What is a royalty audit? - Licensing Executives Society USA and ...
What is a royalty audit? - Licensing Executives Society USA and ...
What is a royalty audit? - Licensing Executives Society USA and ...
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When Does a Royalty Audit Make Sense <strong>and</strong> How<br />
Do They Work<br />
Presented by<br />
Debora R. Stewart, CPA, CFF<br />
Managing Director<br />
October 19, 2009<br />
LES 2009 Annual Meeting
It’s about the money<br />
2
Why license?<br />
▼ Nonprofit institutions often license to benefit the<br />
public<br />
▼If that was the only purpose, then you would license<br />
your technology for free<br />
▼ For-profit enterpr<strong>is</strong>es license for some type of<br />
benefit<br />
▼If a <strong>royalty</strong> rate or payments of any kind are included<br />
in the license there must be some profit or revenue<br />
generation motivation<br />
3
Question:<br />
▼ How would your CFO feel if the head of the<br />
Accounts Receivable department decided to let<br />
customers take d<strong>is</strong>counts that were against company<br />
policy or that they have not earned or just pay less<br />
than they owed because he/she didn’t want to “rock<br />
the boat” by asking the customer to explain<br />
themselves?<br />
4
Audit Deficiencies / Percent M<strong>is</strong>reported<br />
Invotex 2008 Cumulative Findings<br />
19 %<br />
Properly<br />
Reported<br />
27% fell in<br />
Over 100%<br />
Underreported!<br />
19% fell in<br />
1-5%<br />
Underreported<br />
8% in the<br />
6-10%<br />
14% in the<br />
11-24%<br />
10% in the<br />
25-49%<br />
3% in the<br />
50-99%<br />
5
Goals Of A Well Run License Management System<br />
Your goals – whether they are managed internally or<br />
with the ass<strong>is</strong>tance of outside support – are to:<br />
▼Identify,<br />
▼Control, <strong>and</strong><br />
▼Maximize<br />
the potential of all licenses.<br />
6
Audit Compliance Program for all Licensees<br />
<strong>What</strong> <strong>is</strong> a <strong>royalty</strong> <strong>audit</strong>?<br />
▼ The confirmation that a Licensee <strong>is</strong> complying with<br />
the license/contract, including payments, research<br />
milestones, advert<strong>is</strong>ing or any other clause that<br />
allows itself to be tested by an independent party<br />
Why have a <strong>royalty</strong> <strong>audit</strong> program?<br />
▼ As part of a strategic effort to ensure Licensee<br />
compliance <strong>and</strong> to demonstrate protection of rights<br />
7
Audit Process<br />
1. Choose an <strong>audit</strong>or<br />
2. Decide who you want to <strong>audit</strong> (your <strong>audit</strong>or can<br />
ass<strong>is</strong>t with th<strong>is</strong> dec<strong>is</strong>ion)<br />
3. Inform the Licensee of the <strong>audit</strong><br />
4. Transfer knowledge to <strong>audit</strong>or<br />
5. Let <strong>audit</strong>ors do their thing<br />
8
Decide who you want to <strong>audit</strong><br />
▼ Review <strong>royalty</strong> bearing licenses for red flags<br />
▼ Good rule of thumb <strong>is</strong> to consider <strong>audit</strong>s of licenses<br />
generating over $100,000 in running royalties per<br />
year<br />
9
Red flags:<br />
there may be errors in the <strong>royalty</strong> report if…<br />
▼ The person preparing my <strong>royalty</strong> report has changed<br />
▼ My Licensee has launched new products<br />
▼ My Licensee has started selling my product in new territories<br />
▼ My Licensee has opened a new manufacturing facility<br />
▼ My Licensee has been acquired or has merged with another<br />
company<br />
▼ My Licensee <strong>is</strong> having financial difficulty<br />
▼ My Licensee has changed its accounting system<br />
▼ My <strong>royalty</strong> reports have been late <strong>and</strong> are arriving later each period<br />
▼ My Licensee’s sales of the covered product are not keeping track<br />
with the industry<br />
▼ The person preparing my report <strong>is</strong> not familiar with the license<br />
