Licensing a product or service idea to an established manufacturer / distributor can save you many headaches.
By sharing the load with another stakeholder, you can do what you do best and let your partner shoulder some of the load.
Consider all your options before creating a business plan for your big idea; of the many paths-to-market you can choose, licensing a product to another company may suit you best.
1) Examine Your Options: Licensing a Product vs. Starting a Small Business
Yes, you can create a traditional business around your great idea.
You can incorporate a business, find startup capital, manufacture your product, and sell to retailers/consumers.
However, building a business from scratch means learning every aspect of business management at once. It means laying out massive amounts of capital before making a penny in profit.
Sure, you’ll get the lion’s share of the profits if succeed; however, the amount you’ll lose if your idea doesn’t sell could bring down your fledgling company. Because 8 out of 10 new companies fail in the first year-and-a-half, consider a different strategy than traditional incorporation. Limit your risk by licensing a product; give yourself the best chance of recovering from losses, learning from your mistakes, and trying again.
If you license your product/service idea to an established business, you don’t have to learn to manage a small business overnight.
You can focus on your big idea, not the millions of unrelated tasks involved in building a company from the ground up.
Don’t worry – you’ll still face many exciting challenges in the licensing process. You’ll still have to learn about incorporation and licensing law (with the support of your legal professional, of course). But, you can streamline your company’s operations down to a simple focus: licensing a product to the right partner.
2) Understand the Math of Starting a Small Business
Licensing a product may provide a larger potential return on investment (ROI) than your other options. This option involves many fewer logistical, operational, and networking barriers to market entry.
By licensing a product/service to a manufacturing/distribution company, you’ll spend far less time and money on this project. Sure, your partner will take a cut of the proceeds; however, the financial burdens they take from your shoulders can more than outweigh this cost.
For example, say you have a great new idea for phone cases made entirely of bubble wrap and eschew the “licensing a product” option.
You could scour the globe for an inexpensive manufacturer that meets your standards. You could contact every electronics store and mall kiosk in the country and explain why they should sell your product. After two years of effort, you finally find the right manufacturers and distributors and get your product to market (keep in mind, however, many businesses go out-of-business before this point).
You spend the next three years in the red, slowly increasing your sales until you break even at the five-year mark. You now own a business valued at $100,000 annually, but at what cost?
Add up the lost wages for the years you’ve spent on this hypothetical project at the U.S. 2016 average of $36,000 per year.
The five years you spent living on spousal/family support or a business loan would cost you $180,000 (even without considering the interest you could make by saving a portion of that sum).
Salaries for two full-time and four part-time developers, operations, sales, and marketing employees would cost you $720,000 (ignoring employee benefits, liability insurance, etc. in this simple example). Remember, Toggl dramatically simplifies time tracking and payroll for business owners and managers.
With legal fees and other costs, you’ve spent a million dollars to create a business that makes $100,000 a year. You’d need to operate this business for another 10 years without dipping into the profits to recoup your million-dollar investment (not considering the interest payments on any loans you may have taken out).
At this point, you now have a business that makes $200,000 a year. (Let’s say your business has thrived, expanded, and increased its annual profits over this decade.)
You’ve now been running a business for 15 years without making a dime in profits. You plan to retire in ten more years; you can expect a comfortable 2 million in the bank by that point. With business growth and proper investment, let’s say you retire with three million dollars and enjoy the rest of your life. You’ve invested 1 million dollars over 30 years and made three million dollars. That’s 300% profit over three decades, which equals an ROI of 10% per year.
Although you might have fared better simply investing this money in the market (and leveraging the power of compound interest), this small business success story is possible.
However, it’s quite possible that you gave up on your company after 18 months, as many do. You could have continued on for few years, making profits and recouping part of your investment, just to find that people no longer need phone cases because cortical implants have become all the rage.
Someone could steal your intellectual property, costing you market share and legal fees.
For many reasons, you could end up going out of business while still deep in debt. Do you really want to take all the risks involved in owning a business, or do you want to consider licensing a product to a manufacturer/distributor?
3) Understand the Math of Licensing a Product/Service
If you partnered up with a company that already sells phone cases to big-box retailers instead of starting a small business, you could realize much faster and greater ROIs.
You could rely on your partner’s contacts with manufacturers to get your product mass-produced quickly and efficiently. Your licensee could use their existing business relationships to put your product in front of customers in big box stores.
Let’s say you license your big idea for 5% of the total revenues (royalties can range from 2-10 percent). This may not seem like a lot, but remember your licensee will spend most of the remaining 95% on manufacturing and distribution. Remember, revenues and profits are grossly different concepts.
Let’s say your partner sold half a million bubble wrap phone cases in the first year at $10 each. You would get 5% of these $5 million revenues, earning you $250,000. Let’s say you invested $125,000 in research, legal advice, and networking costs to find the right licensee.
Your ROI would be 100% in a single year.
Sure, you haven’t built a business over decades with a consistent profit margin; conversely, you haven’t taken many risks and have those decades to do other work.
Surely, you can count on a few years of continued success before your phone case idea becomes dated. Spend this time investing your profits, digging into the work that inspires you the most, and creating more great ideas. The sky’s the limit!
4) Examine Your Options: Licensing a Product vs. Crowdsourcing
Knowing how to license an idea can lead to big profits; however, crowdsourcing provides a cheaper option if you don’t have much initial capital. Remember, you can’t contact a manufacturer and say, “I want to license my product.”
You need to invest a good amount of money in research and B2B advertising. If you’re light on funds, consider the crowdsourcing option.
