IP · Licensing 11 min read

Licensing your IP: how Texas businesses make money from what they own.

Most Texas businesses with valuable intellectual property either don't license it (and leave money on the table) or license it without proper structure (and create the disputes that destroy the value they hoped to capture). The architecture of an IP license, the royalty structures actually used in Texas commercial practice, and the structural decisions that determine whether licensing produces revenue or litigation.

Practice areas this article covers

IP & Licensing Fractional GC Corporate

If you read nothing else

An IP license is a contract that grants permission to use intellectual property in defined ways, in exchange for compensation, while ownership remains with the licensor. Every well-structured license addresses six layers: the grant, scope and restrictions, royalties and compensation, quality control and reporting, improvements and grant-backs, and term and termination. Each layer answers specific questions, and skipping or under-specifying any of them is the most common reason licensing arrangements produce disputes rather than revenue. The royalty rate matters less than the royalty structure — running royalty, lump sum, milestone, or hybrid each fits different commercial situations and produces materially different outcomes. And for Texas businesses specifically, three considerations recur: the franchise tax treatment of royalty income; the federal trademark "naked licensing" doctrine that can destroy a mark when quality control is contractual but not operational; and the bankruptcy risks under Section 365 of the U.S. Bankruptcy Code that few license drafters address until the licensee files Chapter 11.

Call Chuck Kraus: (682) 529-7177

Licensing is the alternative to selling. A Texas business with valuable IP — a patent, a trademark, a copyrighted work, a trade secret, software, or know-how — can transfer ownership through an assignment, retain ownership and exploit the IP itself, or grant rights to others through a license. The license preserves ownership while monetizing the IP through controlled use by third parties. Done well, it produces a recurring revenue stream from an asset that has already been created and protected. Done badly, it produces disputes that consume the revenue, damages that exceed the royalties received, and sometimes the loss of the underlying IP itself.

The earlier article in this series, Patents vs. Trademarks vs. Trade Secrets, addresses what IP rights are and how to create and protect them. This article addresses the next question: once you have IP that has commercial value to others, how do you structure the arrangement that lets others use it while you continue to own it?

The answer, in practice, is the architecture of the license — six structural layers, each answering specific questions, each requiring deliberate decisions that the parties will live with for the duration of the agreement.

The six-layer license architecture

Every well-structured IP license addresses the six layers below. The substance varies by IP type, by industry, and by the parties' commercial objectives. The structural framework is consistent.

License architecture

The six layers every IP license must address

01
Layer 01

The Grant

The grant defines what rights the licensor is conveying to the licensee. It is the central operative provision of the agreement. The grant must specify which IP is being licensed (with sufficient identification — patent numbers, trademark registrations, copyright works, defined trade secrets), which rights are granted (make, use, sell, distribute, display, reproduce, prepare derivative works), and the structural form of the license (exclusive, sole, non-exclusive).

Must address
  • Specific identification of the IP licensed (no general categories)
  • Exclusive vs. sole vs. non-exclusive structure and the licensor's reserved rights
  • Specific rights granted under the relevant IP regime
  • Whether the license includes future improvements or only the IP as it exists at signing
02
Layer 02

Scope & Restrictions

The scope provisions define the boundaries within which the licensee may exercise the granted rights. The most consequential are field of use (the industry, application, or use case), geographic territory, and duration. Vague or ambiguous scope provisions produce most license disputes — the licensee operates in territory or applications the licensor believed reserved, or the licensor encroaches on activities the licensee believed exclusive.

Must address
  • Field of use definition with sufficient specificity to resolve boundary disputes
  • Geographic territory and any reserved territories
  • Permitted channels of distribution and customer categories
  • Sublicensing rights — only if expressly granted, never implied
  • Restrictions on competitive activity by either party
03
Layer 03

Royalties & Compensation

The economic terms — what the licensee pays, when, on what base, with what minimum guarantees, and with what audit rights. The royalty structure (running royalty, lump sum, milestone, hybrid) often matters more than the rate. The base on which royalties are calculated — gross sales, net sales, gross margin — drives the actual cash flow and is one of the most negotiated provisions.