<strong>and</strong> /or technology being licensed<br />
10
Choose an <strong>audit</strong>or….<br />
▼ Who will represent you in the manner that you<br />
prefer<br />
▼ Who underst<strong>and</strong>s that a license agreement <strong>is</strong> a<br />
partnership not an adversarial proceeding - they<br />
need to do a thorough investigation while making<br />
sure the relationship remains positive<br />
▼ Who uses a dedicated team that specializes in<br />
technology license <strong>audit</strong>s<br />
11
Inform the Licensee of the <strong>audit</strong><br />
▼ Send letter out to all licensees that you are<br />
implementing an overall compliance program to<br />
remain cons<strong>is</strong>tent with best practices used in your<br />
industry<br />
▼ Send specific letter to <strong>audit</strong> c<strong>and</strong>idate informing<br />
them of your choice to initiate an <strong>audit</strong> through the<br />
chosen <strong>audit</strong>or<br />
▼ Include the <strong>audit</strong>or’s contact information in the<br />
letter <strong>and</strong> let the c<strong>and</strong>idate know that the <strong>audit</strong>or<br />
will be contacting them<br />
12
Transfer knowledge to <strong>audit</strong>or<br />
▼ Supply <strong>audit</strong>or with license <strong>and</strong> amendments, <strong>royalty</strong><br />
reports, <strong>and</strong> other correspondence that may be<br />
helpful<br />
▼ Schedule a meeting / call with <strong>audit</strong>or to inform<br />
them of any background information<br />
▼ Schedule a meeting / call with <strong>audit</strong>or <strong>and</strong> person<br />
with technical information to ass<strong>is</strong>t <strong>audit</strong>or<br />
13
“It Takes All Kinds to Make a World”<br />
▼ We are Accountants, not a researcher or scient<strong>is</strong>t<br />
▼ We are all part of the technology transfer process<br />
14
Let <strong>audit</strong>ors do their thing<br />
They will:<br />
▼ Contact licensee<br />
▼ Research public information<br />
▼ Collect data prior to site v<strong>is</strong>it<br />
▼ Perform site v<strong>is</strong>it<br />
▼ Wrap up information requests<br />
▼ Prepare report of findings for you<br />
(if your <strong>audit</strong>or <strong>is</strong> good – they will find all that there <strong>is</strong> to find without<br />
jeopardizing your relationship with your licensee)<br />
15
Royalty Audit Process<br />
Identify<br />
Licensee for<br />
Royalty Audit<br />
Collect Background<br />
Data (External /<br />
Internal) to Underst<strong>and</strong><br />
Technology, License<br />
Agreement <strong>and</strong><br />
Relationship<br />
Prepare Licensee<br />
for Audit – Work<br />
Plan, Documents,<br />
Timing<br />
Field Work<br />
Review Licensee Product L<strong>is</strong>tings, Books <strong>and</strong> Records,<br />
Royalty Calculations, Interviews, Process Review, etc.<br />
Report Findings to Licensor <strong>and</strong><br />
Communicate to Licensee –<br />
Exceptions <strong>and</strong> Improvements<br />
16
Outcomes<br />
17
H<strong>is</strong>torical Stat<strong>is</strong>tics<br />
Underreported Royalties as a Percent of Reported Royalties<br />
81% Underreported – 19% Reported Accurately<br />
19%<br />
Properly<br />
Correctly Properly<br />
Reported Reported Reported<br />
Over 100%<br />
Over 100%<br />
27%<br />
underreported royalties<br />
owed by more than 100%<br />
of the total amount<br />
rep orted.<br />
19%<br />
underreported<br />
ro yalties owed b y<br />
1-5% of the total<br />
am ount<br />
repo rted.<br />
81%<br />
Incorrectly<br />
Reported<br />
25-49%<br />
50-99% 50-99%<br />
10%<br />
underreported<br />
ro yalties owed by<br />
25-49% of the total<br />
amount reported.<br />
3%<br />
underreported<br />
royalties owed by<br />
50-99% of the total<br />
amount reported.<br />
8%<br />
underreported<br />
royalties owed<br />
by 6-10% of the total<br />
amount repo rted.<br />
18<br />
14%<br />
underreported<br />
royalties owed by<br />
11-24% of the total<br />
amount reported.
