An IP license drafted by someone else is written for someone else. That is not sharp practice, it is what first drafts are.
The defaults matter more than the negotiation. Most clauses in a first draft survive because nobody challenges them, so identifying which ones to contest is the whole exercise.
Seven clauses decide most of the value. Read those first, and read them before looking at the headline rate.
The seven to read first
| # | Clause | Decides |
|---|---|---|
| 1 | Grant | What rights move, and how widely |
| 2 | Royalty base | What the percentage applies to |
| 3 | Permitted deductions | How much quietly disappears |
| 4 | Exclusivity | Whether the licensor is excluded too |
| 5 | Term and termination | How it ends |
| 6 | Assignment and change of control | Who you might end up dealing with |
| 7 | Warranties | Who carries validity risk |
The rate is not on that list. It matters, and it is the number everyone negotiates while the base and the deductions decide more of the money.
1. The grant
| Check | Why |
|---|---|
| Are the rights listed by number? | "All IP relating to" is the classic defect |
| Continuations and foreign counterparts included? | Otherwise the family is not covered |
| Future family members? | New continuations should not need a new deal |
| Field of use limited? | An unlimited field gives away other markets |
| Territory? | Rights are national |
| Sublicensing permitted? | And at what share |
As a licensor, restrict the field. A patent licensed exclusively for one application can still be licensed for others, which turns one asset into several revenue streams.
As a licensee, check what you are actually getting. A grant limited to one product line may not cover the version you are planning.
Territory should match where rights exist. Licensing worldwide on a US-only patent gives away future markets for nothing.
2. The royalty base
The most consequential number in the agreement, and rarely the one negotiated.
| Structure | Rate | Base | On 100,000 units |
|---|---|---|---|
| Finished product | 5% | $500 | $2,500,000 |
| Covered component | 5% | $20 | $100,000 |
Same rate, twenty-five times the money.
Which base is correct is a genuine question, not just a negotiating position. Where a patent covers one component of a multi-component product, the base is generally the smallest saleable patent-practising unit — unless the patented feature drives demand for the whole thing.
Conceding rate to win base is usually the better trade. See patent royalty rates.
3. Permitted deductions
| Language | Effect |
|---|---|
| "Customary deductions" | Unbounded — the payer defines it |
| "Ordinary trade discounts" | Vague |
| An enumerated list | Bounded |
| Silence | Disputes later |
Enumerate them. Returns, freight, insurance, sales taxes, documented trade discounts — named individually.
This is where royalty income quietly disappears. A payer acting entirely within an open-ended deductions clause can reduce the royalty substantially without breaching anything.
4. Exclusivity
| Type | Who may practise |
|---|---|
| Non-exclusive | Licensee, licensor, and other licensees |
| Sole | Licensee and licensor only |
| Exclusive | Licensee only — licensor excluded |
Exclusive normally excludes the licensor. If you are granting and intend to keep using the technology, you need a sole licence or an express reservation.
If you are taking an exclusive licence, insist on minimum annual royalties being absent — or rather, expect the licensor to insist on them. They exist so an exclusive licensee cannot take the rights and shelve the technology.
5. Term and termination
| Provision | Check |
|---|---|
| Term | Life of patent, or shorter? |
| Royalties past expiry | Must stop for that patent |
| Breach and cure period | How long, and for what |
| Termination for convenience | Which side has it |
| Insolvency | What happens |
| Post-termination inventory | What may still be sold |
| Survival | Which clauses continue |
Royalties tied to a single expired patent are unenforceable as patent misuse under Brulotte and Kimble. A blended royalty covering an expiring patent risks the whole stream.
Post-termination inventory is routinely omitted and produces disputes at exactly the point when goodwill has run out.
6. Assignment and change of control
The clause most often overlooked and most consequential later.
| Scenario | Without a clause |
|---|---|
| Licensee acquired by your competitor | They now hold your licence |
| Licensee acquired by a much larger group | Use expands, payment does not |
| Licensor sells the patent | Buyer takes subject to the licence |
| Licensee assigns freely | You deal with someone you never chose |
A freely assignable licence can end up with a competitor. Restricting assignment or requiring consent is standard and easy to agree at drafting.
Change of control deserves its own provision. A licensee acquired by a group ten times its size may bring the technology into a far bigger operation, and the royalty base may not capture that.
7. Warranties
| Warranty | Position |
|---|---|
| Ownership and authority to grant | Reasonable for a licensor to give |
| Validity of the patent | Refuse — nobody can guarantee it |
| Non-infringement of third-party rights | Refuse — a patent is a right to exclude, not to practise |
| Fitness or performance | Refuse |
| Indemnity for third-party claims | Negotiate carefully |
Warranting non-infringement is the one licensees most often ask for and licensors should most firmly refuse. A patent gives a right to exclude, not permission to practise, and freedom to operate is the licensee's problem.
