It's What's Up Front That Counts
Bright and airy as it may be, a third-floor walk-up is not the sort of estate business owners picture as home. Eljenn International Corp.'s Mark Weissman almost got to move out of his a couple of years back, except that just as he was on his way to pick up nearly $4 million for his UltraSwim line, the sale was called off. Well, the prospective buyer was not exactly backing out, but technical questions had come up, and more research was needed. If they were to make the summer marketing season, they would have to radically restructure the deal -- downward. "I didn't quite get rich," Weissman philosophizes, "but at least it was a learning experience."
What the expensive B school of hard knocks taught the 48-year-old chief executive officer was a familiar curriculum: (1) a bird in the hand is worth two in the bush; (2) do not count your chickens before they hatch; and, (3) hire good lawyers. Since larger corporations often enhance their product mix by acquiring the patents and brands of others, this is a course that any small business with proprietary property might audit. In this particular instance, what Weissman learned was that in dealing with a big corporation, especially in a licensing deal, a small company is well advised to insist on getting its cash up front. And, Weissman further discovered, the nuances of licensing are so complex that a negotiations team with clout is not enough. Because the patents and trademarks involved are themselves extraordinarily complicated instruments, a savvy patent attorney is a good investment as well.
The 70-plus-page typewritten tome that eventually granted exclusive world rights to Shulton Inc. -- a subsidiary of American Cyanamid Co., best known for Old Spice toiletries and, in scalp circles, for Breck Shampoo -- to manufacture and market Eljenn's UltraSwim brand of hair and skin care was signed on February 16, 1984. Shulton did not acquire the brand and its patent outright under the terms of the renegotiated license, but instead built in an option to buy later. To seal the contract, Eljenn pocketed an initial, nonrefundable fee of $450,000 -- a far cry from the hefty lock, stock, and barrel payment the Eljenn board had been toasting just a few weeks before. To help bridge the gap, Shulton raised starting royalty rates from the original 2% of net UltraSwim sales to 7%. With that boost, Weissman felt he was looking at a return to Eljenn of as much as $3 million over five years, if all went well. And, if all went exceedingly well, UltraSwim might yet fetch its multimillion-dollar lump sum, since the purchase-option price was pegged to a liberal percent-of-sales formula.
Sad to say, however, after only 24 months Shulton threw in the towel. Its first-year sales of the line, which features a chlorine-removing process Weissman co-invented in 1979, amounted to almost $4 million, less than half of projections. Second-year sales dropped to less than $2.5 million. Even more disheartening, Shulton wasn't much more successful than Weissman had been on his own. Though he started Eljenn in 1979 primarily as a product design-and-development operation, Weissman had subcontracted out the manufacture of UltraSwim and had made some inroads in marketing the line. Sales had passed $1.5 million by 1983, the year Weissman decided to "get out of the marketing business" and let a seasoned pro properly exploit the brand in drugstores and supermarkets around the world.
What with gearing up for production and promotion, Shulton may well have poured as much as $2 million down the UltraSwim drain over the two years it had the brand. While such write-offs may be standard operating procedure among big corporations that willy-nilly acquire licenses on the assumption that one will pan out, the fallow years almost did little Eljenn in. Counting on royalty payments of a good $500,000 for the first year alone, the young company blissfully spent revenues that the postman never brought. Eljenn's two remaining products -- Inner Sense Permanent Wave (still in development) and Purifying Shampoo (just going on the market) -- nearly died aborning. To stem the slide toward extinction, Weissman had to pledge $300,000 on his own signature against the accounts-receivable financing that kept him afloat.
How had the once-lustrous deal turned into dross? Weissman blames the mass-retailing company's stubborn inability to market a specialty item. "They had been reading In Search of Excellence," he speculates. "Everyone was into aggressive niche marketing, and this was 1984, the year of the summer Olympics -- a great chance to kick it off into the swimming niche." Shulton tried to get UltraSwim out in time, but with the late start and a tidal wave of competing new products all aimed at the same date, it was unable to establish beachheads on retail shelves. So Shulton jettisoned its advertising -- but little matter: there were great plans for the next summer season.
For starters, Shulton would offer the trade an early-buy special, to be backed up with flossy floor displays and national print and television ads. "Fine," said Weissman, a consultant under the terms of the agreement, "but what are you going to do over the winter to keep some shelf movement going?" Essentially nothing, was the answer. As a result, Weissman relates, goods stayed on the shelves, and retailers didn't place new orders. When Shulton turned to such soap-selling ploys as money-off coupons and sweepstakes, Weissman sniffed disaster. It confirmed the uneasiness he had felt earlier when Shulton removed the slick marketing expert he had been working with and replaced him with an assistant product manager borrowed from one of the company's fragrance lines.
In a letter to Shulton dated June 14, 1985, a frustrated Weissman chided: "People will buy UltraSwim because they need it, not because it's 50? off. . . . Frankly, I don't understand [your marketing approach]. I'd save all my coupon and contest money," he advised, "and spend it on telling people I had a product they really needed." Not only did UltraSwim have outstanding credibility, he had always argued, but its profit margins were considerably greater than most shampoos. Shulton, not yet turned into the art of specialty sales, spurned both features, "and kept selling it as if it were Old Spice. Big corporations tend to think they know everything, and that little guys who built the product from nothing are rubes."
But Shulton could well afford to dabble in the market. By reducing its initial payment to Weissman from $4 million to $450,000, it also had drastically reduced any fiscal motivation to recover the fee. Nonetheless, the smaller sum had bought Shulton the right to do with the products whatever it wanted (short o fiduciary negligence) until the day the UltraSwim patent expires, October 20, 1998. So there was little legal basis for Eljenn's objections. The only performance standard that had been specified in the agreement was the section that required Shulton to commit from 25% to 40% of actual sales to promoting the brand over the first two years. Section 15, Weissman came late to realize, was, in fact, a Catch 22: as sales declined, the less Shulton was obliged to spend on trying to spur them back up.