By submitting your product to a crowdsourcing platform, you benefit from at least a small amount of startup capital. By soliciting pre-orders, you might collect enough funds to order a first run of products.
Hopefully, you’ll have enough left over to market your product properly and afford the massive sales effort it will take to get your product into a retail outlet.
Crowdsourcing can work for people with little or no investment capital (or more ideas than funding). However, you may have little influence over your campaign’s success. Remember, no matter how much you make online, your crowdsourcing platform will take a substantial cut.
Licensing a product/service can mean ROIs of up to 20 times your crowdfunding profits.
If you don’t excel at marketing, social media, and networking, you could fare better by licensing your intellectual property to another company than starting a crowdfunding campaign.
Remember, even if you make the money you need to proceed, you still have to manage the entire manufacturing and sales process.
Why not let someone else do the work and take a portion of the proceeds while you focus on your next invention?
5) Get More Information: How Does Licensing Work?
After that eureka moment, it’s time to dig in and create business structures around your product. You need to create prototypes, test your product, and file a patent application.
No matter how wonderful your product, you have to pour time and energy into product licensing. Companies want as much information as possible before taking a risk on your idea and licensing a product.
After gaining the protection of the patent office (a lengthy process, in itself), you can submit your idea to potential licensees.
Expect to get roughly 5% of the retail price per unit; your manufacturer partner (who takes a larger risk) might make 10%.
You benefit from this arrangement because your licensee wants to regain their investment in your product by getting it into as many retail outlets as possible. All you have to do is sit back and go along for the ride, making a dollar every time your partner makes two (without doing much, if any, work).
6) Understand the Patent Application Process
This topic could anchor an entire blog article, but I’ll highlight the main points here. Licensing products means reaching out to unfamiliar companies who could take advantage of your intellectual property if you aren’t careful. The very first move in the product licensing game must involve getting the legal advice you need and submitting a proper patent application.
- Contact a Patent Lawyer – Even though the initial phase of the patent application process doesn’t cost too much, you need to strategize for the long term. If you want to license a product/service, your potential partners will want to know you’ve crossed all your Ts and dotted all your Is.
- File a Provisional Patent – In most cases, you’ll want to send an initial 12-month provisional patent application to the U.S. Patent and Trademark Office. Remember, this application, if approved, only provides a provisional (temporary) layer of protection. You must continue the application process to keep your intellectual property.
- Apply for a Patent – With the advice of your patent attorney, file either a nonprovisional patent application or a grantable petition to convert your provisional application into a nonprovisional application. (Depending on your circumstances, filing a conversion petition may extend your temporary protections for up to another 12 months.)
- Hope for the Best – A provisional patent application is still just an application. You (and your partners) don’t know for sure the government will approve your patent. Conducting market research and putting in hours of due diligence can dramatically increase your chances of success; however, a provisional application only buys you time to find partners and investors. You won’t know for sure until you hear back from the Patent Office about their final decision.
7) Consider Why You May NOT Want to License a Product/Service
Many factors can affect your decision to license a product. If you want complete control of your product and the way it goes to market, you’ll want to create your own company from scratch.
If you don’t have any startup capital, crowdfunding can help you make the most of limited options. Learning how to license a product can bring large ROIs for the amount of time and resources you invest; however, it can take a lot of work to land a licensing deal.
If you want to license a product, you need a lot of persistence. Convincing another company to take a risk on your idea takes luck, hard work, and good networking skills.
Yes, patent applications don’t cost that much, but you need to consider many other expenses.
For example, licensees will want to see market research on your product, as well as safety studies. You may need to commission research projects to get the right data for your potential partners; after this, you’ll need to hire a marketing team to construct white papers and other B2B marketing documents.
8) Create a Marketing Plan
Reaching out to shark/angel investors takes work and investment. Whether you plan to reach out in person, via B2B documents, or with a pitch video, you’ll have to spend big to put a professional touch on your marketing materials. Remember, to see the massive ROIs some inventors and innovators enjoy, you will have to make a substantial personal investment.
Before you spend your marketing dollars, make a comprehensive plan and answer some big questions.
- How much should you put towards content marketing?
- What percentage of your marketing budget should you invest in networking and attending conferences?
- Should you represent your company yourself or hire savvy and experienced salespeople to promote your brand?
9) Examine Licensing Companies
No matter what marketing strategy you adopt, you’ll have to grind through the process.
Remember, don’t feel discouraged by early rejections; learn what you can do to sharpen and optimize your proposals and keep moving steadily ahead. Finding someone to help you shoulder the burden of getting your product/service to market takes time and effort.
Remember, landing a licensing deal means the difference between going into debt to create a company and sitting back and collecting royalty checks. Neither path offers guaranteed success; however, the passive income you could gain from licensing deals makes the sweat equity you earn early on well work the struggle.
Be careful. If someone shows interest in your idea, you might want to jump the gun and sign the licensing papers right away.
However, data-sharing goes both ways; you need to know as much about potential licensees as they do about you. Don’t take the plunge until you know you’ve found a reliable corporate partner that can offer the greatest sales volumes and ROIs.
10) Make a Decision
Ultimately, only you know if you want to absorb the risks of starting a small business, playing a hand at the crowdsourcing table, or simply licensing a product.
However, you owe it to yourself—and your great idea—to examine all the options before investing your time and money.
Information is power; learn all you can about the various paths to market for your product/service before following the traditional (and risky) path. It could mean the difference between years of frustration and simple, rewarding ROIs!