In any gathering of inventors, there will be a group of inventors who exclaim, “You can't make money licensing your invention!”
Is this statement right or wrong? It depends upon you, your invention, and your goals.
My Take on Licensing vs Building a Business (DIY)
Successful inventor David Lieberstein is a proponent of the DIY (do it yourself) approach – not a big fan of licensing inventions. Mr. Lieberstein has had great success with building businesses around his products so, it's not surprising he would favor the DIY option.
Stephen Key, on the other hand, has had much success in licensing his products – Mr. Key advocates for licensing your product as the better path forward. Your view on this matter is clearly colored by your own experience.
I have done both so I can offer a different perspective on the question of licensing versus the DIY approach. My opinion is that licensing is a better option for most inventors than DIY.
Clearing the ‘Fog' – Two Myths of Inventing
In every business there are myths that are like fog – they keep you from seeing the landscape around you clearly. Here are two of the biggest myths in inventing:
- You will always make more money if you DIY – because you keep 100% of ‘profits'
- Licensing is a ripoff for the inventor – he/she only gets 5% of the ‘profits'
Both of the above statements are false and confusing, but are widely believed by many people, so let me restate the accurate reality (assuming the licensor is paid a 5% royalty):
- When you DIY your invention – you may keep 100% of ‘net profits'
- When you license your invention – you may be paid 5% of ‘net sales'
It turns out that many people misunderstand gross profits, net profits, gross sales, and net sales.
Net profit is what is left after everything and everyone else has been paid in your business. A successful product-based business may have a gross profit margin of 30%, but a net profit margin of perhaps 10% – so on $ 1 million in gross sales, you might have $100,000 in net profits. If your business is a corporation, you pay yourself a salary (part of your costs) and you generally reinvest a portion of your net profit into growing your business – sometimes most of it. A ‘wise' owner of a $1 million business may typically pay herself $50,000 in salary.
Feels like you're not keeping much of the net profits, after all!
On the other hand, when you license your product, the royalties paid to you from net sales are, effectively, your salary – you can do whatever you want with the money. Few companies would choose to license any invention unless they feel net sales will exceed $1 million – most would prefer $10 million – $50 million or more in net sales. The risk in any new product is high, so they expect the rewards to be commensurate with the risk.
If you your licensed invention has $10 million in net sales and you had a 5% royalty, you'd be paid $500,000. That is a pretty good deal for the inventor in my opinion.
Of course, all of the above figures are examples only. There is no guarantee that a DIY business owner will achieve $1 million in gross sales (or any sales) or that a licensed invention will achieve $10 million in net sales (or any sales). In business, nothing is ever guaranteed.
Two Different Models of Success
A very successful inventor running a DIY business might be able to pay himself a salary of $200,000 – which is certainly lucrative. But, he probably works 50 or 60 hour each week, he must work closely with Chinese manufacturers, retail store buyers, must maintain warehouse space, hire and pay a staff of employees, oversee or delegate every aspect of his business. He almost certainly must service debt in the form of bank loans, business credit cards, etc. Every year, inflation chips away at his net profits: manufacturing, packaging, distribution, labor, and overhead expenses all will increase. He must grow his business continually to maintain a healthy profit margin or he will soon be out of business. It's very likely that his employees have much more vacation every year than he does.
His successful business enterprise is indeed an asset that he may sale years later and become a millionaire – and that's not a bad prospect. But, in the meantime, he is effectively a high-paid employee with many headaches and never-ending responsibilities.
A very successful inventor who has licensed her invention to a large company, on the other hand, may live a very different lifestyle. Her royalty is her paycheck and it may be quite lucrative if her product sells well in the marketplace. She may make $200,000 or more per year in royalties. She has transferred all of the headaches to the licensee company. She has no employees, no warehouse, doesn't have to worry about working with retail buyers or Chinese manufacturers.
In fact, she can spend her time however she pleases. She can take several vacations each year with her family, make investments, perhaps work in her yard whenever she wants, spend time on hobbies – or she may devote time developing her next invention.
For as long as her product has successful sales in the marketplace, she has a degree of time freedom that very few people do.
That is why I much prefer to license my inventions!