Byline: Vicki Dallas, Esq.
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Apparel companies are now, more than ever before, recognizing the great potential in having a global presence. Licensing is a cost-effective way for small to medium-size companies to “plant their flag” overseas, without launching speculative joint ventures or wholly-owned subsidiaries. As a licensor, a company can springboard off a local licensee that has the expertise and presence in a particular brand category, with the critical knowledge of local markets and tastes.
Licensing represents a way to move a brand into new businesses, new geographical markets and new distribution channels that otherwise would be unavailable without making a major investment in new manufacturing processes, machinery, or facilities, while maintaining control over the brand image.
Licensing in global markets offers important advantages, but apparel companies should keep a number of other factors in mind, such as the many cultural, linguistic, political, legal and financial differences that exist in different countries.
1. Brand identity. First and foremost, an apparel firm seeking to become a licensor must evaluate whether an international licensing arrangement will enhance and improve the company’s brand. Putting the brand into the hands of an overseas licensee requires proper due diligence, as there is potential for brand damage.
The company needs to be sure the licensee can create and deliver products that are of the agreed upon quality, whose goals for the brand coincide with those of the licensor, and who will be a true partner in furthering the licensor’s brand identity. Also, apparel enterprises run the risk of creating or strengthening a potential competitor should they decide to enter that market on their own in the future.
It is also important to understand and limit the time commitments that will be involved from a creative and management point of view, and that the proper person in the company is in charge of the international licensing program.
2. Selecting a licensee. After thoroughly assessing the new market’s potential, compile a list of promising licensee candidates. International trade show organizers and trade associations can be helpful in identifying and assisting with due diligence. If possible, try to speak with the licensee’s past customers. Search for feedback on the licensee, for example, through the internet or in trade publications.
After meeting a prospective licensee, preferably in person, try to work with the prospective licensee on a trial basis if possible, and trust your intuition. The company also needs to evaluate whether the licensee has the financial strength to perform its obligations to promote the identity of the brand in a manner that will satisfy the stated objectives.
Key issues to address include: which products and trademarks are covered, the royalty arrangements and design fees, whether the arrangement is exclusive or nonexclusive, and the definition of the design and approval relationships relating to the products and product promotions. If any training is involved, any extra fees or charges need to be identified. Advertising and other financial obligations need to be clearly defined.
Performance metrics should be addressed and incorporated into the agreement to ensure performance goals are met by the licensee. The licensor will also need to retain rights to police the quality control of any licensed products to ensure brand integrity. Other licensor considerations include retaining approvals over manufacturing, distribution channels, and advertising and promotion programs.
3. License grant. The initial step is to define the products and trademarks to be covered and the rights to be granted in the license agreement. A licensor can control the scope of the license by including and excluding certain products and trademarks, incorporating exclusivity and territorial restrictions, and limiting assignment and sublicensing arrangements.
4. Territory. A strong licensee in one country is not necessarily a strong licensee in another. Care should be taken in defining the territory and determining if the territory is exclusive or nonexclusive. Provisions prohibiting licensees from sublicensing or selling into other territories should be included as well.
Since the brand is the most important product, in addition to making sure translated materials are accurate and properly credited, a licensor should always take the time to register its trademarks and copyrights in the countries in which it plans to license its products. Although it is expensive, it is cheaper than buying those rights back from squatters.
5. Royalties and other payments. Most licensing arrangements include initial up-front payments that are generally nonrefundable license fees, used to compensate the licensor for the costs of investigating the licensee and covering documentation costs, and which may or may not be creditable to future royalties. The main source of revenue for the licensor is a royalty fee, and this fee may be fixed or varied based on a percentage of sales or other factors. Royalties are typically structured with minimum payments to ensure that the licensor will have a reliable royalty stream.
Royalties based on gross sales or net sales are generally favored by both licensors and licensees. From the licensor’s point of view, gross sales and net sales are harder to manipulate (in contrast to royalties based on net profits that may be manipulated by the licensee, often leading to litigation), and from the licensee’s point of view, the licensee can avoid disclosing profit information to the licensor.
Another method of calculating royalties is to use gross profit, whereby the cost of goods sold is subtracted from gross sales, which generally includes directly allocable expenses, such as manufacturing expenses, raw material costs, and direct labor costs. An upside of this method is that the licensor can take advantage of increasing profit margins. Another royalty option is to use a flat per unit royalty on products sold.
The license agreement may also contain advertising and promotion payment minimums. In all cases, the licensor will need to retain audit rights to verify the accuracy of the licensee’s accounting for royalties and other financial obligations. The currency and payment methods — such wire transfer or other methods — also need to be designated, and it is important to be clear on which taxes may apply against sales and royalties.
6. Approvals and other controls. The licensor will want to include provisions in the agreement allowing the licensor (or a designated representative or agent) to have periodic inspection rights of the manufacturing facilities to ensure the quality of the goods produced, and also to monitor whether the licensee is counterfeiting or otherwise engaging in illegal or unapproved labor or business practices. Even if a licensor is not likely to conduct such inspections, including these provisions is prudent.
7. Term and termination. The duration of the agreement is negotiable. If the licensee is planning to make a substantial investment in launching the brand overseas, it is not uncommon to have a 3-, 5-, or even 10-year agreement, with options to renew. This is often balanced by the licensor with a minimum sales requirement to ensure that the licensee will be actively marketing the licensed products. The duration of the license, and any renewal provisions, need to be clearly set forth in the agreement.
If the arrangement does not work out and the licensor wants to terminate the agreement before the expiration of the term, clearly defined termination provisions need to be included in the agreement. As is the case in other agreements, the parties should be able to terminate the license agreement upon the occurrence of a material breach.
The licensor will also want to reserve the right to terminate the license if the licensee is not performing to the minimum performance thresholds. The termination provisions should instruct the parties on what occurs upon termination and should address the return of all proprietary materials to the licensor. If the company is an American enterprise, it will want any disputes handled in the U.S. It is very important to specify the choice of law and to have the licensee consent to U.S. jurisdiction in the agreement.
Also, carefully consider specifying a third-party arbitrator that is experienced in the type of products being licensed to resolve any disputes that may arise, and include awarding attorney’s fees to the prevailing party in the arbitration or proceeding.
Key takeaways International licensing is an important way for an apparel company to increase profit and diversify revenue streams. A licensor can exploit its brand presence by expanding into new product categories, gaining access to new technology, resources, markets and geographic areas. A well thought out international licensing strategy, incorporated into a written license agreement, is a key tool in implementing a successful international strategic licensing program.
Vicki Dallas is a shareholder in the Buchalter Nemer’s Corporate Practice Group.