FAQ: Royalty Auditing

Answers to the commonly asked questions about Royalty Auditing

Frequently asked questions about royalty auditing

Below are some of the questions we are asked most frequently.  If you have a question you would like to ask, please let us know and we will respond to you by phone confidentially and at no charge (email to db@danielburnsassociates.com) 

How many royalty audits have you conducted, and what kind of results have you had?
We have conducted over 200 royalty audits, mostly, but not exclusively for universities, research foundations, and U.S. government laboratories and agencies.   A selection of the industries or technologies we have recent and relevant experience in is here, and a table giving brief descriptions of selected royalty audits and the associated findings and monetary recoveries is here.   

How much does a royalty audit cost?
While there are always exceptions, most of our royalty audits cost between $17,500 – $27,500, not including travel costs.  Factors that may affect the cost of a royalty audit may include, for example, the complexity of the license agreement, the existence of sublicensees, and the nature and extent of information provided by the licensee.   By the time we have reviewed the license agreement, royalty reports, and done some research on our own, we are generally able to provide a “not to exceed” figure, but if the final charges are less than that amount, you will only be charged for professional fees and out-of-pocket expenses incurred, and never for administrative overhead.  Depending on the terms of your license agreement, the licensee may be responsible for the costs of the royalty audit.

Will the royalty audit harm our relationship with the licensee?
Most of our royalty audits are conducted for universities, research foundations, and U.S. government laboratories and agencies.  In only one case has a licensee terminated a license agreement soon after receiving notification of a royalty audit, and in that case, the licensee argued, and the university ultimately agreed, that the licensee was no longer practicing the licensed patents.  We believe most licensees are accustomed to operating in an environment of increased compliance requirements.  In our experience, licensees understand the licensor’s need to verify the completeness and accuracy of royalty payments, and are concerned primarily with confidentiality, scheduling, and having the royalty audit conducted in a manner that is respectful and fair.

Should I use our internal auditors for a royalty audit?
Although probably less costly, we believe there are shortcomings to using internal auditors for royalty audits of licensees.  First, they lack “independence,” a term of art for CPA’s, but one that is often enshrined in the audit provisions of license agreements.  Even if it is not, licensees will be concerned about independence and, as likely, confidentiality.  Finally, internal auditors may lack the experience to conduct an investigation of a third party, where that party has a different organizational structure and management information system than those with which they may be accustomed.

Should I have the licensee perform a self-audit?
Self-audits may be useful, and often disclose mechanical reporting errors (eg, a product code that should have been captured in the royalty calculation but was not), but are unlikely to reveal, let alone measure the impact of key interpretive assumptions about the license agreement that may differ with the licensor’s interpretation.  For example, should the royalty base be comprised of an entire system containing multiple components, or should it be based on a lesser combination of components?  A self-audit is unlikely to address those types of questions.

Is the current form of my license agreement sufficient?
Increasingly, universities are making their standard license agreement templates available to the public.  In many cases, they are excellent tools to help evaluate your own particular needs.  See, for example, the license agreement templates from Stanford University (here) and the University of Texas at Austin (here), as well as those available from other institutions. [1] 

What are the trouble spots that are most likely to result in royalty underpayments?
There are many, many causes for royalty underpayments.   However, we regularly find very substantial underpayments in connection with:

OK, I have the royalty audit report.  What do I do now?
In almost all cases, you should act quickly upon the royalty auditor’s findings.  To fail to act quickly erodes the currency of the royalty audit report and may lead the licensee to conclude you will not be determined in obtaining the result you are entitled to.  Submit an invoice for the underpayment and, if appropriate, interest and costs, with a demand that payment be made within thirty days.  If the report is potentially controversial in that the licensee does not accept the auditor’s findings in whole or in significant part, consider involving your internal legal counsel soon after receiving the report, or the licensee’s response to your demand for payment.

What are some of the risks of royalty audits that I might not have heard about?
Retaining a seasoned and well-respected royalty auditor should insulate you quite effectively from runaway audit costs, damage to the licensee relationship, and the loss of too much of your time handholding the royalty auditor.  One risk that we believe is underappreciated is the propensity for the licensee to respond to the audit by stating that they no longer practice the licensed patent(s) and that they have overpaid royalties.  This risk is probably greatest where the licensed product has been in the marketplace for a lengthy period of time and has undergone significant design changes.

[1] Daniel Burns & Associates, Inc. does not recommend the use of any particular license agreement template and accepts no liability for adoption of these agreements, in whole or in part, as part of any contractual arrangement.  The license agreement templates in question are for illustrative purposes only.