By Kevin F. Howley
Gray, Gray & Gray, LLP
If you are a licensor of intellectual property, royalty payments are at the core of the value of your business. Your investment of time, talent and capital is repaid in installments from licensees. They are not sharing in their success, but fulfilling their end of a business arrangement that benefits both parties.
Hopefully, all of your licensees are meeting their obligations and paying you the full amount of their contracted royalty fees, on time and without prompting. But that is not always the case. Whether inadvertently or deliberately, some licensees fail to live up to their agreements. How can you tell if you are being shortchanged? Here are five “red flags” that may signal that you are not receiving your full due.
- Royalty payments differ from licensor expectations. If a licensee’s payments do not correlate to market trends it should put you on alert. For example, are royalty payments declining in the midst of a strong economy? Or are royalty payments level at a time when other licensees are reporting increasing royalties? Watch for tendencies that go against the trends you are seeing from other licensees.
- A contentious relationship with licensee. It is not uncommon for disputes to arise between a licensee and licensor. Quality issues, lack of communication, lack of participation in marketing initiatives, lack of visibility of licensed product on licensee website and marketing materials and scant support of licensed products can all be signs of dissatisfaction and a deterioration of the relationship. This can sometimes lead to late submission of royalty reports, late payments, incomplete submission of required support with royalty reports, or even withholding of royalty payments.
- Introduction of generic equivalents. New products entering the market or the availability of lower cost substitutes can allow a licensee to “cross-sell” a customer requesting a licensed product, thus avoiding the royalty payment. Keep tabs on your market and be alert for opportunities which may tempt a licensee to “cheat” on the relationship.
- A licensee who is inexperienced. New licensees without prior experience in the licensing environment may not have the appropriate systems and controls in place to identify and capture the sales of licensed products to accurately record the sales for royalty reporting. If this is the case it may require some education and support on your part to get things on track and keep them there.
- Poor royalty audit history. If the licensee has been audited in the past and underpayments have been uncovered, the likelihood of a breach occurring again is higher. Or, if the licensed technology is nearing the end of its patented life and the licensee has never been audited, it is tempting to cut payments short.
The most accurate way to determine whether or not a licensee is fulfilling their financial obligations is through a royalty audit. This comprehensive investigation looks deeply into the income stream, sales, and payment history of the license holder. Your licensing agreement should include language giving you the right to conduct a royalty audit at your discretion.
Kevin F. Howley is a Partner in the firm of Gray, Gray & Gray, LLP in Canton, MA, and a certified public accountant with more than 25 years of auditing experience, including royalty audits. He can be contacted at khowley@gggcpas.com or (781) 407-0300.