How do you know your licensees are paying the correct amount of royalties? Generally, royalties are paid quarterly with statements from your licensing partner showing the previous quarter sales and amount of royalties owed. But a royalty report doesn’t always mean you’re getting paid the right amount.
There are still a some ways your royalty payments can be under reported. Here’s a list of the 3 big royalty reporting errors and how to avoid them:
Vague Royalty Calculation Formula: Whether the royalty is a percentage, fixed fee or annual amount, the calculation formula must be clear. If it’s vague or general, then it’s open to interpretation. The result is a significant difference in what the licensee pays you and what you’re owed. For example, if the definition only says “sales”, your licensing partner can interpret this as net sales after deducting certain costs, such as production or advertising. Or the “sales price” is different from the “selling price”, one is the listed price and one is the price it’s actually sold for. That’s why I like to use deal memos to followup negotiations. It specifies the formula for calculating royalties on sales so everyone is in agreement before it’s included in the licensing agreement.
Under-Reporting Sales: The biggest reason for this error is a product definition wasn’t specific. The licensee adds a new product (or territory) that wasn’t originally in the agreement, and it’s “overlooked” when reporting royalties. When Power Ranges was red hot, the studio audited licensees each year, and inevitably recovered “under reported” sales. Typically these were on products added after the contract was signed. You can avoid this mistake be making sure you are very specific about the products (or services) included in the licensing agreement. If more products (or extensions) are later added, be sure to update the agreement , and make sure they are included in the royalty reports.
Non-Allowed Deductions: This error happens often. These are deductions from the royalties that are not allowed. Some of these include advertising, overhead, damaged goods, returns, warehousing, production or other selling costs. Sometimes the royalty report will only give a general summary of deductions, making it hard to figure out if it’s allowed. Most of the agreements I negotiate have very limited deductions, and these are 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.
The best way to avoid these 3 big mistakes is to make sure the royalty calculation formula is clearly defined in your licensing agreement. Be sure to describe the products (or services) in detail and make sure your licensing agreement is updated with the changes. Most important, be sure to list allowed deductions, as well as those not allowed, and give a royalty report template so you can easily verify the payment your licensing partner is making is what they owe. Otherwise you could wind up getting short-changed on your royalty payments.
Rand Brenner is an IP professional whose passion is helping inventors, startups, and businesses of all sizes use licensing to turn their IP into income-producing products, services, and technologies. His decades of experience run the gamut from medical devices to food technology to consumer products. He’s licensed some of the biggest Hollywood entertainment blockbusters including the Batman Movies (1 and 2), and the number one kid’s action TV show, the Mighty Morphin Power Rangers. Rand speaks about licensing and is a featured speaker at investment conferences, trade shows, colleges and startup events. He’s a published writer with articles appearing in several prestigious trade magazine including The Licensing Journal, Intellectual Property Magazine, and License India. Rand also mentors at the Cal State Fullerton School of Business and Economics and is a judge for their startup business plan competitions.