The potential reward from your idea must be much greater than the cost and risk involved in getting it on to the market.

It may be worth going out on a limb for an idea if there’s a real prospect of huge worldwide sales. But if you’re looking at low volume sales in a limited market, your idea may not be worth any significant risk, no matter how good it is.

Profit Options

Your two broad options for profit are:

1. Aim for a licensing (or royalty) agreement with a company.
2. Make and sell the product yourself, either alone or as part of a joint venture with a
partner or another company
3. Make a business of developing your invention.

A licensing agreement is probably the best option for most inventors and most inventions. But your chances of getting one are likely to be much improved if you’re prepared to assume some kind of entrepreneurial role, such as option 2 and 3.

Licensing - the royalties route:

Unless you’re already in business or have a burning desire to jump ship and be your own boss, you’re likely to prefer to reach a licensing agreement with a company.

This means you grant a company the exclusive right to use your intellectual property for a fixed period, during which they produce and sell the product made from your idea. Your reward is an agreed percentage of sales known as a royalty. (And a royalty is ALL you’ll get. Contrary to popular belief, it’s extremely rare for companies to give inventors large pre-sales lump sums even if they’re to be deducted from future royalty payments.)
For many inventors the big advantage of licensing is not that it necessarily offers the best prospects of getting the product to market (it may offer the worst) but that it offers the lowest personal risk.
On the other side of the fence, most companies now can’t afford in-house R&D, making them more willing to look outside for new ideas. Although that normally means licensing in existing products from other companies (this could be you if you start your own business!), it also creates opportunities for licence-hungry inventors

In broad terms a licence protects you by making the company reward you for the use of your idea and protects the company by preventing you from then selling your idea to others (unless the licence specifically allows it).
It enables either of you to take action against others who steal or copy the idea.
If you’re not the sole owner of the idea: ALL its owners must agree to the granting of a licence. It only takes one ‘difficult’ co-owner to give you two problems: an idea going nowhere, and a power game that has to be resolved. It happens a lot, so be careful in your choice of partners

Royalties calculation

You have to remain realistic about financial expectations. The royalty calculations below are based on reality in the commercial world.
Most royalties are expressed as a percentage of the product’s net sales price. But though that’s an easy calculation to make and verify, it won’t help you establish the value of the product for negotiating purposes and is thus no guide to the royalty percentage you should get.

A solution is to calculate your opening royalty bid on your estimate of the product’s likely gross profit per unit (selling price minus manufacturing cost) and probable market size, as both are relatively easy to estimate and a much better indicator of value.
Basically, the bigger the potential gross profit per unit, the higher should be your royalty percentage. For example: if your product can be made for a penny and sold for a pound, there is far more profit and thus more scope for a high royalty than if it costs 50 pence to make but still can’t sell for more than a pound. Next estimate the size of the probable annual market for your product. A product that can potentially sell in huge numbers for several years has a higher value than a product with the same gross profit per unit but only a limited life in a small market.

Once you have a clear notion of your product’s overall value, don’t bid for too high a share of gross profit as the company’s eventual net profit will be much lower. Your best shot is likely to be 10-25 per cent of gross profit per unit. For a company making a 20 per cent gross profit, 10-25 per cent of that gives an eventual maximum royalty (it may in practice be much lower) of 2-5 per cent of net sales price. Very few companies make net profits of over 10 per cent, so to get a significant share of that is a considerable achievement.

A worthwhile refinement is to accept or even suggest a sliding scale of royalties based on the total royalty income involved. For example: 7 per cent up to £20,000-worth of royalties, reducing to 5 per cent between £20-50,000 and to 3 per cent when your total royalty income exceeds £50,000. This (a) shows that you acknowledge the company’s falling profit per unit as sales rise and (b) demonstrates your willingness to be flexible in everyone’s best interests.

What can be licensed?

Any intellectual property, including: Know-how or confidential information. Copyright works. Shapes and patterns. Patents for inventions or improvements. Trade and service marks.

