BDO’s Contract Compliance Series
Licensing agreements generate significant value for both the licensor and the licensee. However, in the world of licensing agreements, the lines between profits and pitfalls can be thin. Misuse of licenses and breaches of agreements can damage business relationships, violate compliance requirements, and lead to loss of value for all parties involved.
To help minimize risk, licensors should proactively conduct contract audits, both on a regular basis and in response to external triggers. A proactive audit posture is key to maintaining compliance, protecting trust, and optimizing revenue. Understanding when it’s essential to conduct contract audits can mean the difference between enhancing value and falling into costly compliance traps.
The Case for Regular, Proactive Audits
Regular contract audits are essential to good fiscal hygiene and can provide peace of mind to licensors. These routine checks offer a range of benefits. For example, they allow licensors to maintain control over their assets and help verify licensees are compliant with licensing agreements.
Let’s take a closer look at the benefits offered by regular, proactive contract audits:
- Peace of Mind: Regularly scheduled audits provide licensors with confidence in the health of licensing contracts. Knowing that audits are planned and consistent can alleviate concerns around compliance and contractual obligations.
- Risk Mitigation: Audits act as a preventative measure against non-compliance issues that may otherwise go unnoticed. By conducting audits on a routine basis, licensors can detect and address potential issues before they escalate.
- Maintaining Control: Maintaining control over your licensing agreements is essential. Regular audits help licensors stay in the driver's seat, helping to confirm that licensees adhere to the terms and conditions set forth in the agreement.
- Transparency: Audits promote transparency within the licensing relationship. Both licensors and licensees benefit from clear, well-documented processes and reporting, which reduce the likelihood of disputes or misunderstandings.
- Cost Savings: Regular audits can help licensors detect compliance issues early on, enabling them to rectify discrepancies and avoid costly legal battles or revenue loss due to non-compliance.
Going Beyond Routine Audits
While proactive, routine contract audits are critical to enhancing the value and compliance from licensing contracts, certain scenarios may trigger an audit outside of the regular audit program. Licensors should consider performing an audit when:
- They see a drop in sales or royalty revenue. Sales drops or noticeable revenue discrepancies can be early signs of non-compliance, signaling the need for a contract audit.
- A contract is up for renewal. Regular contract renewal cycles provide another strategic window for audits. Reassessing agreements during renewals is not just good fiscal hygiene; it's a proactive approach to keeping your licensing terms in alignment with your evolving business needs.
- There is a change in ownership. Changes in contract licensees, as with mergers and acquisitions, often necessitate a compliance review to verify that agreements align with evolving business structures. When companies merge or licenses change hands, it's a flag to evaluate the compliance and accuracy of licensing agreements.
- There is a shift in the related market or industry. Industry dynamics can also trigger audits. In rapidly evolving sectors, frequent audits may be necessary to keep pace with changing technology or market trends.
- You want to know what your competitors are doing. Competitive benchmarking is critical to helping get the most value out of your licensing agreements. Comparing your licensing performance with industry standards or competitors can reveal both discrepancies and opportunities for optimization.
- You are seeing atypical behavior from your licensees. Vigilance is essential in a licensing relationship, enabling you to promptly identify and address unusual activities, disputes, or compliance concerns. Any of these factors should trigger a closer examination of the contract to safeguard your interests.
A contract audit isn’t just a box for a licensor to check each year. Instead, it’s an opportunity to realize more value from licensing agreements. For this reason, knowing when to initiate a contract audit outside of the regularly scheduled audit cycle is crucial. Conducting audits proactively, rather than reactively, can help you avoid costly mistakes and damage to your business relationships.
Four Steps to a Positive Audit Outcome
When conducting a contract audit, fostering a positive and collaborative relationship between licensor and licensee is paramount. Open and transparent communication is required to maintain trust throughout the audit process. To that end, all parties should approach the audit as a joint effort to maintain compliance rather than as a punitive measure. This, in itself, is easier when audits are undertaken proactively, before any misunderstanding, rather than as a result of a potential compliance issue on the part of the licensee.
To help ensure your audit is a value add to all parties, consider the following steps:
- Start by clearly defining the audit scope and objectives. Make sure you’re involving all relevant stakeholders and securing their buy-in, so everyone is working toward the same goals.
- Keep lines of communication open and respectful. Address any concerns or discrepancies promptly and transparently.
- Document all audit findings accurately and comprehensively. Make sure all stakeholders understand the findings, and then work together to rectify any issues discovered.
- Consider the long-term implications of the audit on the licensing relationship. Use the audit as an opportunity to optimize the agreement for both parties and improve the existing relationship wherever possible.
It’s important to keep in mind that a proactive approach to compliance management is a good financial practice and can provide a competitive advantage. It helps you keep your licensing agreements on track and safeguard the integrity of your business relationships. Audits aren’t just about minimizing risk; they’re about evoking the value inherent in your licenses.