Key Strategies for Licensees Facing Audits

For top licensors, periodic audits are standard practice to ensure quality, brand consistency, and a healthy partnership.

For licensees, audits are expected but nevertheless they can disrupt normal business operations, pulling resources and diverting attention from core activities, which costs precious time and money. However, licensees recognize the importance of responding to audits in a timely fashion and demonstrating compliance. Not only can failure to comply with licensing agreements result in financial penalties or legal action from the licensor, it can damage the strategic licensee-licensor relationship, which may lead to termination of licensing agreements and hinder a licensee’s opportunity to win properties in the future.

In this article, we discuss the three most prominent audit challenges we have heard from licensees and how to overcome them.

Problem #1: Responding to audits is time consuming and difficult

Preparing for an audit requires time and effort. Licensees can find themselves spending, in some cases, 150-200 hours over 6-9 months to complete. Over this duration, they need to gather sales data, royalty reports, and other relevant financial and contractual data to respond to an audit and audit findings. Depending on the licensor, the level of detail asked for can be down to the line level of every invoice over multiple years. Common requirements during audits include:

• Items sold
• Net price
• Royalty rate used
• Territory
• When sold
• Where sold
• Customer recipient
• SKU
• Channel
• Language
• Currency
• Exchange rate
• Advance recouped
• Carry forward

To further complicate matters, audit procedures—along with reporting protocol—vary from licensor to licensor. Each one is looking for a specific format, and many require documentation to be presented in their dictated template. In some instances, licensees need to hire an outside resource to respond to the audit because they don’t have the manpower or skillset in-house.

Problem #2: Licensing agreements are complex, causing confusion at audit time

The terms of licensing agreements can be intricate. While newer and smaller licensees may be able to manage their licensed properties using spreadsheets, that approach is not scalable for long. Licensees must ensure compliance with specific clauses related to royalties, reporting, and usage, and misinterpretations or oversights can lead to non-compliance. As the volume of licensed properties and merchandise grows and terms and conditions become more detailed, e.g., limited timeframes and territories, minimum guarantees, compound IP, and multi-party payouts for co-branded products, it becomes impossible to keep an eye on it all. Unintended mistakes could pop up during audits, and if it is a multi-year audit, penalties could be compounded by interest.

Solution:

A platform that stores contract terms in a visible way makes it easier for licensees to understand and adhere to their obligations. The ability to handle complex, rule-based payment models, linking them to financial obligations and associated sales, sets licensees up to scale their business without the constant concern that things are falling through the cracks and may come back to haunt them during an audit.

Problem #3: Data accuracy is a challenge when managing reporting with spreadsheets

Licensees must maintain accurate records of sales, usage, and royalties. Inaccurate reporting can result in discrepancies during audits. Ensuring that the data provided to the licensor is accurate and compliant with the terms of the license agreement is critical, as mistakes or discrepancies can lead to disputes and financial penalties that may even exceed the royalty rate. At the same time, licensees should assess the accuracy of any infringement claims that may be made by the licensor during an audit. Mistakes can occur on both sides.

Solution:

A system that captures complex deal and payment terms, analyzes sales data, calculates royalties based on those terms, and has the power to conduct automated, real-time compliance checks and produce audit trails will help you slice and dice numbers with confidence. You can catch and address violations before they compound over time, rest assured that your reporting is accurate, plus be able to defend any royalty billing claims to the contrary.

Transforming Challenges to Opportunities

Trust, transparency, and open communication are hallmarks of the most successful licensee-licensor relationships. By proactively addressing these challenges, licensees can maintain compliance and a positive relationship with licensors, paving a path for future growth.

LicenSee by FADEL is a platform designed to enhance and automate royalty management for small-to-midsize consumer product licensees engaging in merchandise licensing. With LicenSee, there is no need to dread audits. All the information you need is right there at your fingertips.

Schedule a demo to See for yourself.