When trying to reach agreement with a company, you MUST include EVERYTHING. It’s quite possible to have a blockbuster agreement with a separate licence - and a separate royalty - for all of the above. No one can predict how the different components of your intellectual property will change in value over time - like a little-known trade mark that becomes enormously valuable later - so NEVER be persuaded to exclude anything ‘minor’ from your licensing agreement

Licence or business start-up?

Many inventions suit licensing or business start-up equally, so it’s down to your choice. Some inventions however are much better licensed.

For example: ‘Add-on’ inventions dependent on an existing product. Your best (and perhaps only) bet is usually an agreement with the company making that product, or
products whose manufacture is unavoidably expensive to set up.

Other inventions may fare better as business start-ups.
For example: Products in ‘knowledge or creative’ industries where small players can thrive such as software or Cheap-to-make products which depend primarily on astute marketing, or Conviction’ products that an entrepreneur believes will succeed if marketed in a way that other companies can’t or won’t try.

Remember even if you prefer to start your own business, licensing out your product, once it’s successful can widen your markets, increase your profits and limit your risk.

2. Starting your own business venture

If you've tried and failed to get a licensing deal with a company, a good positive move is to consider starting your own business, making and selling the product of your idea.

That means you’re no longer an inventor waiting for something to happen; you’re an entrepreneur making things happen. For many inventors this shift in thinking and behaving is the key to success.

Starting your own business venture needn’t mean giving up your existing job, and it certainly doesn’t mean abandoning your goal of a licensing agreement. If companies say ‘We like the idea but don’t think it will sell’, all it may take to change their minds is some proof of sales. For many products that involves setting up only a very small business that you can run in your spare time from home.

But for anyone running any business, survival has to be the number one priority. Entrepreneurs may be risk-takers, but good entrepreneurs limit their risk as much as they can. One, who started his business in a chicken shed and is now a multi-millionaire, says: ‘If you want to be successful you must first avoid failure. You can’t hope to get it right if you don’t first reduce your chances of getting it wrong.’

Your initial goal should therefore be to operate a business for only as long as it takes to find out if your product sells. You’re out to prove a point, not make a profit. And if the product doesn’t sell, you must be able to get out fast with minimal loss.

You can start your own business venture in three ways:
On your own, with partners, or as a joint venture with another company

A large company might help develop your product so that they can better assess it, but if they then don’t see enough profit potential they may dump it. A more meaningful joint venture is likely to be with a smaller company, who might want your idea more but be reluctant to take the plunge into full, expensive commitment. Your willingness to lighten their load could make all the difference. For example, if you can handle marketing they save thousands of pounds immediately.

If you get such a joint venture opportunity, consider it very seriously. A company’s involvement can dramatically increase your product’s market potential AND reduce your exposure to risk.

3. Make a business of developing your invention.

Whatever your idea, you’re more likely to get the support you need to succeed if other people - companies, potential partners or investors etc - see you make some significant commitment to your idea. Without it you’re unlikely to get any matching commitment from them. The best way to convince them of your commitment may be to run the development of your idea as a business.

That needn’t mean giving up your day job unless you actually want to change your lifestyle. It’s relatively easy to run a very small, home-based business in your spare time. Even if you prefer to license your idea to a company it can be a good idea to set up a temporary business with the limited aim of achieving a licensing agreement.

The key advantages of operating this kind of temporary business are:

Many of your expenses become tax deductible.
Companies and others will take you more seriously.
You avoid the deadly ‘garden shed inventor’ label.
You’re more eligible for grants and support schemes not normally available to individuals.
It’s the most convincing form of market research. If you make sales, you can then show companies hard evidence of the value of your idea.
if the product doesn’t sell, you can get out fast with minimal loss.

Note:

This fact sheet is mainly based on the NESTA Inventors' Handbook, http://www.nesta.org.uk/ which is copyright to © 1999 Peter Bissell and Graham Barker (ex staff member). We highly recommend this site and their book, "The Business of Invention" (ISBN 0951 3856 31) to any inventor, as it is the best we can find relating to turning inventions into a business in the UK. This copyrighted material should not be used for commercial gain without the prior permission of the copyright owners being sought.