Most Common Errors D<strong>is</strong>covered<br />
▼ Bizarre interpretations of your license agreement<br />
that had not occurred to you<br />
▼Combination products that aren’t or percent not<br />
based on economic value<br />
▼Price averaging<br />
▼Foreign sales that aren’t<br />
▼Purchaser (OEM) says they don’t have to pay<br />
▼Cash v. Accrual<br />
▼Didn’t “sell” just received “service” revenue<br />
▼D<strong>is</strong>tributors<br />
19
Audit Deficiencies / Underreported Revenue<br />
$ Impact of the 81%<br />
Invotex 2008 Cumulative Findings<br />
License Interpretation<br />
51%<br />
Underreported Sales<br />
21%<br />
D<strong>is</strong>allowed<br />
Deductions 7%<br />
Royalty Rates 4%<br />
Math Errors 5%<br />
Unreported<br />
Benchmarks 2%<br />
20<br />
Transfer<br />
Prices 2%<br />
Unreported Sublicenses 8%
Audit Deficiencies / Frequency<br />
Frequency of the 81%<br />
Invotex 2008 Cumulative Findings<br />
• Underreported Sales<br />
• Interpretation Issues<br />
• D<strong>is</strong>allowed Deduction<br />
• Rate Errors<br />
• Math Errors<br />
• Sublicenses<br />
• Benchmarks<br />
• Transfer Prices<br />
0% 10% 20% 30% 40% 50% 60%<br />
21
Intangible outcomes of <strong>audit</strong><br />
▼ Revamp license language in light of <strong>audit</strong> findings<br />
▼ Educate internal staff about license language for<br />
future licenses<br />
▼ Increase incidents of desk <strong>audit</strong>s<br />
▼ Exp<strong>and</strong> compliance efforts, look to more licenses,<br />
<strong>and</strong> potentially exp<strong>and</strong> <strong>audit</strong>s<br />
22
Advice - Continued Communication with the<br />
Licensee<br />
▼ Consider yourself their bank; they owe you money<br />
▼ Need open lines of communication at various levels<br />
▼ Dec<strong>is</strong>ion maker<br />
▼ Person preparing <strong>royalty</strong> report<br />
▼ Develop <strong>and</strong> d<strong>is</strong>tribute a Licensee questionnaire annually<br />
▼ Who calculates royalties due?<br />
▼ Do they have the agreement?<br />
▼ <strong>What</strong> procedures are performed in calculating royalties?<br />
▼ Is a second review performed?<br />
▼ Etc.<br />
23
Why have a <strong>royalty</strong> compliance program?<br />
▼ Maximize revenue negotiated<br />
▼ Maintain a good Licensee relationship<br />
▼ Ensure compliance / clarify ambiguity<br />
▼ Send a message of intent to protect rights<br />
▼ Benchmark performance / industry / project<br />
revenue<br />
▼ Manage fiduciary duty<br />
▼ Exemplify proactive philosophy<br />
24
It’s about the money<br />
25
Speaker<br />
Debora R. Stewart, CPA, CFF<br />
Managing Director<br />
Invotex Group<br />
1637 Thames Street<br />
Baltimore, MD 21231<br />
(410) 824-0141<br />
dstewart@invotex.com<br />
www.invotex.com<br />
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