Must address
  • Royalty structure and the rate or amount for each component
  • Royalty base with all permitted deductions specifically defined
  • Minimum guaranteed royalties and consequences of failure
  • Reporting frequency, content requirements, and certification
  • Audit rights, including frequency, scope, and cost-shifting on material discrepancy
  • Withholding tax provisions for cross-border arrangements
04
Layer 04

Quality Control & Standards

For trademark licenses, this layer is determinative — without meaningful quality control, the license is "naked" and the trademark can be deemed abandoned. For other IP types, quality control protects the licensor's reputation and the integrity of the underlying right. Contractual quality control without operational enforcement is treated as no quality control — the licensor must actually exercise the rights it has reserved.

Must address
  • Specific quality standards applicable to licensee's use of the IP
  • Approval rights for materials, products, and uses (if applicable)
  • Sample submission requirements and licensor approval procedures
  • Inspection and audit rights
  • Cure periods and remedies for quality breaches
  • Branding standards and usage guidelines (for trademark licenses)
05
Layer 05

Improvements & Grant-Backs

During the term of the license, the licensee may develop improvements to the licensed IP. The license must address who owns those improvements, what rights either party has to them, and what compensation flows. Grant-back provisions can have antitrust implications if drafted overbroadly — broad grant-backs of all licensee improvements have been challenged as anticompetitive in some contexts. The drafting must balance the licensor's reasonable interest in improvements to its own IP against the licensee's investment in development.

Must address
  • Definition of "improvements" — distinguishing improvements to licensed IP from independent developments
  • Ownership of improvements and any cross-license arrangements
  • Disclosure obligations for licensee-developed improvements
  • Use rights of either party in the other's improvements
  • Compensation, if any, for improvements flowing back to the licensor
06
Layer 06

Term, Termination & Effects

The term defines how long the license lasts. Termination provisions define when either party can end the license before the term expires — for cause, for convenience, on insolvency, on change of control, on failure to meet milestones. The effects of termination — what happens to inventory, sublicenses, ongoing royalties, and the rights themselves — are often inadequately addressed and become the source of post-termination disputes.

Must address
  • Initial term and any renewal mechanism
  • Termination triggers — material breach, performance failure, insolvency, change of control
  • Cure periods and notice requirements
  • Effect on existing inventory, work-in-process, and sublicenses
  • Survival of confidentiality, indemnification, and other key provisions
  • Bankruptcy considerations under Section 365 of the U.S. Bankruptcy Code

Royalty structures and what each one fits

Within Layer 3 — the royalty and compensation provisions — the most consequential drafting decision is the royalty structure itself. The five structures below are the building blocks. Most well-drafted licenses use one as the primary mechanism, often combined with one or more of the others to balance the parties' commercial objectives.

Royalty structures

Five structures, when each one fits, and the trade-offs

Running Royalty
% of net sales or revenue
When it fits The licensee will commercialize the IP at scale. The licensor wants ongoing economic alignment with the licensee's success. Most common structure for patent and technology licenses.
Trade-offs Requires sustained reporting and audit infrastructure. Royalty base disputes are common — particularly around permissible deductions. Risk to licensor if licensee underperforms.
Per-Unit Royalty
Fixed amount per unit sold
When it fits Products with stable per-unit economics where pricing fluctuations should not affect royalties. Common in consumer products and licensed merchandise.
Trade-offs Doesn't capture pricing increases over time without inflation adjustments. Simple to administer. Vulnerable to redefinition of "unit" disputes.
Lump Sum / Paid-Up
One-time payment
When it fits The licensee wants certainty and the licensor wants liquidity. Often used for older IP, specific applications, or where the licensee has resources to monetize. Sometimes structured as paid-up license after a running royalty cap is reached.
Trade-offs Licensor loses upside if the IP becomes more valuable. Eliminates ongoing administrative burden. Single point of compensation creates valuation risk for both parties.
Milestone Payments
Payments tied to specific events
When it fits Early-stage IP that requires further development by the licensee before commercialization. Standard in pharmaceutical, biotech, and certain technology licensing. Aligns compensation with development progress.
Trade-offs Milestone definitions become contested if events occur in modified form. Risk of stalled development killing the milestone schedule. Often combined with running royalties post-launch.
Hybrid Structures
Combination of mechanisms
When it fits Most commercial licenses of meaningful value. Typical: upfront payment + milestone payments + running royalty + minimum guarantees. Permits balanced risk allocation between licensor and licensee.
Trade-offs Increased drafting complexity. More provisions to negotiate. Required when the parties' commercial objectives don't fit a single structure cleanly — which is often the case for high-value IP.

