A licensing deal gone wrong
I know that in spite of my many warnings to the contrary, a lot of people are hot for licensing deals. In that vein, I found a cautionary tale in the form of a series of blog posts which provides a detailed description of a licensing deal gone wrong. I decided to feature it with the hope of preventing something similar from happening to any of you. First I will try to summarize the situation, then include comments from Rebecca (the author of the work) and then close with my comments.
Ed has a track record in the apparel industry as a successful sales rep for DC Shoe (later sold to QuickSilver) and then a product manager for Converse. Rebecca is married to Ed and wrote the story of their venture into licensing a bubble gum idea. The story starts here, at the close of each entry is a link to the next entry in the series so it’s nicely organized if you want to read it sequentially.
Circa 2000, Ed came up with an idea for a bubble gum product designed for the skate market. He wrote a business plan, got some investors, incorporated, hired employees and within three years, the products were sold nationally and in 12 different countries. They decided to exit this venture based on conflicts with partners and investors. In the end, Rebecca summarizes the three years of their biggest mistakes with:
He [Ed] called up his sales rep and told him he wanted to run with the bubble gum idea and offered to make him equal partner. That was our first fatal mistake. It’s one thing to have a good idea, it’s quite another to turn it into an actual product, let alone an actual company. No, we were not wise enough to pay ourselves first. We sold our house, used the profits to help us get by, ran up the credit cards, cashed out insurance policies and 401Ks, we were even crazy enough to have a baby. So when the fingers started pointing and the money ran dry, we had no choice but to look for a job that would put food in our mouths.
The above is the story before the story, the stage setting as it were. Ed and Rebecca abandoned this project and moved onto their second venture, producing a chewing gum designed to appeal to the NASCAR crowd. Here she says the fatal flaw was the single product problem. Rightly, most buyers aren’t interested in a single product. This is why Ed thought this time it would be better to partner with an existing confectionery manufacturer. Initially the firm seemed to be interested to the extent they had Ed sign a confidentiality agreement but as negotiations progressed, terms became tighter and more restrictive. As Rebecca said, “At one point, the representative from Impact [the manufacturer] told Ed ‘Why do we even need you guys? We’ll just give it a new name and do it ourselves.'”
And they did. The manufacturer borrowed the concept, created a similar name and logo complete with a NASCAR license. After their failed first experience, Ed and Rebecca decided to find an attorney who would take their case on contingency and sue. After a year of wrangling, the suit was filed. Merits of the case and discovery were mixed. While in initial discovery, the manufacturer claimed the NASCAR gum project flopped at market. If the [hijacked] product failed to perform, financial damages would be limited. The manufacturer claimed they only sold a few hundred thousand dollars worth of product and said buyers changed their minds because the product looked like chewing tobacco.
Next in the story (over several entries) are lots of legal shenanigans. The attorney turns out to be a dud acting with what appears to be malpractice. They decide to sue her and pursue the original case with a new attorney. After the second attorney drops the ball, they decide to pursue the case themselves as pro se litigants. After several more entries, the case is in stasis. I actually read the whole thing, it’s quite compelling. At the end of it, I wrote her and asked:
If you knew then, all that you know now, what would you do differently? This may seem an obvious question. Of course you wouldn’t have trusted Impact, Susan [the first attorney] and avoided entanglement with Dylan [previous partner] etc. You don’t owe me an answer of course but I’m interested in how you might have proceeded at the outset of your venture.
Rebecca -who agreed to participate- responded:
To generalize what we would have done differently at the outset of our business; we would have been more selfish. It seems an ugly thing to say, but it is necessary if you want to protect your company so that it has a chance to succeed.
We would not have given our partner an equal share. That was a mistake we should have easily avoided, because we knew he would not put in an equal amount of effort. Nonetheless, we were trying to be “fair” and avoid any ugliness… not realizing the ugliness he could cause later as equal partner. We would have chosen our investors more carefully. We were so eager to get the company off the ground, we basically took money from anyone. Most were inexperienced investors, and considered themselves emotionally invested in the company as well. My husband spent too much time trying to manage his partner and investors – it took him away from managing the company.
We would not hire friends. We would not make our employees our friends. There is nothing wrong with being friendly, but we would keep it on a more professional level.
