What Is Licensing? Advantages and Disadvantages

what is licensing

One of the most passive and lucrative ways to make money is licensing your product, idea or service. In fact, it can be considered one of the fastest ways to become a millionaire. In this article, I will talk more about licensing and what you need to know about it.

So, what is licensing? Licensing is a legal agreement made between a licensor and a licensee. The licensor is the owner of a product, idea or service. The licensee is the organization that will manufacture, market, and sell a product, service, or idea. In exchange for the rights to the product or idea, the licensor will receive a royalty. 

Day after day, we walk to our mailboxes with slumped shoulders to pick up piles of paper – envelopes stuffed with bills we wish we didn’t have to pay, store flyers selling things we don’t necessarily need, and offers for yet another credit card with superior incentives to the five we already have tucked away in our wallets.  

Getting the mail isn’t as fun as it used to be.  

But imagine that slumbered stroll to the mailbox on a Tuesday afternoon didn’t only reward you with a reason to walk a few steps further to recycle those pesky piles of paper. This time, the envelope you’ve been waiting for has finally arrived – your first royalty check. And what exactly did you have to do to collect that money? Not a thing. It becomes a form of passive income. 

That’s the beauty of a licensing deal.

Every time someone buys your product, you get paid. But before you sign on the dotted line, there are some important things to know about licensing agreements, including the advantages and disadvantages, how to go about finding the right company, and a few important steps you’ll want to take as you consider your options. 

Starting a Business or Licensing: Which is the Right Choice for You?

You’ve likely been on quite a journey if you are considering a licensing deal, having gone through the new product development process and determined that your product or service is ready to go to market. 

At this stage, the primary decision you will need to make is whether to start your own business or license your product to another company. Much of the decision lies in how much control you want to retain, and whether or not you have the necessary resources to start your own business. 

In either case, the goal with all products and services is, of course, to make a profit. An important consideration is whether or not you will be able to bring in more revenue by starting your own business and producing the product or service yourself, or if licensing to another company is going to provide you with a more significant return for all of your hard work (Abedi, 2018).  

Why Licensing is a Great Option

Often, licensing is a more lucrative choice for certain products and industries, especially when considering the costs of starting a new business (both time and money), and because licensing gets your product or or service in front of an already established customer base and much wider audience (Abedi, 2018).  

Let’s say, for example, that you’ve invented a snack cup for kids that not only prevents spilling, but also contains multiple compartments for a variety of snacks.

Your design is simple enough that kids can choose the snack they want, and just complex enough to prevent goldfish and cheerios from spilling all over the floor. You could certainly start your own business and create an in-depth marketing plan to reach your target audience and sell your product.  

But, if you market your idea to an already established, well-known company who already has a presence within your target market, it is likely that you will do much better in the long run, and you avoid the risk and responsibility associated with starting your own company (“Getting Started as an Entrepreneur,” 2019).  If your product does well, licensing can bring in quite a bit of income with little to no effort on your part. And, the company benefits too – they’re also making a substantial profit with a new product line, something companies need in order to continue to compete in the marketplace.  

Still, there are certainly pros and cons to both alternatives, so it’s important to weigh your options carefully if you do decide to license your product or idea and take some necessary steps before entering into a contracted relationship with a licensee. 

The Purpose of Licensing

The main purpose of licensing is two-fold. On one hand, well-established companies have access to capital, expertise, and experience in an already established market.  (“Product Licensing,” n.d.). As a startup business, you will need to either seek investment from others to fund the production of your product or put forth your own money to do so. This can take a considerable amount of time and expense – and, it can be risky.  

Secondly, a larger, profitable company will be able to manufacture in greater quantities and market your product on a much larger scale – to a much wider audience – something smaller, independent companies are not as equipped to do (Weston, 2019).

In essence, the reason a licensing deal seems like an obvious choice is because you collect a percentage of the revenue generated, and you do not have to do any of the work. You can sit back, relax, and check your mailbox for that ever-elusive return on your investment as the funds begin to roll in.  

