Editor’s note: Despite high IQs, 80 hour work weeks, and technical achievements, the majority of startup entrepreneurs will fail to live out their entrepreneurial dreams. Several years ago, author, business consultant and entrepreneurial coach Susan Schreter set out to uncover the pivotal mistakes and regrets of struggling entrepreneurs and bankrupt business owners, especially during the critical first two years of operations. Some of those lessons are shared in her new book “Start On Purpose: Everything You Need to Know and Do to Startup with Strength.” Today, GeekWire is running this excerpt from the new book.
A generation ago, most small businesses were valued by the sum of their tangible assets such as inventory, cash, equipment, land and other physical property. Today, the process of valuing startups and other privately-held companies is more complex and highly influenced by the perceived and actual value of a company’s intangible assets.
Intangible assets include a company’s know-how, patents, trademarks, copyrights, customer lists, trade names, brand names, proprietary processes, and trade dress. Even though you may not be able to physically touch intangible assets, they can have tremendous financial and strategic value to your company as it grows over time.
You don’t have to own a high tech business to have intellectual property or IP. Every type of business in America — from restaurants to fertilizer manufacturers —has some element of IP in its operations.
For example, a startup guitar manufacturer may file trademark applications on the novel shape of an electric guitar as well as its brand name. A proprietary curriculum that helps beginners learn how to play the guitar will be covered by copyright. The manufacturer’s unique production process may qualify for trade secret protection and, as the company grows, its proprietary customer database may be covered by copyright just like dictionaries. If the manufacture expands online and develops innovative software code to allow customers to design their own custom electric guitar, the software code may be covered by copyright law, patent law and trade secrets. And even a unique fabric design for a guitar strap may be covered by copyright and trademark registrations.
It’s crucial that you boost your working knowledge of the administrative deadlines and documentation needs associated with protecting your company’s innovations and most valuable intellectual property.
The more you know about IP the easier it will be for you to recognize new opportunities to increase the value of your business and collaborate with qualified legal counsel. And of course, you won’t likely end up saying “I wish I had known better” or “I waited too long.”
Turning Ideas into Cash
When investors ask entrepreneurs how they intend to “monetize their intellectual property” they are referring to the entrepreneur’s strategies to convert a company’s intangible assets into tangible business value…preferably cash. Here are some of the most common ways patents, trademarks, copyrights and trade secrets can contribute value to your business:
- Your business can sell a product at a higher price because one or more patents can give your company a temporary monopoly to sell an invention, a new product or a new drug in the U.S. and possibly other countries.
- Your business can sell a commodity product at a higher price than competing brands because of the good will value of your company’s brand and trademark protections.
- Your business can license its IP to one or more investors, corporate partners, or brand licensing specialists in exchange for royalties based on sales or other considerations.
- Your business can operate more profitably because of your company’s special “know how” that may be covered by proprietary “trade secrets.” Unlike patents, trade secrets don’t expire if the secret is closely guarded by its owners.
- Your business can sell its patent for a lump sum to one or more investors, corporate buyers or “patent aggregators.” Patent aggregators buy patents not for traditional manufacturing or commercialization purposes. Their business model is to sue infringers to collect large damage awards plus ongoing royalty payments.
- Your business can borrow against future royalty fee income
As you explore more about the potential strategic opportunities associated with IP, you will see that whenever you combine the fundamentals of business value (Chapter 3) with IP, then your company will be in a stronger position to negotiate more lucrative royalty fees, investment transactions, corporate partnerships and company sale deal terms.
Royalty Rate Primer
A common question entrepreneurs ask as they research and prepare business plan projections is how much do corporations pay to license patents, product-related trademarks, cartoon characters, recipes and other kinds of IP. It’s a prudent question to ask before investing in IP development.
The negotiation of licensing fees and royalty rates is not at all arbitrary. In general, royalty rates charged to industry competitors for access to critical technology will be higher than royalty rates charged to companies in other industries.
It’s a matter of how badly a corporation “needs” a deal to happen. Other factors that can influence royalty rates include the expected license term, the number of years until patent expiration, degree of industry exclusivity, potential for ongoing new product or service development, the potential for a third-party lawsuit, and the comparable costs and time associated with trying to design around the IP.
Higher royalty rates are applied to higher profit margin products and services as well as items that sell at high retail or commercial price points. It makes sense too. Well-recognized characters such as SpongeBob, Dora the Explorer, Angry Birds or Mario might generate a royalty rate of about 5% of net product sales when licensed to a food manufacturer and 8% when applied to children’s apparel simply because the profit margins for apparel are higher than most food items.
Ever wonder what celebrities earn for licensing their name to consumer goods manufacturers? Food manufacturers pay big bucks to celebrity food chefs – about 10% of net product sales which explains why their products are sold at premium prices when compared to other brands. In apparel categories, the rough standard is 12%. In toys, games and entertainment, celebrities receive royalty rates of about 10%. In the uber high profit margin perfume category, celebrities can earn up to 15%.
Of course, lower royalty rates are paid for less well-known brands. Here are some broad ranges.
Consumer products: 4 to 12%
Food products: 4 to 5%
Apparel: 2 to 15%
Toys and games: 3 to 12%
In the pharmaceutical industry, royalty rates are based on the stage of product development, clinical trial outcomes, patent status, U.S. Food and Drug Administration (FDA) approval status, and the expected consumer and healthcare demand for the medical treatment.
Here are some additional guidelines: A patent may get a 1% to 2% royalty; a pharmaceutical product with strong clinical trial support may secure a 3% to 4% royalty; and a proven drug that is ready for commercial sale may secure a 7% to 10% royalty. Pharmaceutical royalties on patented products in blockbuster healthcare categories can top 20% during the first years of product sales.
What will it take for you to license your IP-protected business concept (a recipe, trademark, technology, or product) to a corporate partner who has the resources to market the product successfully?
In most cases, it will be up to you to present a persuasive, factual case on why your technology, trademark or product line will be a lucrative business initiative.
Then, prospective corporate partners will evaluate the risks and rewards associated with the venture and determine the likelihood that business revenues will recover all the costs associated with packaging, distributing, marketing or integrating a newly licensed product into its operations, pay royalty rates, and make a generous profit.
If your projections are reasonable and meet the corporation’s minimum “hurdle rate” or profit on invested capital, then negotiations continue. If the proposed business opportunity falls short of the hurdle rate, then the corporation will either decline the opportunity or ask for royalty rate concessions.