and commercialise their application by raising funds through conventional methods may not be the best option. Another challenge that innovators will increasingly face is to develop the expertise to transform the business from invention / prototype to commercialisation. It is at this juncture that growth capital is needed, but due to lack of investor interest, innovators may find themselves in a difficult position. But, the lack of institutional equity investors need not be a death knell for such innovators. Institutional investor funding is not the only avenue to be explored!

India is home to many large business houses which have thrived for decades, by manufacturing products using technology licensed from western markets. A more feasible option for an Indian innovator with an IP Innovation would be to license their invention into a collaboration venture (SPV) with an established corporate. The founder and corporate could be shareholders of the SPV, based on an agreed shareholding proportion. This mutually beneficial arrangement would allow each party in the bargain to blend their respective skill sets and leverage off each other. The corporate would have gained access to a potentially game changing invention without incurring extensive expenditure on R&D. The innovator would gain access to the marketing and production capabilities of the corporate without expending significant resources or partaking complete ownership of the IP Innovation. By this arrangement, innovators can channelize their energies on product enhancement until it reaches a stage for market launch. Thereafter, the product launch and marketing can be driven by the experience of the corporate’s team, subject to the founder’s rights to provide inputs.

The licensing arrangement is not regulated by specific legislation and the parties have complete freedom to determine the arrangement that best suits their needs. Given that it is a negotiated agreement, founders should take special care in negotiating and drafting the licensing agreement. Corporates would generally have had the benefit of past licensing arrangements and would be well versed in negotiating such Intellectual Property (IP) licensing agreements. Founders should pay special attention to the following while entering into an IP licensing agreement:

Confidentiality

Confidentiality assumes a great deal of significance in IP licensing arrangements. Most potential partners would be keen to understand in detail about the IP and the invention prior to concluding a formal arrangement. It can be a challenging situation for a founder to share confidential information without having a concrete commitment in place. In situations such as these, the unequal bargaining position of the parties needs to be kept in mind. Founders would seldom have deep financial resources to commit into a legal battle with an established corporate, were the latter to infringe upon the innovator’s IP once all information was shared. At the same time, it would be unfair for a corporate to be asked to commit resources to a potential invention without satisfying themselves of the commercial merits of the invention. A founder should, along with their advisors, assess the level of information that can be shared, without compromising the IP. Depending on the commercials and the potential value of the invention, other monetary safeguards can also be considered. But, whichever course a founder wishes to pursue, at no point should any details of the IP be shared without a proper non-disclosure agreement between the founder and the corporate.

Ownership & Grant of IP

The IP in question should be conclusively registered in the name of the inventor or a company owned and controlled by the inventor. The license offered to the SPV should be limited to the product that the corporate is interested in developing and should not extend to other applications of the IP. An IP Innovation could have other potential spin off applications and the ability to capitalise on the spin offs should be retained with the innovator. Unless the upfront compensation offered by the corporate is commensurate for an expansive grant of the IP, the innovator should retain the right to monetise future spin-off applications.

Initial Consideration

The initial license should be accompanied by a lump sum payment by the SPV to compensate the inventor for developing the idea and expending resources to develop it. Depending on the financial wherewithal of the innovator, the lump sum should also factor an estimate of funds required to enforce IP rights lest the venture with the corporate does not progress as envisaged. Once the SPV commences work, the innovation team would have shared all details of the invention, with the team members of the corporate. Subsequently the only way to enforce the IP rights in case of an infringement would be by court proceedings. Approaching a judicial forum in India and seeking redress against an established corporate can be an expensive proposition. Innovators should plan and build a contingency fund to tackle any such potential expenses. The initial upfront consideration should take into account such a contingency fund.

Term of License

The license to the SPV should be for a limited period and a renewal of the license should be subject to the SPV achieving certain defined milestones, such as market penetration, sales volumes, revenue etc. This would allow the innovator to discontinue the arrangement with the concerned corporate and explore other avenues, if the corporate is unable to deliver on its commitment. Once the defined milestones are achieved, the license could crystallise into a permanent / longer term license in favour of the SPV. Innovators must bear in mind that the protection derived by a registered patent is for a limited period and the innovator should seek to maximise the commercial returns during this period. Granting a long term license to a corporate with no levers of protection in favour of the innovator would be detrimental to the commercial interest of the innovator.

Exclusivity

Generally, a corporate would be unwilling to accept a non-exclusive license from a start-up. Any form of exclusivity should be linked to the above milestones and should be linked to the term provided for achieving the milestones. If the milestones are not achieved the license should either be discontinued or become non-exclusive.

Royalty

The terms of the royalty can be based on any method the parties chose. Depending on the commercial application of the product, the royalty could be a function of gross sales, net sales, net profit or a variable portion based on the ability of the corporate to monetize the IP. In case of a new innovation which has never been tested in the market, a corporate may negotiate the royalty as a function of net sales. Chances are royalty payments could also be deferred in such cases, for the corporate to recover upfront expenses incurred in launching the product to market. Further, since the innovator / founder would also be a shareholder in the SPV, the corporate may insist upon the founder to participate in the equity appreciation, by foregoing immediate royalty benefits. Balancing the royalty, initial consideration and prospect of equity appreciation is a fine negotiation based on the commercials surrounding the invention and its perceived value.

A useful strategy that a start-up founder could adopt would be to initiate discussions with more than one corporate operating in the relevant industry. The knowledge that a competitor could gain an edge over it may nudge a corporate towards a more reasonable negotiating position with the founder.

Each one of the above heads would assume significance based on the commercial viability of the IP, disruptive nature of the technology / invention, bargaining position of the parties, competing offers for the IP etc. Like with most commercial agreements, there is no decisive formula that affords the best protection to parties. Each transaction will need to be customized based on its commercial setting. Corporates should assess product innovations by Indian start-ups in light of the value the IP could add to their business. A start-up’s financial position would usually be stretched by the time it has made any material progress with its invention. In that context, it would be prudent for corporates to be mindful of an innovator’s financial concerns and accordingly compensate them for their labour and efforts expended in developing their idea into an IP. Lastly, it is also important for founders to have a realistic expectation of the commercial value of the IP developed by them. Having the IP valued by a professional valuer to determine its market value would go a long way in framing a realistic expectation for the founder.

Ajay Joseph

Partner, Veyrah Law

Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.