Patent Protection for Ideas and Inventions

With licensing, you are essentially selling your intellectual property, your ideas.  So, before you enter into an agreement, you’ll first want to check to ensure that your product is eligible to be protected by a patent – and register with the United States Patent & Trademark Office. There are various types of patents, most commonly utility and design – the former specific to the functional aspect of your product, and the latter to the aesthetic appearance or design. A patent protects you by ensuring that others cannot make, use, or sell your invention without penalty (Purvis, n.d.).

An additional purpose of a licensing agreement is to ensure that the rights of both you, the licensor, as well as the licensee are protected by law. By entering into a contracted relationship, your patented technology or product cannot be violated by the licensee (the company to which you are entering an agreement) without penalty.  The licensee is also protected and permitted to use your patented technology, idea, or product for as long as your agreement allows, provided you are given the established royalty fee at the agreed upon time (“All Kinds of License Agreement Templates,” n.d.).

Advantages and Disadvantages of Licensing

One of the biggest advantages for a licensor is that it allows you, the creative genius behind your invention, to continue to do what you love: come up with new ideas for innovative products or services. You won’t have to worry about starting or running your own business, or the manufacturing and marketing necessary to become profitable. And, having already forged relationships with well-established companies can open the door for further opportunities down the line.  

Advantages to LicensingDisadvantages to Licensing
You will not need to incur the costs of producing, promoting, packaging, or selling your product.  You will likely lose control over your product, including promotion, packaging, and selling.
The licensee already has knowledge and know-how as it pertains to breaking into an already established market, so there is no risk to you.You will only receive a portion of the profits from the sale of your product, as outlined in your agreement.  
Depending on the terms of your agreement, your royalty payments can last a very long time.If your product does not sell well, you will not receive royalty payments; or, it may take a while until you receive a payment, depending on your agreement

Much of the decision pertaining to whether or not you choose to license is dependent upon your goals.  If you prefer to have complete control over your invention, including branding, promotion, and packaging or design, you may not want to go the licensing route because you will likely lose control over these aspects.  

If, however, you’d prefer not to risk financial loss if your product does not do well, and you are more interested in creating other new products or technologies, licensing can certainly benefit you more so than starting your own company.  

Types of Licensing Agreements

The most common type of agreement for independent entrepreneurs will fall under the patent license category (“All Kinds of License Agreement Templates,” n.d.). In the simplest of terms, you are allowing some entity to use your intellectual property – your idea or invention – which you have taken steps to protect via a patent.  You are essentially granting permission to reproduce what you have created, whether that is a tangible product or design, or an intangible idea.  

Licensing agreements can also come in the form of trademark agreements, copyright material, technology licenses, and trade secret agreements.    

Examples of Licensing Agreements

Type of License AgreementDefinitionExample
Patent LicenseThe licensee gains the right to use your patented intellectual property (IP) for a fee (royalty).Tangible products or ideas created by a company or independent entrepreneur
Trademark LicenseThe licensee gains rights to utilize your trademark in connection with specific goods and services.Design, artwork, fictional characters for use on other products
Copyright Material LicenseThe licensee gains rights to use material developed or created by a licensor.Educational resources and materials; branding or logos
Trade SecretsThe Licensee is required to disclose use of trade secret information that is deemed secret and has commercial value over other businesses or organizations.Formulas, patterns, information or processes, etc., as well as designs, prototypes, programs and/or codes
Technology or Software LicenseThe licensee is granted permission to use the licensor’s technology or software programs, and will often also receive related services (training, maintenance, and support).Computer programs and the code therein (the code, as stipulated by the licensor, may or may not be altered, as specified by the owner of the technology)

Many times, licensing categories overlap and are not mutually exclusive.  Most importantly, the agreement should include the description of the product or service being licensed, the license grant, which provides license for use of the intellectual property or asset, the obligations of both parties, and most importantly, the agreement of financial arrangements, both minimum payments and royalties on sales as well as the minimum sales target and timeline (“All Kinds of License Agreement Templates,” n.d.).

Licensing with the Right Company

All companies are not created equal in this equation.  It’s important to do your research if you do plan to license. You want to ensure that the company you market your invention to is one who will best be able to produce, market, and sell you product or service (“Getting Started as an Entrepreneur,” 2019).  Find out about the company’s sales, product lines, and market and determine how you will fit into their structure.  

