How do you know your licensees are paying the correct amount of royalties? Generally, royalty are reported quarterly. The licensee provides a statement showing the previous quarter sales and amount of royalties paid. However there are still some ways that royalties are under reported.
Here’s a list of the 3 big royalty reporting errors and how to avoid them:
License interpretation: The formula for calculating royalties are very clear. A vague or general royalty clause is open to interpretation in several ways. The result is a significant difference in royalty calculations between you and your licensee. For example, if the definition only says “sales” this could be interpreted as net sales after deduction of certain costs. Or the “sales price” is different from the “selling price”. That’s why I like to use deal memos to followup negotiations. It clearly defines sales and the royalty calculation formula, and include that formula in the licensing agreement.
Under-reporting sales: The biggest reason for this error is a product list that is fluid and constantly changing. For example, if a licensee adds a new product or territory that wasn’t originally in the agreement, gets overlooked when reporting royalties. When Power Ranges was red hot, the studio audited licensees each year, and inevitably recovered “under reported” sales. Typically these were on products added after the signed contract. You can avoid this mistake with clarity on the specific products (or services) that can use your IP. Make sure to update your agreements with any new products (or extensions), and be sure to include these in the royalty reports.
Non-Allowed Deductions: This error happens often. These are deductions from the royalties that are not allowed. Some of these include advertising, overhead, damaged goods, returns, warehousing, production or other selling costs. Often times the royalty report only provides a general summary of deductions, so you won’t know if it’s allowed. Most of the agreements I negotiate have very limited deductions, and these are clearly spelled out in the agreement. You can also avoid this mistake by providing a royalty statement template that requires a clear explanation of deductions.
The best way to avoid these 3 big mistakes is to make sure that royalties are clearly defined in your licensing agreement. Make sure that any deductions allowed are included on the royalty reports so they are easily audited.
Are you monitoring your licensing partners to verify the accuracy of their royalty payments? If not, then give us a call. If you’ve got an active licensing program, we can help you make sure your licensees are complying with the terms of your agreement. We can also help you in managing your IP assets and finding new ways to put your IP to work for you.
Rand Brenner is an IP professional whose passion is helping inventors, startups, and businesses of all sizes use licensing to turn their IP into income-producing products, services, and technologies. His decades of experience run the gamut from medical devices to food technology to consumer products. He’s licensed some of the biggest Hollywood entertainment blockbusters including the Batman Movies (1 and 2), and the number one kid’s action TV show, the Mighty Morphin Power Rangers. Rand speaks about licensing and is a featured speaker at investment conferences, trade shows, colleges, and startup events. He’s a published writer with articles appearing in several prestigious trade magazine including The Licensing Journal, Intellectual Property Magazine, and License India. Rand also mentors at the Cal State Fullerton School of Business and Economics and is a judge for their startup business plan competitions.