Reporting and audit
| Provision | What to require |
|---|---|
| Itemised statements | Units, gross, each deduction named, net, rate, royalty |
| Frequency | Quarterly is standard |
| Audit right | At least annual |
| Records retention | Must outlast the audit right |
| Cost shifting | Licensee pays if the shortfall exceeds a threshold |
| Currency and conversion | Which rate, on which date |
A statement showing only a net figure cannot be checked. Every question then requires an audit, which turns routine queries into confrontations.
Cost shifting is what makes audits happen. Without it, the cost of auditing frequently exceeds the expected recovery, so nobody ever audits and the reporting is never tested.
Terms with hidden reach
| Clause | Effect nobody notices at signing |
|---|---|
| Most-favoured-nation | Constrains every future deal you sign |
| Audit cost-shifting threshold | Determines whether audits ever happen |
| Records retention period | An audit right over purged records is worthless |
| Improvements and grant-backs | Who owns what the licensee builds |
| Confidentiality of the deal | Whether it becomes a comparable |
| Governing law and forum | Where any dispute happens |
MFN clauses compound. Each future licence must be checked against every MFN promise already made, and the constraint tightens as the programme grows.
Retention must outlast the audit right. An annual audit right over records kept for two years leaves a gap the licensee can rely on without breaching anything.
Worked example: the same deal, two drafts
A patent covering a filtration membrane. Both drafts say 5%.
| Clause | Their draft | After review |
|---|---|---|
| Grant | "The Patent and related IP" | Numbers listed, plus continuations |
| Field | All fields | Water treatment only |
| Territory | Worldwide | US and EU, where rights exist |
| Base | The membrane, $30 | The filtration module, $260 |
| Deductions | "Customary" | Enumerated |
| Minimum annual | None | $80,000 from year two |
| Assignment | Free | Consent required |
| Warranties | Validity and non-infringement | Ownership and authority only |
| Their draft | After review | |
|---|---|---|
| Rate | 5% | 5% |
| Royalty at 40,000 units | $60,000 | $520,000 |
| Other fields licensable | No | Yes |
| Validity risk | Licensor's | Licensee's |
| Could end up with a competitor | Yes | No |
Nearly nine times the revenue at the same headline rate, plus three fields left free and the validity risk where it belongs.
Nothing in the review was unreasonable. Every change is standard in a negotiated licence; they were simply absent from a first draft.
Common first-draft defects
| Defect | Fix |
|---|---|
| Grant covers "related IP" | List by number |
| No field-of-use limit | Restrict to the intended application |
| Base set at the finished product | Move to the covered unit, or vice versa |
| Deductions undefined | Enumerate |
| No minimum on an exclusive | Add one |
| Freely assignable | Require consent |
| Validity warranted | Delete |
None of these is unusual and none is unreasonable to change. They persist in signed agreements because nobody read past the rate.
Payment structure
| Element | What it does |
|---|---|
| Upfront fee | Paid at signing; non-refundable |
| Milestone payments | Triggered by events |
| Running royalty | The ongoing stream |
| Minimum annual royalty | Protects against a dormant licensee |
| Sublicence share | Percentage of what the licensee receives |
| Step-downs | Rate falls as volume rises |
Minimum annual royalties are the licensor's protection against shelving. An exclusive licensee with no minimum can take the rights, do nothing, and block the market for years at no cost.
Upfronts change the risk profile more than the total. Money received at signing is certain; a running royalty depends on a product that may never launch.
Step-downs favour the licensee at scale, which is reasonable where volume drives the value, and worth pricing rather than conceding.
What a licence leaves the licensor holding
| Obligation | Continues |
|---|---|
| Maintenance fees | $14,470 across a large entity patent's life |
| Enforcement against non-licensees | Yours |
| Validity defence | Yours |
| Royalty monitoring and audits | Yours |
Run the arithmetic before signing. A royalty of $30,000 a year against an approaching $8,280 fee plus monitoring is thinner than the headline suggests, and 58.6% of US utility patents are abandoned because that arithmetic stops working. See the patent survival curve.
Compare it against selling. A sale ends every row in that table for one payment.
Reviewing an IP license: the checklist
- Read the grant and the base before the rate. They decide more of the money.
- Check the rights are listed by number, including continuations and foreign counterparts.
- Enumerate permitted deductions. Never accept "customary".
- Confirm whether exclusivity excludes the licensor, and reserve rights if it does.
- Require itemised royalty reports naming each deduction.
- Check audit rights against records retention. The second must outlast the first.
- Restrict assignment and address change of control.
- Refuse to warrant validity or non-infringement if you are the licensor.
- Confirm royalties stop at patent expiry, with any know-how priced separately.
- Ignore signing deadlines. Patent deadlines are real; contract urgency is usually a tactic.