Royalty Audit - Is Your Income Everything It’s Cracked Up To Be?

Wednesday, August 7, 2013
In days gone by, people used to think of royalties as something that really only concerned authors and musicians. The truth is that today royalties are paid on a whole range of goods and services which third parties have been given a licence to use themselves or supply to others for cash. This might apply to everything from food outlets and computer software to pharmaceuticals and technology. Very often there may not be anything physical involved but simply intellectual property.

Either way, it is essential that anyone granting a licence or franchise or allowing the use of IP gets used, early on, to the idea of royalty auditing. It doesn’t matter who you are providing a licence to, you need to assume that, at some stage, you will suspect that you are not receiving as much by way of royalty income as you thought you might.

This is where royalty audits comes in. Even if it is not written into the original contract, you are entitled to insist on a specialist royalty auditor going in and examining the books of your licensee to check whether everything is in order.

An experienced licensee or someone who is just taking a chance will doubtless find all sorts of wrinkles that result in reduced royalty payments. One crude example might be when a licensee deducts a percentage of sales to allow for pilferage by customers and staff.

A specialist royalty auditor will be well acquainted with all the potential pitfalls and things to expect when experiencing the reality of a licensing agreement in practice rather than in theory. In fact, most licensors will take the precaution of having the auditor in at the initial contract drafting stage so that all the usual areas of contention can be covered at the outset. Don’t worry about your prospective licensees being frightened off by this. It is perfectly reasonable for you to insist that the auditor is there at the beginning and is entitled to make future inspection visits to audit the books.

If you plan to license IP overseas, you will also need to make sure that your royalty auditor has wide international experience. What goes on in one country might be the norm there but might well be considered totally unacceptable in the UK and other mature Western jurisdictions.

Finally, if you think that royalty auditing is not, on balance, likely to prove worthwhile bearing in mind any associated fees, it is worth noting by way of example that an audit of a major international publishing company conducted on behalf of a global entertainment giant identified a whopping 27% shortfall in licensing payments compared with what was actually due.