The Texas-specific considerations

Three Texas-specific considerations recur across IP licensing matters and warrant explicit attention in any structure of meaningful size.

Franchise tax treatment of royalty income. Royalties received by a Texas entity for IP licensing are generally included in the entity's total revenue for purposes of the Texas franchise tax under Chapter 171 of the Texas Tax Code. The franchise tax is calculated on the entity's taxable margin — the lesser of total revenue minus cost of goods sold, total revenue minus compensation, total revenue times 70 percent, or total revenue minus $1 million. For licensing-focused entities, the cost-of-goods-sold deduction is typically minimal, and the 70 percent floor often controls. Texas-source apportionment of royalty income depends on factors including where the IP is used, where the licensee is located, and where the activities generating the royalties occur. The apportionment analysis is fact-intensive and the rules have evolved through Comptroller administrative guidance. For licensing structures of meaningful size, the franchise tax analysis should be part of the upfront strategic work rather than an afterthought.

Naked licensing in Texas trademark practice. Texas trademark practice follows the federal "naked licensing" doctrine: a trademark license without meaningful quality control over the licensee's use of the mark can result in the mark being deemed abandoned. The legal consequence is severe — the licensor loses its rights in the mark, not only against the licensee but against all third parties. The mark passes into the public domain. Quality control requires both contractual provisions (a license that establishes standards, audit rights, and remedies for breach) and actual operational enforcement (monitoring, periodic audits, response to violations). Texas trademark licensors who include strong quality control language but never enforce it remain at risk. The cost of monitoring is significant; the cost of losing the trademark to naked licensing is significantly higher.

Bankruptcy and Section 365. Bankruptcy of a licensee creates significant complexity for IP licensors and is one of the most underappreciated risks in license drafting. Under Section 365 of the U.S. Bankruptcy Code, a licensee in bankruptcy can either assume or reject executory contracts, including license agreements. If assumed, the license becomes property of the bankruptcy estate and may be assigned — potentially to a competitor of the licensor. If rejected, the license is treated as breached, and the licensor's claim is for damages rather than the continued royalty stream. For trademark licenses specifically, the Supreme Court's 2019 decision in Mission Product Holdings v. Tempnology held that rejection of a trademark license does not strip the licensee of trademark use rights — the licensee can continue using the mark as if rejection had not occurred. License drafting can mitigate but not eliminate these risks: provisions identifying the license as personal and non-assignable, performance milestones with termination rights, financial covenants, and structural alternatives such as escrow arrangements or holding the IP in a separate licensing entity. None of these provide complete protection — but they significantly improve the licensor's position when bankruptcy occurs.

The royalty rate matters less than the royalty structure. The royalty structure matters less than the field of use definition. The field of use definition matters less than the licensor's actual operational discipline around quality control. The architecture compounds.

What this article cannot tell you

The framework above is the structural architecture every license should address. The specific drafting — the right royalty rate for your industry, the field of use language that fits your strategic objectives, the quality control standards appropriate to your trademark, the termination triggers that match your commercial dynamics — depends on facts that a general article cannot evaluate.

For most Texas businesses considering IP licensing as a revenue stream, the most useful first step is the working session that maps the specific IP and commercial objectives onto the architecture above. That session produces a working direction in fifteen minutes, identifies which structural decisions are most consequential, and surfaces the questions that the licensing strategy will turn on.

How I help

The architecture is the work. The drafting follows from it.

My practice covers IP licensing strategy and structure for Texas businesses — the upfront analysis that determines which licensing structure fits the specific IP and commercial objectives, the architectural decisions that drive the agreement, and the integration with broader corporate counsel work. The work is part of the broader fractional general counsel relationship for many Texas businesses; for others, it operates as a defined licensing strategy engagement.

