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Licensing by Startups: A Reality Check

by Jackie Hutter

A significant proportion of startup entrepreneurs tell me that their strategy to generate revenue centers on licensing their protected product or technology to an established company, after which I provide them with a reality check.  In truth, as general matter, licensing is a fairly low probability outcome for a startup.  Startups are based on ideas for products, but companies do not license ideas.  An idea, no matter how strong it may appear, will not interest another company unless there are customers who will pay more than it costs to make and sell a product incorporating the idea.

Of course, conventional thought (and late night infomercials) would lead one to believe that licensing of a protected innovation is a viable business strategy for a startup.  The truth is that few large companies license ideas from the general public.  And, why should they?  They maintain internal R&D and marketing staffs who develop new product ideas.  Acquiring innovations from outside of the company means that their people, who are paid for their product and market expertise, could not adequately do their jobs.  Put in economic parlance, the decision makers at most companies are disincentivized to go outside their facilities to acquire new products.

Moreover, most ideas submitted from the general public, while often quite creative, are flawed in some way that makes them unacceptable from the outset.  For example, a product embodying the product idea may require purchase of new capital equipment in order to manufacture or will not fit into existing shipping containers or any one of many reasons why an ostensibly interesting idea will not get a second glance by the company.   When combined with the natural disincentives to acquire innovations from the outside, even good ideas will be rejected if they do not fit perfectly with the company’s needs in the form they are presented at an early stage.

But licensing of protected products or technology created by startups does happen.  Notably, however, no license will ever result unless the startup’s product aligns with a customer who will pay for a product that incorporates that idea.  There are two ways for this to happen: 1) the startup company develops the idea into a product that shows promise in that customers exist today and will continue to exist in increasingly larger numbers in the future; and 2) there is an existing customer/market where revenues can be enhanced by integration of the startup’s innovation into the company’s products.

The first situation will occur if the startup entrepreneur does the hard (and expensive) work of developing the idea into a product and successfully bringing the product to market.  A license will then occur if a larger company seeks to buy access to that now-existing customer or market.  The second situation will occur when a larger company with existing customer and market expertise seeks to satisfy an unmet need by acquiring an innovation that fills a gap in its suite of products.  MotionX, a company with core motion sensor technology for wearable products, has developed its technology into a functioning product and is now licensing its well-protected innovation to a number of companies .  Atlanta startup United Sciences is an example of a startup that does not make a product but that is generating revenue from licensing by targeting its well-protected 3D imaging technology to create new innovations in existing product categories.  United Sciences’ licensees are OEMs that seek to improve their established product categories by integrating the innovation to drive sales.

However, in neither of these situations is it the idea that is licensed; rather the licensee is buying access to a new product or innovation that aligns with a validated business model–either that of the startup or its own.  When licensing is broken down into this framework, it should be fairly clear why licensing does not occur as often as conventional thought would make it appear.  This is a tough reality for startup entrepreneurs to accept, but going into the process with open eyes is a lot better than the alternative.

Now that readers have been given the hard truth about licensing as a revenue generation strategy, I can say that ways to improve the probability of licensing to a large company do exist.  I will talk about these in later posts.  In the meantime, if you have any questions, please contact me at jhutter@leanlegalteam.com or check out my IP Asset Maximizer Blog where I have been writing about IP Strategy, licensing and innovation since 2008.

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