The company should also have products in the same category. If we go back to the example from earlier about a snack cup for kids, you may consider seeking a licensing agreement with an established baby or toy company who is already successful in the market. You don’t want to compete with products the company is already producing, but rather add to the value of the existing product line (“Getting Started as an Entrepreneur,” 2019). In this way, you are much more likely to land a lucrative deal. 

Licensing Versus Franchising

Where new services are considered, it’s a little bit different that the process of obtaining a licensing deal for a product or idea. A franchise, unlike a license agreement, refers to granting rights of use for service companies or business models rather than products. While similar in idea, the two are not quite the same. 

The main difference lies in the idea that licensing refers to granting another entity permission to utilize your invention, idea, or technology in order to create a product that will benefit (via revenue) both parties in the agreement. It is generally a one-time transfer of intellectual property. A franchise, on the other hand, involves ongoing assistance and a mutual relationship between two parties (Sharma, n.d.).

As the owner of the business model and branding for your service, you would be deemed the “franchisor.” A “franchisee” is the person or persons who will then sell your service to an additional customer base in a separate location. The franchisee is granted permission to use your business model, as well as your name and branding, in order to profit from selling your service as an independent branch of a parent company (Sharma, n.d.). As the franchisor, you exact a fee from the franchisee for use of your service idea.

The simplest example of a franchise agreement can be seen in the fast food industry.  If you walk into any McDonalds or Dunkin Donuts, you will see a very similar if not exact business model, branding, and product line. These details are dictated by the franchisor. While the franchisee runs the day to day business operations, the franchisor has considerable control over the process. In this way, the franchisor retains more control over the service than a licensor would over the manufacture of a product (Sharma, n.d.).

Advantages and Disadvantages of Franchising

The benefits of franchising are similar to that of licensing. The franchisor does not incur the cost of developing branch locations – that is the responsibility of the franchisee, though there is generally required some level of training and support. The risk in expansion is lowered exponentially, especially as it pertains to entering global markets Sharma, n.d.).   

The reverse disadvantage, however, can occur in the management of quality control. It is much more difficult for the franchisor to oversee the quality of the service. However, the ideal situation is that the brand name itself represents the quality customers can expect, no matter the location (Sharma, n.d.). 

Licensing and franchising are both simple and simultaneously complex. A lot goes into the end result, and the decisions about how to proceed should be made with caution. It is generally recommended that you seek the assistance of an attorney who is well versed in areas of licensing agreements to ensure that your agreement is properly negotiated.  

Final Thoughts

Perhaps long gone are the days when we’d run off to the mailbox after school, frantically searching for a single envelope with our names on it, the one that just might be hiding a crisp, candy store worthy five-dollar bill from Uncle Ted in Florida.  

But this envelope is even better.  

Once you’ve landed a licensing deal, that shoulder slouching stroll to the mailbox after a long day will once again be reminiscent of your childhood – only this time it is a white business envelop holding a much more lucrative sum than those five golden dollars from years before.  All you need to do is check store shelves for your invention, watch your sales, and wait for that golden ticket to arrive – your first royalty check.  


Abedi, K. (2018, October 22). So You’ve Invented Something… Now What? (Licensing Your Product). Retrieved from https://sites.psu.edu/entrepreneurshiplaw/2018/10/22/so-youve-invented-something-now-what-licensing-your-product-agreement/.

All Kinds of License Agreement Templates Download. (n.d.). Retrieved from https://www.agreements.org/licence-agreements/.

Getting Started as an Entrepreneur/Plan/Licensing as Part of the Plan. (2019, April 29). Retrieved from https://en.wikibooks.org/wiki/Getting_Started_as_an_Entrepreneur/Plan/Licensing_as_Part_of_the_Plan.

Product licensing. (n.d.). Retrieved from https://www.infoentrepreneurs.org/en/product-licensing/#2.

Purvis, S. A. (n.d.). Basics of Patent Protection. Retrieved November 13, 2019, from https://www.uspto.gov/sites/default/files/about/offices/ous/Cooper_Union_20130604.pdf.

Sharma, D. (n.d.). Franchising and Licensing. Retrieved November 13, 2019, from https://www.academia.edu/39699767/Franchising_and_Licensing.

Weston, B. (2019, March 21). Product Licensing for Beginners. Retrieved from https://www.score.org/blog/product-licensing-beginners.