For matters that require deep IP-specific expertise — patent prosecution, trademark prosecution and enforcement, copyright registration, complex IP portfolio strategy — Scale LLP's IP team handles the specialist work, with the corporate and licensing strategy integrated. The boundary is intentional: the architectural and commercial work is different from the prosecution and enforcement work, and they are typically best handled by attorneys whose primary practice fits each.

For Texas businesses considering IP licensing as a revenue model — or facing an inbound licensing inquiry — the first conversation produces a useful direction. The architecture is the same regardless of whether the IP is a single patent, a trademark portfolio, software, or know-how.

Schedule a Call

Going deeper

Questions I hear from Texas businesses considering or negotiating IP licenses.

A contract by which the owner of an IP right (the licensor) grants another party (the licensee) permission to use the IP in defined ways, in exchange for compensation, while retaining ownership of the underlying right. The licensor does not transfer ownership — that would be an assignment, a different transaction. The licensor grants permission to do things that, without the license, would constitute infringement: making, using, selling, displaying, performing, reproducing, distributing, or otherwise exploiting the IP. Common categories of IP licensing include patent licenses, trademark licenses (often within franchise relationships), copyright licenses, trade secret licenses, software licenses, and know-how licenses. Most commercial IP licenses combine multiple categories — for example, a license to manufacture a product may include patent rights, trademark rights, and trade secret rights for know-how, all in a single agreement.

An exclusive license grants the licensee the right to exploit the IP within the defined scope to the exclusion of all others, including the licensor. The licensor cannot license the same rights to anyone else and cannot use the rights itself within the licensed scope. Exclusive licenses command higher royalties because the licensee is the only authorized user; they often include performance requirements because the licensor depends on this single licensee. A sole license grants the licensee exclusive rights against third parties — the licensor will not license the same rights to anyone else — but the licensor retains the right to use the IP itself. A non-exclusive license grants the licensee the right to use the IP within the defined scope, but the licensor remains free to license the same rights to other parties and to use the IP itself. Non-exclusive licenses typically command lower royalties because the licensee competes with potentially many other users. The choice should match the licensor's strategic objectives.

A field of use restriction limits the scope of the license to a specific industry, application, or use case — permitting the licensee to exploit the IP within that field while reserving other applications for the licensor or for other licensees. Field of use restrictions are particularly common in patent licensing where a single patent may have applications across multiple industries (medical devices, consumer products, industrial equipment) and the licensor wants to grant rights for one application without foreclosing others. A typical definition might specify a particular industry sector, product category, customer type, or technical application. Drafting field of use definitions is one of the most contested areas in license negotiation. Vague or ambiguous field definitions produce disputes that are difficult to resolve except through litigation. Specific, technical, narrowly drawn definitions reduce dispute risk but limit licensee flexibility. Well-drafted field provisions balance specificity with reasonable flexibility through carefully defined terms and, where appropriate, mechanisms for negotiated expansion.

Royalty rates vary significantly by industry, technology type, exclusivity, stage of development, and competitive dynamics. There is no single typical rate. For patent licensing in mature consumer products, running royalties of 2 to 5 percent of net sales are common. For pharmaceutical and medical device patents, rates of 5 to 15 percent are typical, often with milestone payments. For software and technology licenses, royalties of 5 to 25 percent of revenue are common depending on the criticality of the IP. For trademark licensing in franchise contexts and consumer goods, royalties of 5 to 10 percent of net sales are typical, often combined with marketing fund contributions. The royalty structure (running royalty versus lump sum versus hybrid) significantly affects the effective rate. Exclusive licenses command 1.5 to 2 times higher rates than non-exclusive. Early-stage technology that the licensee will need to develop further commands lower royalties than fully commercialized technology. The royalty rate should reflect the IP's contribution to the licensee's product or service value, not simply the licensor's perceived value of the IP.

