Negotiating Complex Licensing Agreements III - A Case History

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We were involved as consultant and advisor in a complex licensing deal between two multinational food companies. The deal would affect both companies’ basic business for perhaps the next 50 years.

Company A, our client, is a publicly traded manufacturer and marketer of consumer and commercial food products. Well known for its corporate name and brand, along with other trademarks and brands it controls, it is also respected for its consumer marketing abilities in a highly competitive environment.

Company B is a very strong publicly traded multinational focused on consumer foods. The parent company has several strong divisions and this deal involved its snack foods operations. The division is well known and thoroughly respected for its ability to deliver, distribute and merchandise in tens of thousands of outlets.

This complex deal had five key elements: use of the trademark and brand name, production and technology know-how, manufacturing capabilities, physical distribution and delivery, and finally, merchandising and marketing of product. These five core elements were then divided into two distinct agreements and two sets of negotiations. The first agreement covered the manufacturing elements including plant construction, testing, product development, etc. It also covered the basic elements of marketing, merchandising and distribution. The second agreement, the licensing agreement, covered the use of the brand name and of packaging and other production technology, all provided by Company A.

There was substantially more than simply a trademark and patent involved: First, the marketing bundle of rights along with the brand name and trademark. Second, the technical intangibles licensed in the technology section of the agreement.

MARKETING BUNDLE OF RIGHTS	TECHNICAL BUNDLE OF RIGHTS
Umbrella Brand Name	Packaging Technology
Sub-Brand Names	Baking Technology
Product Names	Formulae and Blending
Trademark Registrations	Product Shapes/Designs
Copyrights	Process Technology
Graphics	Key Patents
Corporate Name and Logo	Equipment Design
Labeling and Package Design

GENERAL BACKGROUND

The two companies had mutually identified a product category that was ripe for a new competitor. The category had been in existence for several decades and was dominated by a handful of competitors who were strapped by high production and distribution costs combined with low efficiencies. Consequently, Company B saw an opportunity to quickly build a market that offered annual sales volume between $300 million and $1.5 billion. However, they lacked the product know-how and suitable brand franchise which Company A had.

There was a good marketing match. Company A does an effective job of consumer advertising and promotion and is superb at pulling product through the distribution channel via consumer advertising and promotion. Company B, on the other hand, is superb at pushing product through multiple channels via merchandising and pricing. Jointly, therefore, they would jointly decide on and control effective trade and consumer marketing programs. Finally, there was good use of Company A’s general product technology. However, it meant that in addition to negotiating the manufacturing and distribution deal, it was necessary to put together a license agreement to cover the trademark and brand name, along with the technology.

We were hired to help our client review some of its alternatives, including the possibility of having a joint venture with Company B, a pure licensing agreement, simply private labeling and packaging for them, or a combination of the above. In the final analysis, we believed that a combination deal of manufacturing agreement and licensing agreement was best. Company A agreed. We used the set of key factors that helps predict success in a licensing environment like this. As shown in the Table below, there are 10 key factors we considered in this licensing deal. The match appeared to be exceptionally good in this case.

Key Factors In Consumer Goods Licensing

Licensor Contribution or Support for Licensee	Company A Rating
1…Consumer awareness of licensor	+++
2. Retailer acceptance of licensor	++
3. Strength of licensor’s core products	+++
4. Advertising/promotion by licensor	++
5. Piggyback on licensor’s distribution	-
6. Volume potential for licensed product	+++
7. Filling a void for the licensee	+++
8. Manufacturing/product fit	-
9. Higher attainable margins for licensee	++
10. Potential for efficiencies, profits, licensee	++

Company A had broad goals or primary issues they needed fulfilled from this licensing agreement. The first was to generate incremental income from all of the assets employed in the license agreement, both trademark assets and technology assets. The second key interest was to broaden their consumer and trade franchise, increasing distribution and production while, third, ensuring that their image was not cheapened or damaged.

Company B had four interests that were clear to us. First, and most important, was to better utilize its distribution capabilities. The second was to spread distribution costs over product lines. Third, was to launch a new product line that it could not make. The fourth and final interest was maximum cash flow and income.

The issues, which are secondary to the key interests, also differed for the two companies. The key issues for Company A were:

Potential damage to the name.
The danger of a short-term arrangement.
The loss of proprietary technology.
The need for market-based royalty rates.
Annual royalty guarantees.
Effective escape clauses

For Company B, the issues included:

Use of unique technology.
That new products were continuously developed.
That the costs of promotion and royalties remained manageable.
That this not be a short-term affair.
That the total cash paid to its partner not be excessive in any given year.
Effective escape clauses.

Finally, there was a key difference in overall corporate philosophy, operating style and management. Company A is a production and marketing-driven company. Company B is distribution driven and has a distribution mentality. Those two diverse points of view and corporate strategies had to be reconciled in the license agreement, at the juncture where sales and distribution intercept manufacturing and marketing. With these key thoughts in mind we moved to establish a framework for negotiating the deal.

NEGOTIATING A FRAMEWORK FOR THE DEAL

We identified as many comparable licensing transactions as were appropriate, and determined that a royalty rate for use of the brand name and other marketing intangibles would be between 2.0% and 6.0%. We then undertook a similar exercise for food technology licensing and determined the royalty rates were somewhere between 0.5% and 5.0%.

After further research, we provided Company A guidance as to trademark royalty rates and technology royalty rates. We suggested royalty step-ups with price increases and royalty rates with volume discounts. We helped establish minimum sales levels and minimum royalties. We recommended proportionate pricing formulas, and addressed the issue of branded product sales versus unbranded product sales. We also created a framework of approvals over marketing, packaging, labeling, etc. And, finally, we provided to each company a number of unique escape mechanisms or exit clauses that could be exercised in five-year intervals – with a substantial fiscal penalty should the escape-clause mechanism be exercised.

By reducing the key terms and conditions of the proposed license agreement to a common deal memo, we were able to help Company A and Company B reach an agreement on the following:

Term and renewals
Royalty rate scales
Options
Minimum sales clauses
Minimum royalty clauses
Test market details
Channels of distribution
Product definition

In essence, by reducing the negotiating process to address the key interests and issues, we were able to condense the wanted result into a one-page deal memo, from which a full-fledged license agreement was structured.

Comparable Transactions

Trademark Royalty Rates	2.0%	6.0%	3.5%
Technology Royalty Rates	0.5%	5.0%	2.0%

CONCLUSIONS

What conclusions do we draw from this long but ultimately successful process? First, that complex issues can be resolved and unified via a licensing agreement. Second, that trademarks and technology can be married in one deal. Third, this combination or hybrid deal will play an ever-larger role in the future of corporate licensing and corporate transactions in general. Finally, when negotiating, get the parties to separate their key interests from the more minor issues. And, make sure that each party understands its BATNA.