As far as strategic partners, again, we would be more selfish. Look for a partner who has more to offer you, rather than vice-versa. Leave room to get out of, or alter, the relationship as the company grows. The partner you team up with at the outset of the business might not be right for the company five years down the road if the company is successful and ready to grow. You cannot predict what your needs will be in the future, so you need an exit strategy.
Be very familiar with any contracts you sign. Know what you are signing. Don’t assume anything. It is easiest to work with the same documents over and over so that you are familiar with them and consistent. If your business associate wants you to sign their documents, read it over carefully, or have your attorney go through it point by point.
Also, own at least 51% of your company. I know that is not always possible, especially with many venture capitalists, but it is a HUGE bonus.
Other than some of what Rebecca said, this is my take on it as it applies to apparel. Over all, I think it was a mistake to start a second company from a compromised position having lost all of their cushion in the first bubble gum venture. I can’t speak to the confectionery industry but in apparel and with seasonal product changes, you shouldn’t borrow money against your house to do it. Proceeds from one season should feed the next cycle of development and production. I don’t mean to imply you should have the expectation of breaking even to include paying yourself a salary at the outset but having a cushion can mitigate a term of discomfort.
I think that getting into a venture on the the basis of licensing a single product is fundamentally problematic especially if the product is a concept rather than one with demonstrable efforts of a tangible prototype behind it. As Rebecca and Ed’s case with a concept only product illustrates (they had planned more products but never got the opportunity to launch them), controls are largely out of one’s hands, reduced to relying on legal instruments. If someone wants to renege, a contract isn’t going to stop them from doing it. Steve Pavelina says assuming a signed contract will be honored is one of the ten most stupid mistakes made by the newly self employed. Being conservative, I personally need control. I only have control if I can manufacture the product myself. With licensing, the manufacture, sales, marketing, and distribution is left up to someone else and you’re still dependent on the party to honor their agreements with you. This is simply too tenuous for me. This is not to say you shouldn’t have a contract under these circumstances, only that you shouldn’t be confident; remain vigilant.
This is not to say licensing isn’t an option but it needs to be done differently. I think you have more leverage if you create the product autonomously and go out and drive up interest and sales. Then you can either ride for what it’s worth, add products to your line up or sell it as a property to another interest. I think it is very smart to develop concepts with the goal of becoming acquired by a larger stable of labels. Big design firms don’t grow by creating new labels themselves. They buy existing properties that hit a segment of the market where they lack presence or have established relationships.
Investors and partnerships can also be problematic as this frank interview I published before from a well known but unnamed designer illustrates. Based on what others have told me and as Rebecca concurs, you shouldn’t hire your friends because you can lose the business and the relationship. This doesn’t mean you shouldn’t hire friends or even partner with them but you must have clearly stipulated boundaries and an exit strategy if issues come to a head. One of our designers told me an interesting story about dissolving her partnership. She said things came to a head one day and she couldn’t take it any more. She sat her partner down and told her “I’m going to name a figure. You tell me whether you want to buy me out for that amount or whether you want to sell it to me.” If you failed to create an exit strategy at the outset, this strategy could work assuming you’re prepared to back it up and leave the business.
One last matter that remains unresolved is whether Rebecca and Ed’s product was viable. I mean this in a very specific way, not knowing anything about the ancillary appeal of NASCAR or chewing gum products. At this stage viability is of secondary concern except as it relates to the potential awarding of damages. The manufacturer claimed that sales bombed after launch because buyers said the product’s packaging looked too similar to packaged chewing tobacco. There is some basis in this claim if it is true; there is significant liability in packaging products to resemble tobacco (it’s illegal to sell candy that looks like cigarettes etc). It seems likely that if the product legality was questionable, the manufacturer could have made a settlement based on the quantity sold and let the matter die justifying this as the reason. As it happens, the manufacturer did express interest in a settlement earlier on but Rebecca’s recitation discounted this reason as a strategy the manufacturer employed to avoid paying more extensive damages. Obviously this bares scant resemblance to what is likely to occur with a licensed sewn product unless it’s unsafe but a manufacturer is likely to avoid paying what you are due if the product is deemed to have limited potential. Sometimes you just can’t know if a product has appeal until it’s launched and marketed.