Why had Eljenn not required dollar-sales floors, below which the license would automatically be forfeited? It was getting late and he was getting nervous, Weissman explains. "They were asking, 'Are you going to run with us?' We couldn't have done the deal if we tried to lock them into guarantees, so we went along with it. Anyway, the royalties were such nice percentages we thought whatever minimums we put on would be far surpassed." To that he adds unerringly: "We were naive."
And then some, adds businessman Jerome Goldstein, a veteran licenser who served on the Eljenn board at the time. "They had to trade in the guarantees for a bigger up side, but it was totally unnecessary. Management's inexperience allowed it to happen. Once they took it so far into the selling season, they were committed to doing a deal regardless. That's a bad situation."
Indeed, the alternatives were few. Time was running out on a summer-oriented product, and both sides considered the summer Olympics an essential marketing peg. The larger up-front fee would have required the approval of several layers of Shulton's top management, an uncertain, time-consuming process; only an immediate few, however, were needed to endorse the smaller payment. The higher sum also was contingent on clearing up the legal technicalities that concerned Shulton's lawyers, another potential delay. Even then, Weissman couldn't be certain that Shulton would remain interested, or that a competing brand might not pop up in the meantime. Finally, the fact that other big companies such as Johnson & Johnson, Vidal Sassoon, and Olin had already rejected Weissman's licensing proposition dictated playing out the hand then and there. "Besides," Weissman says, "we were enthusiastic, they wer enthusiastic. We figured they'd do a great job. The main difficulty we had was, it went from the money in the bank to almost all the money on the come." But the come never came.
Even if Eljenn had insisted on written guarantees to protect against such misfortune, there is little it could have done in practice.As is often the case, licensees like Shulton don't have to pay the guaranteed minimum just because it's written in a five-pound document. They have to pay it only if they want to keep the license. So when a product falls disappointingly short of sales projections, most would just as soon dump the license as throw good money after bad.
For a small company, there is, however, at least one effective alternative to cash guarantees: make the licensee's performance a matter of pride. That, for instance, is the strategy of Moleculon Inc., a small Cambridge, Mass., developer of transdermal patches that has begun to license patented products to large companies. Moleculon insists that the acquiring company promote the product under one of its own brand names, rather than Moleculon's. Shulton, it follows, would have worked harder on behalf of Eljenn's hair rinse had it been marketed under, say, the Old Spice trademark.
In any case, after the second summer's flop, Weissman raised the possibility to Shulton of bringing his baby back home, and in September 1985, Shulton agreed to open negotiations for return of the brand. At the time, Weissman says, "we considered whether we wanted to get back into it ourselves, or whether we wanted to find another Big Brother to license it to. We decided that for the same reason we licensed in the first place, we wanted to license it again -- we didn't feel we had the financial resources to manage a mass-merchandised brand." Shulton, it turned out, was holding over a million dollars' worth of inventory that it planned to let dribble out to retailers over the next several years. But Weissman felt his only chance of saving UltraSwim was to get it all back immediately for resale. That, however, would require a bit of cash -- "an amount equal to Shulton's factory cost," according to the licensing agreement. After the persistent Weissman got through, though, Shulton agreed to let him have the lot at discount.
With timing as dramatic as the U.S. cavalry's, to the rescue came Chattem Inc., niche-marketer of such emollients as Mudd facial masks and Corn Silk cosmetics. The $64-million Chattanooga company's researchers studied the UltraSwim brand and became "very excited." The retail market had not been injured, they found, and with two years of proper marketing, UltraSwim sales could be built into the $6-million range.Weissman immediately sensed the specialty-marketing kinship he never had with Shulton. "Their products had stories to them," he says. "Salespeople and marketing people love products with a story."
Even at only 5% royalties (versus Shulton's 7%), the notion was so irresistible that Weissman struck a handshake agreement with Chattem before he had gotten the inventory back from Shulton, and for the next three months, he paid for attorneys negotiating both deals. Although the service comes high (about $50,000 per deal), a good lawyer, he insists, "can get you back several times what he's charging you over what you could have done on your own." Case in point: the attorneys Weissman tapped to do the deed, both MIT alumni who had gone on to specialize in drafting hard-nosed licensing arrangements, were able to place the orphaned brand with unpredicted advantage. The license was reassigned to Chattem this past January, and the deal was sealed with a solid $1.25 million up front, paid as a nonrefundable advance against royalties rather than a simple fee. "We were fortunate," says Weissman, a striking understatement for one who not only had just executed the rare fiscal feat of reselling a defunct brand, but got more for it the second time around.
The royalty rates on net sales are less, but, boilerplate for boilerplate, the arrangement with Chattem is essentially the same as the Shulton deal. Chattem, too, was unwilling to commit to performance minimums, but it made the up-front considerations attractive. Eljenn was able to post the advance on its books as revenues, instantly turning a potentially disastrous '85 into the black. The profit phenomenon is likely to be short-lived, however, since that revenue represents royalties on $25 million of future UltraSwim sales that Eljenn will have to wait out before it can dip into a fresh revenue stream.
To Weissman there is no question of the relative quality of the new arrangement: "A deal where you get the money and it's there is the best deal of all," he concludes. That, of course, is yet to be seen. And it's possible that even the Shulton deal eventually would have been rewarding, inasmuch as the original Shulton marketer put in charge of UltraSwim went on to roll out a cockroach product successfully. But one thing is for sure, as Jerome Goldstein succinctly sums up the bottom line:
"No deal with Chattem, the company folds."