Naked licensing refers to a trademark license that fails to include and enforce meaningful quality control over the licensee's use of the mark. Under federal trademark law, a trademark licensor must maintain control over the nature and quality of goods or services sold under the licensed mark, on the rationale that consumers associate the mark with a consistent source and the licensor's failure to police the licensee's use destroys this association. The legal consequence is severe: the trademark can be deemed abandoned, with the licensor losing its rights not only against the licensee but against all third parties — the mark passes into the public domain. Quality control requires both contractual provisions (a license establishing standards, audit rights, and remedies for breach) and actual enforcement (monitoring, periodic audits, response to violations). Trademark licensors who include strong quality control provisions but never enforce them are still at risk. The cost of monitoring is significant; the cost of losing the trademark to naked licensing is significantly higher.

Only if the original license expressly permits it. Sublicensing rights are not implied in IP licenses and must be specifically granted. The default rule under U.S. IP law is that a licensee cannot sublicense without express authorization from the licensor. Where sublicensing is permitted, the license should specify which rights can be sublicensed, to which categories of sublicensees, on what terms, with what royalty obligations flowing back to the original licensor, and with what continuing licensor approval rights. Common protections in well-structured sublicensing provisions include: requirement that all sublicenses include specific terms (quality control, IP protection); pass-through royalty obligations; licensor approval rights for sublicense agreements; automatic termination of sublicenses on termination of the master license (with carve-outs); and reporting obligations covering all sublicensee activity. The specifics depend on the licensor's strategic objectives and the licensee's operational needs.

Bankruptcy of a licensee creates significant complexity. Under Section 365 of the U.S. Bankruptcy Code, a licensee in bankruptcy can either assume or reject executory contracts, including license agreements. If assumed, the licensee must cure existing defaults and provide adequate assurance of future performance, after which it may use, assign, or sell the license as part of the bankruptcy estate — potentially including assignment to a competitor of the licensor. If rejected, the license is treated as breached, and the licensor's claim is for damages rather than the continued royalty stream. For trademark licenses, additional considerations apply under the Supreme Court's 2019 decision in Mission Product Holdings v. Tempnology, which held that rejection of a trademark license does not strip the licensee of its trademark use rights — the licensee can continue using the mark as if rejection had not occurred. License drafting can mitigate but not eliminate bankruptcy risk: provisions identifying the license as personal and non-assignable; performance milestones; financial covenants; structural alternatives such as escrow arrangements or holding the IP in a separate licensing entity. None provide complete protection, but they significantly improve the licensor's position.

Royalties received by a Texas entity for IP licensing are generally included in the entity's total revenue for purposes of the Texas franchise tax under Chapter 171 of the Texas Tax Code. The franchise tax is calculated on the entity's taxable margin — the lesser of total revenue minus cost of goods sold, total revenue minus compensation, total revenue times 70 percent, or total revenue minus $1 million. For licensing-focused businesses, the cost-of-goods-sold deduction is typically minimal, and the 70 percent of total revenue calculation is often the effective floor. Texas-source apportionment of royalty income depends on factors including where the IP is used, where the licensee is located, and where activities generating the royalties occur. The apportionment analysis is fact-intensive and the rules have evolved through Comptroller administrative guidance. Texas businesses considering IP licensing structures should evaluate the franchise tax implications as part of the strategic analysis. The federal income tax treatment is separate. Coordination between Texas tax counsel and federal tax counsel is appropriate for licensing structures of meaningful size.

Patents vs. Trademarks vs. Trade Secrets Read Contract Disputes in Texas Read Cross-Border U.S./Canada Transactions Read Texas Business Law: A Lifecycle Map Read

The architecture is consistent.
The right structure depends on the specific facts.

Whether you have IP to license, an inbound licensing inquiry, or an existing arrangement that needs review — the first conversation produces a useful direction in fifteen minutes.

Schedule a Call (682) 529-7177

This article describes the structure of intellectual property licensing under federal and Texas law at a general level and is not legal advice for any specific situation. The drafting of an IP license, the selection of royalty structure, the field of use scope, the quality control framework, and the tax analysis depend on the specific IP, the parties, the industry, and the commercial objectives — none of which can be evaluated in a general article. Consult counsel licensed in the relevant jurisdictions before entering into or modifying any IP license. Chuck Kraus is licensed in Texas, Minnesota, Washington State, and Canada.