Choices for Inventors: Financial Arrangements

As any viewer of “Shark Tank” can attest, the variety of financial arrangements which are negotiated between inventor entrepreneurs and investors is broad. A final agreement is always the result of negotiation between the two parties. Unfortunately, many inventors go into the gunfight with a knife, so to speak, over-matched and under-prepared.

Unless you are a veteran of previous negotiation and thoroughly understand the potential value of your invention, you would be wise to engage the services of an attorney and/or a firm who has previously negotiated financial transactions for similar inventions. You don’t want to leave money on the table, nor do you want to have an unrealistic view of your work. Expert assistance can help you avoid either outcome.

The following descriptions are by no means exhaustive, but represent a sample of the strategies you might employ in order to monetize your work:

1. Sell Interests in Your Invention

Ideas, once protected legally, are intangible intellectual assets which can be bought and sold as readily as tangible assets. This ability provides inventors a number of opportunities to raise funds, such as:

• Selling Proportional Interests. For example, an inventor might give an investor a 50% interest in the invention in return for paying for patenting costs and a regular stipend during the patent application stages. The investor, alongside the inventor, would subsequently benefit or lose based upon the commercial success of the invention.
• Selling 100% Ownership. If you are a serial inventor eager to move on to your next big idea, you might consider selling your invention with no strings attached to a third party. (If you had previously sold proportional interests, the earlier investors would receive their proportional share of the proceeds.) Payment terms can be extremely flexible, ranging from a single up-front payment to a series of future payments which can be fixed amounts or vary according to some other measure. Selling your invention can eliminate any liability for future expense or product liability. However, the total amount of payment is likely to be lower than any other strategy because the buyer bears all risk and takes that into account when negotiating your payment.
• Transferring 100% Ownership to Your Private Corporation. There are a number of business advantages inherent in corporations, not the least of which is the elimination of your personal liability. While you can continue to own 100% of the company, you have the added option of selling shares or borrowing money via the corporation. Corporate security transactions are generally more simple and straightforward than selling interests in the invention itself and more apt to be accepted by potential investors and lenders. You also have the added flexibility of selling the invention outright and keeping the proceeds in the corporation or selling the corporation which may allow you to treat the proceeds as capital gains rather than ordinary income.

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2. License Your Invention

Regardless of where ownership of your invention resides – with you individually or in a company – you can elect to license its use to one or more parties in return for a fee or royalty payment. The terms of such arrangements are flexible and include:

• Conditions. A license might be limited to a defined geographical area, certain industries, and/or a particular use, and can require specific performance levels to remain in place. It can be exclusive or non-exclusive. For example, you could license ABC Company to sell your product in healthcare facilities within Pennsylvania provided that they sell at least $100,000 per year of your product.
• License Fees. Fees can be fixed or variable based upon number of units sold, gross revenues, profits, or any other criteria mutually agreed upon between licensor and licensee.
• Term. A license can be limited to a specific period or perpetual with provisions to extend or lapse in the event of certain events occurring, such as the bankruptcy or sale of the licensee.
• Remedies. All contracts (and a license is a legal contract) should have terms setting out penalties and actions to be taken in the event of a default by either party. If a licensee defaults, for example, the contract might require the payment of a specific sum of money and an abrogation of the agreement going forward.

While licensing others to develop and market an invention is the most common strategy elected by inventors, there are risks and drawbacks. Licensees may not approach your product with the same passion and dedication you would. In some cases, licensees may even bury the product concept and prevent it from coming into the market – if they see it as competition to their own product.

3. Manufacture and Market It Yourself

Some inventors elect to retain full control of their inventions and take them to the market themselves, effectively “doubling down” their bet on the success of the idea. Unfortunately, only those rare individuals lucky enough to combine the creativity of an innovator and the hard-nosed practicality of a businessperson are likely to be successful. The personal traits necessary to build a successful company – discipline, practicality, logic – are dissimilar from the qualities of a good inventor who sees opportunity where others do not, persists in the face of over-whelming odds, and is likely to seek accomplishment, rather than fat bottom lines.

An inventor turned start-up entrepreneur has to attract a team of equally committed individuals or have the experience and time to do the following:

• Attract and Negotiate Favorable Funding Sources. Even in those instances where manufacturing and other production functions can be outsourced, a minimal amount of capital is necessary. For most companies, especially start-ups, cash flow is more important than profitability. As sales grow, the pressure on adequate cash mounts since the payment of costs to produce, transport, and sell at a profit always precede the collection of cash from sales. For that reason, the availability of an experienced chief financial officer (CFO) is critical for most companies.
• Understand Manufacturing Processes and Materials. Even in cases where manufacturing is outsourced, the inventor must understand the elements involved in order to negotiate a beneficial contract at the lowest possible price. If manufacturing will be done in-house, facilities must be acquired, equipment purchased and set up, and employees recruited, trained, and managed with all of the attendant administrative and legal responsibilities.
• Develop and Direct Marketing and Sales Strategies. A successful product launch is contingent upon being able to identify individuals who need the product, crafting a marketing message that resonates with potential customers, selecting the optimum channel(s) over which the marketing message will be delivered, and establishing a fulfillment environment where sales can be completed, funds collected, products shipped, and customer issues resolved. An inventor electing to do these functions alone is likely to be overwhelmed.

Before electing a course that will require all of your attention and all of your time, often to the exclusion of family, hobbies, and other business activities, you should seek competent advice from your accountant, your attorney, and other business advisers. Make sure these advisors are familiar with the trials and tribulations of other inventor/entrepreneurs trying to build their own companies with short funds, limited staffs, bureaucratic regulators, and hostile competitors. While the potential gains are enormous, the odds of success are long and the potential scars long-lasting.

Final Thoughts

The immediate aftermath of a successful patent application is a combination of euphoria and bewilderment. The energy and stress of translating an idea into tangible reality is finally over, leaving the question of “What do I do now?” Recognize that the next phase of your invention – making it a commercial success – is likely to be as difficult as developing the creative idea initially, if not harder.

Fortunately, you are at the stage where professional assistance is available, possibly for little or no out-of-pocket cash. Many inventors make the mistake of “drinking their own bath water,” believing they can transfer their creative expertise and experience easily into the business world. But most cannot, and many can’t get their egos out of the way in order to seek help. Be realistic in your self-evaluation before deciding the next step. And good luck!

 

About the Author

Michael Lewis is a former business executive and writer for the financial resource, Money Crashers.