The Anatomy of a Licensing Audit

Licensees of all sizes, from mom-and-pop shops to global brands, are subject to audits by licensors. Even if there are no red flags like improper product approval, excessive volume, or not meeting forecasts, most licensors conduct audits every three to five years and, in some cases, every year. In short, audits are an inevitability for licensees.

Audits can be extremely disruptive to business continuity, especially since licensors drive the timing. In order to mitigate the time and money spent on an audit, detailed and fastidious recordkeeping are essential, as is a willingness to gather and locate evidence to defend claims. Yet traditional spreadsheet management or financial systems that are not designed to manage royalties render this type of data collection and reporting quite difficult. 

With the complexity of today’s licensing agreements, a technology solution designed to handle rights and royalty management allows licensees to:

• Automate royalty calculations and violation notifications to ensure accuracy
• Shrink time spent on preparing statements and responding to audits
• Drive down the cost of audit claims with detailed reporting and audit trails
• Negotiate more favorable terms with insights into contract performance

All of these support business—and bottom line—growth and provide a return on investment that can easily pay for the technology solution while at the same time opening opportunities for additional revenue streams.

As licensors continue to slice and dice properties to create more revenue opportunities, the restrictions they put into licensing agreements are becoming more granular. Licensees often need to comply with a multitude of contract terms, for example:

• minimum guarantees,
• marketing fees,
• territorial restrictions,
• advances by territory,
• advances by category,
• manufacturing requirements,
• quality standards,
• and general liability policies. 

Since sales and marketing teams are focused on moving product, they may not have an eye on whether they are in violation of these terms. Platforms that automatically send violation alerts help licensees get ahead of noncompliance and remedy infractions before an audit comes around. This can save enormous costs and headaches, as violation penalties can be as much as 3x the royalty rate, and some licensors compound interest over the term of the violation. 

The vast majority of licensees have no intention of underpaying royalties. Yet the complexity of licensing agreements often results in unintentional property misuse or undercalculation of royalties owed. The audit will often uncover and penalize these. However, since large licensors may have hundreds of licensees and lack visibility into the nuances of a licensee’s sales, audit claims are often compiled with a broad stroke. This means that audit findings can carry much higher price tags than what is justified.

For instance, one licensee reported that a licensor included everything with the word “princess” in the product description in their audit claim. However, several of the products were made of princess-cut glass, which had nothing to do with the licensed property. It is the responsibility of the licensee to provide the data to defend their usage and royalty payments in order to clarify these mistakes and bring down the price of these claims. 

In many cases, the differences between the penalties licensors claim and what is eventually settled can be extreme. One of FADEL’s clients had a licensor claim the licensee owed $1.2 million, which after over nine months of painstaking data retrieval was reduced to just $35.

In absence of visibility into their data, many licensees make costly decisions to cover anticipated shortcomings.  These include:

• Intentional overpayment of royalties
• Maintaining a contingency fund
• Foregoing credit for discounts, allowances, and chargebacks
• Limiting innovation, e.g. joint branding, because of accounting complexities

These workarounds to ensure royalties are covered cut into licensees’ profits. With a rights and royalty management platform, licensees can eliminate these costs and embark on new business ventures without fear of whether they are adhering to complex contract terms.

Licensees have reported spending 150-200 hours over 6-9 months to complete an audit. One licensee recently told us that they have been defending an audit for more than a year now. In order to respond to an audit, licensees must produce an audit trail that tracks changes to agreements, contract deal terms, financial requirements, and design and product approvals, as well as detailed information that, depending on the licensor, could be required to go down to the line level for every invoice. 

Producing an audit report that can be sent to the licensor with supporting documentation typically falls to licensing, legal, and finance teams, and detracts from their ability to perform their core jobs. A sophisticated royalty management platform can reduce this months-long effort to mere days, plus provide the information needed to reduce penalty price tags.

Licensee-licensor relationships are mutually symbiotic and staying above board is key to maintaining a positive partnership. For some of FADEL’s licensee clients, licensed properties represent as much as 95% of their revenue. Therefore, positive partnerships are essential for them to grow and thrive.

Demonstrating accuracy, timeliness, and transparency builds confidence among licensors, laying a foundation that puts compliant licensees in pole position for acquiring and retaining the most sought-after properties.

In addition to empowering licensees to stay compliant with licensing agreement terms and build stronger partnerships with the licensors they work with, a comprehensive royalty management platform provides valuable insights into various aspects of contract and property performance. Dashboard visibility into minimum guarantees can help inform decisions on which products you may need to push so that you don’t end up paying royalties on unsold merchandise. In addition, visibility into rights, payment terms, and contract restrictions allow licensees to keep an eye on commitments. Plus, licensees can pull reports and analytics to support forecasting and inform negotiation strategies when properties are set to renew. Finally, sales teams have at-a-glance visibility into what properties are performing and are armed with data to support proposals for new properties.

FADEL arms licensees with the tools they need to grow and thrive. LicenSee® by FADEL is a plug-and-play rights and royalty management platform with features and functionality tailored specifically to the needs of licensees:

• Automated royalty calculation that can tackle the most complex contract terms and payment rules
• Templatized statement generation that complies with the format and requirements of top licensors
• Real-time compliance checks that identify violations before they escalate out of control and drive up penalty fees
• Full reporting capabilities to provide audit trails for easy account reconciliation and defense of audit claims
• Detailed audit reports that support data collection and evidence gathering
• Dashboard visibility into contract terms and property performance to ensure compliance and inform strategic decision making

Simplify compliance, dial in your business, and spend more time on innovation. Contact FADEL today for a demo.