Life Sciences: Licensing Agreements Part 1

Negotiating an IP licensing agreement with a partner institution is one of the earliest legal responsibilities of healthcare startup founders. If executed poorly your company could be living with that mistake permanently.

As an academic, clinician or researcher your employing institution has priorities related to its existing (successful) business. A governing hierarchy and resulting bureaucracy grew to support and defend that business model. As a founder your responsibility is to master that bureaucracy.

The information revolution has driven a premium valuation for Intellectual Property (IP). In response, over the past decades a new culture of early stage venture capital has proven its worth across the globe. Even institutions built on staid business models now recognize the importance of fostering their own in-house innovators and entrepreneurs. For life science startup entrepreneurs, partnering with academic, healthcare or industrial institutions provides invaluable access to cutting-edge research, deep benches of experts and collaborative opportunities.

Over the course of a company’s growth and evolution many different stakeholders will be deeply interested in the most valuable asset created: your Intellectual Property. Negotiating licensing agreements regarding that IP is a complex and crucial process that requires careful consideration of terms and strategic planning. Complex processes do not have simple solutions, instead we must embrace a process and the solution will follow based on your specific situation.

Laying the Groundwork: Essential Terms to Be Negotiated

Successful licensing agreements hinge on a clear and mutually beneficial understanding of the terms. Key areas to negotiate include:

• The Scope of the License—Defines the extent of a startup’s right to use licensed technology. Defining the specific field of application ensures clarity and prevents conflicts with other licenses issued by the academic center.
• Financial Terms—Typically include upfront fees, milestone payments, and royalty payments. Upfront fees should be limited to preserve early stage capital and milestone payments should reflect realistic development timelines.
• Intellectual Property Ownership—Specifically address if improvements to licensed IP will fall under the existing licensing terms, and how that ownership is to be managed and transferred.
• Performance Obligations—Require startups to meet development milestones within specified timeframes. Flexibility in these timelines is essential to account for unforeseen delays in the R&D process.
• Termination Clauses—Should be reasonable and not unduly penalize the startup. Include “cure periods” to address any breaches before termination.

Designing the Structure: Managing Cash Flows and Fee Structures

Effective management of fee structures, economic incentives and timelines in licensing agreements requires a thoughtful, strategic approach that balances the interests of both licensors and licensees. The foundation of this management begins by aligning the fee structure with specific business objectives. Licensors must decide whether immediate revenue or long-term royalties take precedence, while licensees should evaluate whether paying larger upfront fees in exchange for reduced royalties aligns with their financial strategies.

• Keep it Flexible—Tiered or milestone-based payments, spread upfront fees across multiple installments tied to specific achievements or timelines. This arrangement reduces the risk for licensees while ensuring that licensors receive a guaranteed income.
• Keep it Transparent—A transparent and steady capital stream for the startup and a clear incentivization framework instills confidence in your partners and investors.
• Consider Alternatives to Cash—Options such as equity stakes or in-kind services can deliver value to licensors, while easing the immediate financial burden on licensees.
• Trust but Verify—The inclusion of audit rights can provide licensors with oversight of sales records ensuring royalty accuracy and potentially justifying lower upfront fees.
• Expect the Unexpected—Always include provisions for term renegotiation under specific conditions.  Arbitration and other legal structures can provide an extra layer of protection for investors and partners at a much lower cost by preempting litigation.

Know Your Playing Field:  Common Limitations in Agreements with Academic Institutions

Every institution has rules that govern the ways in which it behaves. Smart founders find ways to use those rules to their company’s benefit.

• Laws and Regulations—The Bayh-Dole Act: Allows universities and other non-profit institutions to retain ownership of inventions developed through federally funded research provided they meet some specific obligations.
• Rules about Publication or Confidentiality: Institutions may limit the timing or content of research publications to protect proprietary information or maintain confidentiality over certain aspects of the research, which can impact the dissemination of findings.
• Disclosure Laws—Freedom of Information Act (FOIA): Public universities are subject to state and federal open records laws, which may require additional public disclosure.
• Private Rule Books: Large organizations often adopt mission statements or other documents which place restrictions on their research or development activities. Find out if your project falls under review.  There may be restrictions on your actions or alternatively, strategic benefits as a third party licensee.

Defining and Defending Your Rights: Good Partnerships Benefit Both Parties

Licensing agreements are not merely transactional; they establish long-term relationships that must be mutually beneficial to ensure sustained success. A well-structured licensing agreement aligns the interests of both the licensor and the licensee—fostering a partnership where both parties are invested in each other’s success. Such mutual benefit encourages open communication, shared goals and collaborative problem-solving—all of which are essential for navigating the complexities of bringing innovations to market. Especially in health care and other heavily regulated industries.

Royalties and dispute resolution are two areas which are incredibly tricky to get right but benefit from properly defined partnerships.

Common practice in IP-heavy industries like pharmaceuticals and life sciences is to set two distinct royalty rates: 1.) a patent royalty rate for net sales early on, and then 2.) a reduced step-down royalty rate kicks in for use of know-how and trade secrets after the exclusive patent expires. Establishing a transparent royalty rate with a known timeline will limit future legal challenges and headaches.

Differences of opinion will occur in any business relationship. Dispute resolution mechanisms are a critical component of licensing agreements, offering a pathway to address conflicts without jeopardizing the partnership. For small companies, a clearly defined arbitration process is often preferable to courtroom litigation, as it is typically faster, less expensive, and more private. Arbitration allows both parties to resolve disputes efficiently while maintaining focus on their shared goals, minimizing disruption to business operations.

Alexandra Svensson of Much Law highlights the significance of aligning interests to prevent disputes: “Identify potential disputes. Figure out where interests don’t align to be prepared for potential disputes early on.”

Stop and Ask for Directions When Needed