• A royalty rate that is based on a percentage of net sales. Royalty rates paid to licensors typically range from 2 percent to 20 percent of the licensee's net sales. Thus, the most important provision in the license agreement is how the term "net sales" is defined.
Royalties are calculated by multiplying a royalty rate by net sales. "Net sales" is typically defined as gross sales less deductions, which can include customer discounts, returns, shipping costs and allowances. A licensor will want the "net sales" definition to contain as few deductions as possible, to maximize royalty payments; a licensee will want to include as many deductions as possible, to reduce royalty payments.
If you are a licensee, try to include additional deductions in the "net sales" definition, such as commissions and/or marketing expenses. Licensors should include a cap on deductible expenses to 5 percent of gross sales.
• Audit rights for the licensor. The licensor should have the ability to audit licensee's books and records to verify royalty payments and any deductions from "net sales."
• Quality control rights for the licensor. The licensor should have the ability to review and monitor the quality of products manufactured bearing the licensor's intellectual property.
• A clear definition of the scope of the license. The license agreement should contain a full and complete description of the intellectual property being licensed and the products for which the intellectual property may be used by the licensee.
• A clear definition of the term of the license and whether it is exclusive or non-exclusive. The license agreement should contain an initial period of time for which the intellectual property may be used and any other limitations (e.g., geographical limitations, whether the license will be exclusive or non-exclusive, etc.).