Licensing Agreement

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What is a Licensing Agreement?

A licensing agreement is a contract between two parties (the licensor and licensee) in which the licensor grants the licensee the right to use the brand name, trademark, patented technology, or ability to produce and sell goods owned by the licensor. In other words, a licensing agreement grants the licensee the ability to use intellectual property owned by the licensor. Licensing agreements are commonly used by the licensor to commercialize their intellectual property.

Summary

• A licensing agreement is a contract between a licensor and licensee in which the licensee gains access to the licensor’s intellectual property.
• The party providing the intellectual property is called the licensor while the party receiving the intellectual property is called the licensee.
• In a licensing agreement, the licensee typically pays an upfront fee in conjunction with a royalty fee.

Understanding a Licensing Agreement

In a typical licensing agreement, the licensor agrees to provide the licensee with intellectual property rights such as the licensor’s technology, brand name, or product creation know-how. In exchange for the licensor’s intellectual property, the licensee typically plays an upfront fee and/or a royalty fee to the licensor. A royalty fee is an ongoing fee paid for the right of use of the licensor’s intellectual property.

It is important to remember that:

• The party that is providing intellectual property rights to another party is called the licensor
• The party that is receiving intellectual property rights from another party is called the licensee

Example of a Licensing Agreement

In May 2018, Nestle and Starbucks entered into a $7.15 billion coffee licensing deal. Nestle (the licensee) agreed to pay $7.15 billion in cash to Starbucks (the licensor) for exclusive rights to sell Starbucks’ products (single-serve coffee, teas, bagged beans, etc.) around the world through Nestle’s global distribution network. Additionally, Starbucks will receive royalties from the packaged coffees and teas sold by Nestle.

The licensing agreement provided Starbucks with the ability to drive brand recognition outside of its North American operations through Nestle’s distribution networks. For Nestle, the company gained access to Starbucks’ products and strong brand image.

Advantages of Licensing

The advantages of licensing can be viewed from two perspectives: licensor and licensee.

Advantages to the licensor include:

1. The licensor being able to utilize the licensee’s distribution network to quickly enter into new geographical regions and foreign markets
2. The licensor facing lower capital requirements and lower costs due to not having to invest in distribution
3. The licensor having the ability to generate passive revenues through royalties
4. The licensor being able to gain the expertise and skills of the licensee

Advantages to the licensee include:

1. The licensee gaining access to established intellectual property and being able to enter the market more quickly
2. The licensee not having to pool resources to conduct research and development to develop their own products or services
3. The licensee being able to generate revenues by using the intellectual property of the licensor

Disadvantages of Licensing

The disadvantages of licensing can be viewed from two perspectives: licensor and licensee.

Disadvantages to the licensor include:

1. The licensor having loss of control of their intellectual property
2. The licensor having to depend on the skills, abilities, and resources of the licensee to generate revenues
3. The licensor being exposed to intellectual property theft by the licensee

Disadvantages to the licensee include:

1. The licensee being responsible for production, marketing, selling, etc.
2. The licensee potentially being dependent on the licensor’s intellectual property
3. The licensee having to pay an upfront fee and/or royalty to the licensor

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:

• Copyright
• Equipment Lease Agreement
• Intangible Assets
• Products and Services
• See all accounting resources

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