What to Consider Before Licensing Your Brand

Licensing your brand can be a great way to generate passive income, but it requires careful planning and an understanding of the opportunities and risks involved. With the right strategy, you can protect your brand's reputation while creating a successful and profitable partnership for you and your licensees.

Here's what you need to know about licensing your brand, including opportunities and risks, key components of a licensing agreement, and best practices to follow.

What does it mean to license your brand?

When you license your brand, you are giving another company permission to use your intellectual property on products they produce and sell. You can earn an upfront advance as well as royalties, which are calculated as a percentage of total sales or net profits, depending on the licensing agreement.

[Read more: Intellectual Property: Differences Between Patent, Copyright, and Trademark Laws]

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Key clauses to include in a licensing agreement

Structuring your licensing agreement is key to protecting your brand while maximizing its revenue potential. To build a strong foundation, include the following components:

• Exclusivity clauses to prevent licensees from partnering with competitors.
• Detailed payment structures, such as upfront fees versus ongoing royalties.
• A clearly defined length and territory of the agreement that ensure usage rights remain controlled and aligned with your business goals.
• Quality control provisions, which help maintain brand integrity by setting standards for product development, marketing, and distribution.
• Performance requirements, such as sales targets, can protect your interests, and it gives you the option to end the agreement if the licensee doesn't meet your expectations.
• Liability clauses establish the parties' responsibilities and accountability in cases of product failures, recalls, or legal disputes.
• An exit strategy that outlines how either party can terminate the agreement early, including any necessary notice and conditions.

Benefits of licensing your brand

Many companies, from major corporations to small independent artists, recognize the benefits of licensing their brands. Consider these major benefits:

• Increase profits without cost risks. You can earn royalties without investing any money into the production, marketing, or distribution of the goods.
• Increase brand recognition. If you are not already a big name in your industry, you can benefit from more people seeing your licensed merchandise. And if you are well known, you can expand into other markets through licensing for increased visibility.
• Expand your market internationally. Licensing enables you to expand into foreign territories without the hassles and stress of building relationships with retail outlets or distributors overseas.

Potential pitfalls in licensing your brand

Of course, as with any business venture, licensing your brand has some potential pitfalls that you should watch out for. Being aware of these pitfalls and putting systems in place to combat them can help ensure a successful licensing arrangement.

• Risks of intellectual property theft: Licensing agreements should be clearly defined in terms of how and where the licensee can use your intellectual property (IP). However, it can be challenging to police all the uses of your brand or its IP. If you give a company permission to use a character on a T-shirt, for instance, the company might take the liberty to also use the art on a tote bag. You could lose royalties that you deserve.
• Competition in the marketplace: You could limit licensing agreements to items you don't personally sell or manufacture. But if you license the rights to use your brand in certain markets, you will have competition if you enter those markets in the future.
• No guarantee of income: Nothing is guaranteed in business, but licensing your brand carries the risk that you could agree to a license and never see any royalty payments. On the positive side, you didn't lay out money to manufacture or market the products, so you're losing less than the licensee.
• Loss of control of your brand: If you don't have specific and strict licensing requirements — and you don't enforce those rules by monitoring the companies licensing your brand — your brand's reputation could suffer.

It's crucial to protect your brand's reputation by ensuring that not only is your IP reproduced faithfully but that the products using your IP are manufactured using strict quality standards. You also want to ensure your IP is only used on products that are consistent with your brand and mission. For instance, a brand likely wouldn't want its beloved children's character depicted on a bottle of alcohol.

[Read more: How to License Your Artwork]

Common mistakes to avoid when licensing

As a small business owner, it's easy to overlook critical details when licensing your brand — ones that can lead to financial losses and reputational damage. Keep an eye out for these common missteps to protect your business:

• Using vague contractual language: Using ambiguous language in your contract can create loopholes and disputes over rights, payment structures, and quality control.
• Failing to conduct thorough due diligence on potential licensees: Partnering with the wrong company can result in misaligned values, poor brand representation, or even legal issues.
• Undervaluing the license: As part of your business's valuation, consider your industry, market demand, and uniqueness of your offering as well as any potential revenue streams that could result from your license.
• Nonenforcement of the licensing terms: Not addressing licensing issues and concerns head-on can weaken your brand's integrity and set a precedent for future violations. Again, setting liability clauses and other provisions gives you a structure to rely on and ensures your partnership remains mutually beneficial.

How to price your brand license

Clearly defining the terms of your brand licensing agreement is helpful when protecting this revenue stream and ensuring a successful partnership. A well-structured licensing agreement should include both upfront fees and ongoing royalties. Keep the following in mind when determining your fees and royalties:

• When setting initial fees, an upfront, flat fee paid yearly can provide immediate financial benefits and a predictable income from the agreement's inception.
• Equally important are ongoing royalties, where you receive a percentage of the sales for each licensed product. This setup incentivizes the licensee to drive sales, and with a clear royalty rate, such as 10%, you can directly benefit from the licensee's success. It's important to be specific about these terms, as royalty rates can vary significantly based on the type of product or market.

In addition to setting a pricing structure, you should also address the potential issue of discounts. Clearly stating the maximum discount a licensee can offer on your license helps protect your royalty payments and company.

Setting license terms and renewal conditions

When establishing the terms and renewal conditions of your licensing agreement, consider your brand's short-term and long-term goals. A short-term agreement allows for more flexibility and a quick assessment of profitability, while a longer-term contract provides more stability and more time to generate revenue.

It's important to set a review period — typically annually or biannually — to assess your partnership's success and adjust terms as needed. During these reviews, business owners can renegotiate royalty rates based on market conditions or the licensee's performance.

Should the relationship no longer be mutually beneficial and you cannot agree, consult with the terms in the agreement and your exit strategy. By setting clear terms upfront — and enforcing them — your small businesses can maintain control over licensing deals and avoid unwanted surprises while creating mutually beneficial partnerships.

Partnering with licensees: Mind your P's

When partnering with a licensee, you want to ensure that not only is the licensee depicting your brand in an accurate and positive light, but they are maximizing their chances of profitability with relevant, well-made, and well-marketed products.

Consider the "three P's" of licensing, which originated as guidelines for collegiate licensing, but are good rules for any organization to follow.

Protection: Protect your intellectual property

To protect your brand, make sure that your IP is only reproduced on relevant, appropriate, well-manufactured, and high-quality products. You also want to ensure that your IP is reproduced accurately. It is not appropriate, for instance, to change a professional sports team's colors on a hat or jersey.

To ensure the accurate reproduction of your brand by licensees, create a licensing guide and consider holding training that outlines the appropriate use of your IP and what licensees can and cannot do.

[Read more: Road map for Rebuilding: Marketing and Protecting Your Brand]

Promotion: Ensure your licensees have a marketing plan in place

While it doesn't cost a lot in time, money, or human capital to enter a licensing agreement, there is some outlay. Because of the risks involved in licensing, including creating competition in the marketplace, you want to be sure your licensees maximize their profits. Make sure they have a strategic marketing plan in place to promote your brand.

Profit: Make sure your royalties are worthwhile

Is it worth it to license your brand? You want to make sure the potential profits exceed any of the risks of entering a licensing agreement.

The best licensing arrangements often blossom into productive partnerships, with both companies helping each other to grow through synergistic ideas and cross-marketing.

Dawn Allcot contributed to this article.

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