Armanino Blog

Royalty Audits Can Recover Revenue and Protect Property

May 01, 2011

Whether its software, technology, music, or manufacturing designs, when a company licenses its intellectual property, it obviously expects to be paid. Unfortunately, payment doesn’t always happen on auto-pilot. Anticipated royalties not only depend on the terms of the initial licensing agreement, but often on the company’s diligence in monitoring the contract.

By reviewing its license agreements and auditing the related royalty streams, companies can possibly uncover instances of inaccurate reporting that have resulted in the underpayment of royalty revenue. The reasons for the misreporting can vary: questions around license interpretation, underreported sales, math errors, or, at times, even fraud.

A royalty audit can answer some basic questions, such as: Are the correct royalty payments being made? What are the causes of any infringements and how can these be resolved? How can any underpayment be recovered? And the audit can be used as a negotiating tool to improve future licensing agreements.

But companies don’t always take advantage of these audits. Some global companies find they’re realizing less than 10 cents on the dollar for products sold in some markets because of piracy, but they’re turning a blind eye because the alternative – seeing the bootleggers take 100 percent of the market – is worse.

And in markets where companies can enforce their intellectual property rights, often they’re not exercising those rights. The economic downtown is a factor. Many firms cut back on their compliance and auditing efforts to shave costs. Now they have little check on even the most honest of mistakes – whether it stems from a misinterpretation of contract language, use of outdated currency conversions numbers or simple human error.

An economy that’s showing renewed signs of life suggests this a good time to reexamine the wisdom of cutbacks in corporate vigilance in defense of its valuable intellectual property assets. Staff compliance teams more than pay for themselves and a royalty audit can yield an astonishing return on investment in many cases.

“The real value is that you are going to really understand if your licensees are truly complying with the terms and conditions of the agreement,” said Scot Glover, a Partner at Armanino. “As a result that can help you recover funds that otherwise haven’t been paid or won’t be paid. And you ensure that the licensees are protecting your intellectual property.”

Recovered funds can go directly to improvements on a company’s bottom line, such as these examples:

  • A company that makes a high-tech product for regular household use was struggling to collect licensing revenue. Our audit found that the licensees were underreporting revenues, and we recovered in excess of $3M to $5M for the company that went directly to their bottom line.
  • Or, a Software client had cut back on its compliance function because of the economy. Through a ‘paired down’ version of royalty audit compliance, we found more than $20M in underreporting for this client.

Another factor slowing enforcement efforts is a sales-side resistance to confronting a client who isn’t living up to the terms of a contract. But it’s clear those concerns are overstated – those who make and license the product are in a much stronger bargaining position than those who market and resell the product.

Certainly there are so-called ‘patent trolls’ in the world, who attempt to build a business by spinning the wheel of justice with claims their rights have been infringed. But with so many contracts not in full compliance, making an aggressive but fair attempt to protect your firm’s rights is a simple, good business practice.

Whether you know, suspect or just aren’t sure if your contracts are returning the royalties they should, this seems a good time tout for sure.

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