Taking the position of “I’m not interested in selling” because you think your IP will be worth much more than it is today can be a big mistake. Markets change quickly, especially if your IP is in a very trendy or competitive market. Success in the marketplace quickly fades as new competitive products or technologies enter the market.
There are several formulas for negotiating the terms of a buyout option that help maximize both your royalty revenues and selling price.
One model is to project out the royalties over the life of the IP. The buyout price is then calculated as a percentage of that total (known as the discount rate), generally anywhere from 20% to 50%. I had a client who invented a new accessory item for the professional hair care salon market and was approached about licensing the IP. As part of the deal, the company wanted to buy out the IP at some point in the licensing agreement. Plus they were also willing to pay a royalty after the acquisition for five years.
The buyout terms were based on the company reaching certain minimum royalty payment milestones over the first five years of the agreement. If they met or exceeded those, they had the option right to buy the IP at price calculated using an average royalties paid formula. In this case, it was the average annual royalties paid during the first 5 years of the licensing agreement. This amount would be multiplied by the remaining contract years, then discounted by 50% to calculate the buyout or selling price for the IP.
Keep in mind, royalties will fluctuate from year to year. In many cases, the royalties and IP value will decline in later years as sales peak and new technologies enter the market. That’s why it’s discounted by a certain percentage.
A second formula uses a valuation of the IP at certain points in time, such as when the option is exercised. One example is an IP with heavy (and expensive) R&D, such as biotech or drugs. To fund the IP development, an IP development company (otherwise known as an SPV – Special Purpose Vehicle) is formed to raise capital from investors. The IP is transferred to the SPV with an option to buy it back after a certain period, and pay investors a royalty on the IP when it’s commercialized in the market.
A valuation is done at different stages to decide the option and IP buyback price. One at the investment stage to decide the base value, and a second valuation to decide the buyback price once the IP is market ready.
A third variation on the buyout option is an IP sales and leaseback agreement. This type of agreement is used to raise capital. The IP owner sells their IP, and gets an exclusive license agreement (so they can continue to use it) with an option to buy back their IP for a fixed price before the license ends.
If you’re an inventor with several technologies, why not cash out on a few of them and put the money in the bank. One of the biggest advantages of negotiating a set buyout is that you know that you’ll receive a lump sum payment for your IP at some point down the road. Plus you may even get paid royalties after the buyout.
Holding an IP for longer than its economic lifespan (how long it generates royalties) can actually work against you. If the market changes and revenues start declining, it will impact the value of your IP. You never know what will happen in the marketplace five or ten years down the road, especially if your IP is in a very competitive market, or one in which technologies quickly enter and obsolete earlier technologies.
Don’t overlook the buyout option when negotiating your licensing deals, especially if it’s a patented technology with a limited lifespan. Negotiating the buyout option with performance milestones will help to maximize not only your royalties but also the selling price for your IP. It’s a great way to cash in on your IP and enjoy some significant royalties along the way.