Maintaining the License Relationship Glenn Tautrims & Hugh Jones
Maintaining the License • Outline • Relationship Management • Why maintain a relationship • Understanding each other • Information exchange • Auditing the License(e) • Why and when • Typical issues to consider • License re-negotiation • When • How
Why Relationship Management? • Keep track of progress (or lack of progress) • Identify roadblocks, true drivers, solutions, suitability • Budget for Revenue • Keeping informed means you are better prepared for ‘surprises’, renegotiations, termination • Larger deals require more effort than smaller deals • expanded network • Future deals • Assessment help
Relationship Management • Understanding what the Licensee wants and needs from the License • Access to the technology • Access to the PI • Access to the University • Partnering opportunities • Competitive reasons • Access to improvements in the license agreement • Prevent / control product(s) reaching market
Relationship Management • What drives the Licensee? • Start up • Small company • Large company • Position in the Market • Company • Licensed Product • Culture • Decision making process • Values
Relationship Management • Understanding what the Licensor wants and needs from the License • Payment$ • Successful commercialization • Product development • Launch • Maximize sales • A deal • Access to Licensee’s IP (ie cross licensing) • What drives the UILO? • What are the metrics?
Relationship Management • What information should be exchanged? • Technical • Principal Investigator relates to the R&D team • Grad students, informal reports, data , materials • Open channels for your PI if none establish themselves • Product Development • Milestones • Go no/ go points
Relationship Management • What information should be exchanged? • Patent and other IP • Business • Formal reports • Performance monitoring • Pre commercialization payments • Royalty payments and reports
Relationship Management • You Have to Ask! • Ask About • Review with PI • Involvement • Impressions • Keep Track of Product Development • Ask probing questions regarding the internal process, budgets, market positioning, competition, technical challenges, regulatory • Follow up on Milestones and Go No/Go decisions
Relationship Management • Ask About • Patent decision making • Use conference calls with their patent attorney regarding prosecutions and other decisions • Understanding the role they see for patents • Be aware of general IP issues in company, industry • Market Positioning • Who is the customer, competition, key elements needed for success
Relationship Management • You Have to Ask! • Ask About • Product Launch • Marketing • Sales expectations, budget, your earlier negotiations VS
Relationship Management • You Have to Ask! • Review Reports Carefully • Chart trends • Incorporate into budgeting process • Sublicensing component • Ask about • Projections • New products • Competition • Territories • Product Life cycle
Relationship Management • Patent Maintenance in the License Agreement • Follow the rules of the agreement until working practices can be established • Anticipate filing decisions and do the homework • Know what you want • Be prepared to listen as well as advocate your position • Stay ahead of your Licensee • Anticipate bar dates • Anticipate maintenance payments
What are Royalty Audits • Royalty Audits are not financial statement audits • Forensic based • No defined “materiality” • Limited agreed upon procedures • Conducted to determine if the licensee is in compliance • Identify and quantify understatements • Attempt to manage expectations and outcomes
Why Audit Your License(e) “29% of the 500 companies surveyed by Kessler International in 2000 conduct royalty audits. 25% of those licensees were found to have major discrepancies frequently requiring litigation to solve.” LES Nouvelles – March 2006 – Dr. S. Degnan
Why Audit Your License(e) • To determine / quantify if underpayments have occurred • People make mistakes • Lack of internal controls, underreported sales, miss a payment • People think differently • Poor communications, inappropriate deductions • People even cheat • Rare
Why Audit Your License(e) • Question – how much on average is underpaid • a) 10% • b) 20% • c) 35% • d) none of the above
Why Audit Your License(e) • Ensure all licensees are treated fairly • Improve future licensing drafting • Encourages better future reporting since licensees talk • Meet fiduciary duties • Corporate licensees expect it • Corp. licensors audit as a standard practice
The Royalty Monitoring Process The Royalty Examination Process Review Portfolio and Develop Systems Report & Pursue Conduct Examinations
The Agreement Language “ the authors of this article have seen numerous times where the CFO or controller of the licensee has unilaterally reinterpreted the clear language of the royalty agreement to substantially lower the amount of royalties due to the licensor.” LES Nouvelles – March 2006 – Dr. S. Degnan
Beware of “Net Sales” definitions “Royalty shall be applied to Sales net of all regular (or reasonable) discounts” • Specify if sales need to include lease or rental payments and how they are to be treated. • Total product revenue without regard for discounts, rebates, or pass-throughs. • Average Sales / Unit calc.
Beware of “Discounts” • Freight – reimbursements by customer, corporate vs. actual deduction • Volume discounts – corporate vs. actual taken • Discounts should be stated separately on the invoice.
