Kat S.
Revenue Growth Strategies | Market Development | Product Strategies | Branding | B2B | Marketing Strategy
How do you know if your IP licensees are paying you properly?
I sat on a presentation about royalty audits today and think it's a fantastic to collect due royalties - wrote about it here: http://bit.ly/3cODu1
But I'd be interested to know what other methods are used to ensure proper payment, especially for smaller companies that license out to larger companies and either can't afford an audit or don't feel right about it.
Answers (6)
John M.
Experienced international and domestic technology, intellectual property, and business law attorney.
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Kat,
An audit right is certainly the most common method to try to confirm correct payments of royalties due. But if someone is cooking the books what's to say you are not going to ge the cooked books at audit time anyway. (Oops, did I say that out loud?)
There are other ways to set royalty payments that can avoid audit and royalty concerns. You can set a lump sum to cover the subject matter being licensed or you can set annual fixed fee payment or guaranteed annual minimum/maximum royalties. These methods may take a little more thought up front and do not provide the "comfort" of knowing you are getting a royalty for each and every sale, but they can be effective and reduce or eliminate a need for audits.
If you need to use periodic or running royalties, you can tie the royalty to something other than unit sales that might be easier to track or confirm, such as some more easily identifiable and verifiable metric, possibly even an external metric.
One of the biggest factors in setting a royalty system is consideration of what is being licensed. Licensing of certain processes or methods may require a different means of measuring the royalty base (e.g., weight or volume or raw material consumed) than the licensing of a technology that is to be sold, or incorporated into products, for consumers where unit sales might be a more appropriate measuring stick.
Obviously, the best way to avoid royalty disputes is to choose your business partners carefully, but that only happens on Planet X.
Just some thoughts. I am interested in seeing what others have to say with respect to different royalty models.
Thanks,
John
Keith J.
Intellectual Property Consultant
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Hi Kat
I've heard in the past that the mere indication of an intention to carry out an audit has been enough to focus a licensees mind!
Keith
Rick C.
Business structure expert
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Dear Kat,
First off, "not feeling right" about making sure you're getting paid is a bad strategy. If you need excuses or a way to eliminate the decision-making, institute a program of auditing some random number of customers (volume/dollar weighted, to be sure) each period - month, quarter, year. You can certainly "blame" your accountants, and as a lawyer I've often told my clients to use me as an excuse. Most businesses will commiserate with you, rather than complain, if you tell them your lawyer's making you do it.
Now, as for how to structure payments, the best course is to choose metrics that are easily measured and hard to game. For example, one person I know only take a percentage of the gross sales, since there's much less room for fudging costs of goods sold and SG&A for a particular item. Of course, the number has to change, but the amount should be close, if a little lower, to a % of the net model.
The suggestion below of using gross weight of certain materials is a great example -- the invoices from a third party are good proof and easy to cross-check.
At the end of the day, the best model will depend on what type of IP you're licensing and your goals about risk/reward. Is it easy to measure the contribution to value from your IP, like a Tiger Woods sneaker where you can count pairs, or is it something more vague, like using music in an advertisement? Probably the best advice I can give is to price your license based on your business model and not on someone else's. Most licensees want either a pure net basis percentage fee or a fixed fee regardless of how much money they make. You should be able to analyze these models under various scenarios and see how they work for you. Once you know what you want, then turn the plan over to your licensing lawyer to translate it into a legal structure that implements what you want.
Hope that helps,
Rick Colosimo
www.asdworld.com
Michael A. B.
US-Intl C-level Dispute & Non-Dispute Attorney. Designer Law for Social & Client Health, Wealth & Prosperity.
Your licensing agreement should provide for licensor's right to inspect and audit relevant records, but if it does not, you should review the law in the relevant jurisdiction(s) to determine what rights the licensor has in this regard absent a contractual right. The latter approach ultimately leads to a suit filing for state granted auditing rights or a claim of fraud and asking for an accounting in the context of preliminary relief, discovery and/or ultimate relief.
Aaron W.
Head of Trade Marks and Brand Protection at Briffa
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In addition to the audit right, you may want to consider certain other checks as part of the audit.
Say that the licensed product requires certain parts, why not ask to see the order book and check the number of those parts ordered... that will identify whether the number of products declared seems right. An obvious point, but one worth making I think.
The other point to add is to draft the clause so that the audit costs fall upon the licensee if the discrepancy is over a certain percentage.
If you are smaller then a minimum is probably the way to go as it doesn't take administration until a certain point. The only point to consider is whether a minimum actually harms the business from the point of view of getting the product into the market. A licensee may see a minimum like a "tax"...
Mark A.
IP lawyer at Anderson Law LLP
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Incorrect payment may be deliberate, careless or unconscious. Eg nobody thought to consider whether a new product was covered by the licence. The careless or unconscious categories are probably more frequently encountered than deliberate non-payment. In my view a licensor should make clear during negotiations that it is their practice to conduct audits as a matter of routine, and that no adverse inference should be drawn from doing so.
If you can't afford an audit, that brings into question the scale of the licensing transaction. That's like saying you can't afford a lawyer to assist you in negotiating the licence agreement, in which case don't expect a good deal. Actually, it is worse, because audits happen when you have successfully licensed the IP, and there have hopefully been some royalties which can be saved up to pay for the audit. Fundamentally, a business needs to be sufficiently capitalised to be viable, and having the resource for audits should be part of the business plan.
Another important issue is the payment structure. Royalties based on profits are much easier to manipulate than royalties based on a sales price. Profits depend, for example, on allocation of overheads which can vary between organisations. I would usually advise against royalties based on profits. Similarly royalties based on a price to an end user (perhaps several layers down from the licensee) may be difficult to get accurate data on. A royalty based directly on an amount received by the licensee is usually easiest to audit.
Finally, if you don't trust the (prospective) licensee don't do business with them. If they seem like crooks, they probably are. On several occasions, my instinctive unease with parties in negotiations has been borne out by subsequent events. Sometimes, commercial parties are so anxious to close the deal that they don't seem to be able to say, no this doesn't feel right.
Therefore, getting it right requires a mixture of skills:
1. selection of licensees (business judgment)
2. careful structuring and drafting of the licence agreement (legal)
3. preparing the ground for audits (commercial, psychological)
4. regular and efficient auditing (administrative and accounting)
