How to Make Sure Your Licensees Are Paying the Correct Amount of Royalties

In the intellectual property (IP) world, ensuring that your licensees pay the correct royalties can be daunting. Royalty payments are typically reported quarterly, with the licensee providing a statement showing the previous quarter’s sales and the amount of royalties paid. However, errors and misreporting can still occur, potentially costing you significant revenue. This post will guide you through the three major royalty reporting errors and how to avoid them.

3 Major Royalty Reporting Errors and How to Avoid Them

1. License Interpretation

One of the most common issues in royalty reporting is the interpretation of the licensing agreement. The formula for calculating royalties should be crystal clear. A vague or general royalty clause can be interpreted in multiple ways, leading to significant discrepancies in royalty calculations between you and your licensee.

For example, if the definition only says “sales,” this could be interpreted as net sales after deducting certain costs. Similarly, the “sales price” could differ from the “selling price.” I recommend using deal memos to follow up negotiations to avoid such ambiguity. These memos should clearly define sales and the royalty calculation formula, which should be included in the licensing agreement.

Ensure your licensing agreements are detailed and specific, leaving no room for multiple interpretations. Include clear definitions and formulas for royalty calculations.

2. Under-reporting Sales

Under-reporting sales is another major issue, often due to a fluid and constantly changing product list. For instance, if a licensee adds a new product or territory that wasn’t originally in the agreement, it might get overlooked when reporting royalties.

A case in point is when Power Rangers was extremely popular. The studio audited licensees yearly and inevitably recovered “under-reported” sales, typically on products added after the signed contract. You can avoid this mistake by ensuring clarity on the specific products (or services) that can use your IP. Update your agreements with any new products (or extensions), and make sure these are included in the royalty reports.

Update your agreements regularly and maintain a comprehensive list of products under your IP license. Ensure that new products or territories are promptly added to the royalty reports.

3. Non-Allowed Deductions

This error occurs frequently when licensees make deductions from the royalties that are not allowed. Such deductions include advertising, overhead, damaged goods, returns, warehousing, production, or other selling costs. Often, the royalty report only provides a general summary of deductions, making it difficult to determine whether they are allowed.

Most agreements I negotiate have very limited deductions, 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.

Clearly define allowed and non-allowed deductions in your licensing agreements. Provide a royalty statement template that mandates a detailed breakdown of all deductions.

Best Practices for Avoiding Royalty Reporting Errors

You must ensure that royalties are clearly defined in your licensing agreement to avoid these errors. Moreover, any allowed deductions must be explicitly mentioned in the royalty reports, making them easy to audit.

Following these guidelines and best practices, you can safeguard your revenue stream and ensure your licensees pay the correct royalties. Don’t leave money on the table—take control of your royalty reporting process today.

Are you monitoring your licensing partners to verify the accuracy of their royalty payments? If not, it’s time to take action. Schedule a coaching call today and learn how to ensure that your licensees comply with the terms of your agreement.

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