Beware of “Affiliates and Subsidiaries” • Affiliate – Licensee owns or controls at least 50%. • Transfer price should be set at fair market value at a minimum or recognized upon affiliate’s sale • Subsidiaries should not use transfer pricing but actual sale to 3rd party instead
Beware of “Sub-contracting” • Does the license grant licensee the right to subcontract licensed product (have made clause) • Ensure that subcontractor is bound by licence • Name and location(s)
Audit Provisions • Right to audit – annually • B & R kept for at least 3 yrs • Is the audit window reasonable • Right to appoint an independent examiner • Right to interview key personnel
Audit Provisions • Do not restrict information to F/S or G/L, etc • Catalogues / price lists • Tax returns • Sales Reports • Subcontract / Supplier agreements • Right to make & keep copies of info.
3rd Party vs Internal Audit Group • Look at agreement • Sensitivity of licensee (NDA required?) • Industry experience • Budget and staffing considerations
Penalties Applies to both late or underpaid royalties • You need the “big stick” • Interest – rate, simple or compound • 3% to 5% - cost of audit
Royalty Report Format Attach to agreement and request: • Product number • Units sold, price and extended sales amount • Royalty rate and royalty due • Details of sales by country with foreign exchange rate used • Withholding taxes taken and prior period adjustments • Audit certificates
When to Audit • You need assistance first! • You need buyin from: • Upper management (critical) • PI (if applicable) • Accounting / Finance (if applicable) • Other partners / tech transfer groups (if applicable) • Legal (interpretation and enforcement issues)
When to Audit • Timing and adequacy of royalty reports (and payments) • Expected size of royalty stream • Size and financial condition of the licensee • Other: • Location (office, manufacturing facilities) • Comparison with other licensees, if applicable • Status of current relationship with licensee • PI, press releases, catalogues etc
When to Audit • Consider using a checklist • Segregate the population into H, M & L risk • Hint – use a database or spreadsheets to keep this aspect of royalty monitoring current • Exception / aging reports • Consider charts and trend lines (tie to expected size and by region) • Keep everything in ONE PLACE and assign ONE PERSON as key contact/coordinator (std process) *.
How to Select Licensees • All high risk (low hanging fruit) • All medium risk that have failed desk audits (public info, reporting patterns etc) or researchers have strongly indicated that there are substantial issues. • Limited onsite versus full audit • Randomly select a few low/medium risk to ensure system is working
Roles & Responsibilities • Prior to Commencement • Written notification given to licensee of best practice (“HU and prevent SOS”) • All information is gathered and provided to examiner • Meet with examiner(s) to discuss potential issues, timelines • Notification given to licensee of selection (NDA) • Licensee is contacted by examiner
Beware of NDA limitations • Limitations – can only comment on correct royalties • Consider instead – consulting privilege with licensor related to technology, disclosure of information permitted as long as it relates to agreement, no other NDA required
Fieldwork • Qualitative and Quantitative Analysis • Conduct initial interview (understand the system) • Tie out support used for payments to financial statements • Review manufacturing locations • Conduct reasonableness checks, if possible • Review management and their responsibilities • Review sales brochures and agreements
Wrap Up Fieldwork • Examiner to meet with licensee to discuss findings • Licensee should never receive copy of draft report
Reporting • Examiner should issue a report with supporting documentation and analysis • Scope • Work performed • Findings (discussed with licensee)* • Recommendations • Licensor, if determined appropriate, sends final report to licensee
Typical Issues • Lack of records – waited to long! • Staff preparing royalty calculation have never seen contract • Poor definition wording • Discounts • Volume / freight • Corporate / actual
Typical Issues • Calculation errors • Unusual or aggressive deductions • Returns being resold • Cash vs. accrual • Made vs. sold • Units credited for sales price reduction
Typical Issues • Often convert local currencies of subsidiaries to home office of licensee at standard rates. • Royalties on sub’s sales are often lost on • Translation • Transfer price • Missed on consolidation • Location of books and records are not centralized
Typical Issues • Underreported Royalty : $425,000 • Company: Pharmaceuticals - Vaccines • Problem: Company research staff and marketing staff decided that collectively that they should replace an older product. The new product incorporated the licensed technology however no one notified the analyst preparing the royalty reports.
Typical Issues • Underreported Royalty : $300,000 • Company: High-tech – OEM manufacturer • Problem: Company submitted royalties based on units sold. The accounting system tracked both returns and sales price adjustments by unit. The royalty reporting system was linked to the accounting system and could not distinguish between a return and a sales price adjustment since both were entered as a negative unit.