On-Demand: Managing, Monetizing and Protecting Your Intellectual Property | Part I

We're going to talk about the different types of intellectual property. How to inventory the intellectual property and why you'd want to do that. Some beginning basics on the valuation of intellectual property. Then, my colleagues Nelson and David are going to talk about royalty audits.

The first step for me is I'm going to talk about the different types of intellectual property. The first thing that I need to make sure that we have a good clarity on is I sometimes use the terms intellectual property and intangible assets interchangeably. For everyone's information, we all need to realize that they're not the same thing.

Tangible assets are things that might be different types of assets that are not protected like an intellectual property is protected. With regards to intellectual property, we're talking about things that are created and by statute and defined by judicial precedent, and enjoy a legal recognition. Also, have the ability to be defended in the legal court system.

There are four different types of intellectual property. The first one is copyright. You probably think that copyrights, when you think of copyrights, you think of artwork or you think of music. Those are obviously very good examples of copyrights. In the business setting, what I normally see is copyrights with regards to software.

You can copyright software to do different functions within a company. The duration of a copyright is 70 years from the death of the author. With regards to the business types of copyrights that I see with the software, I don't think you're ever going to get to the point where you're going to have the full legal life of a copyright come into play.

Copyrights with regards to software is probably more driven by the useful life of the technology. What I mean by that is if you have software code, technology is changing at a fast enough pace that pick a time five, seven, 10 years might go by and that software copyright that you have on that software may not be valid or useful anymore for the business.

That's what I mean when I say the useful life. Sometimes and most actually most of the time's different from what the legal life is. Next is trademarks. Trademarks are those things like brands and logos like a Nike Swoosh or McDonald's golden arches. Those are pieces of intellectual property that can be registered with the USPTO, and the international organizations.

They can last technically forever as long as you continue to pay the maintenance fees for those. If you miss the maintenance fees, the chances are you'll lose that coverage. I'm going to skip over the next one, and we're going to talk about patents for second. For patents, there are basically three different types of patents.

There are utility patents, there are design patents, and there are plant patents. Plant patents are actually for those agricultural plants. We're not talking about manufacturing plants, very, very rarely see those. Utility patents is what we normally see. The life of a utility patent is 20 years from the time of filing.

When you're looking at doing either a damages' calculation or evaluation with regards to a utility patent, the issue with regards to the use of a life may come into play again. In other words, what I mean by that is if technology changes and whatever the product is patented the technology might catch up and pass.

Therefore, the patent may not have value after a certain period of time. Again, useful life is something that needs to be considered when you're comparing it to the legal life. The last thing that we'll talk about onto the slide is trade secrets. Trade secrets, you don't have to register those with any of the authorities like the USPTO or YPO.

You do need to make sure that you identify those. Once you identify them, you have to then maintain the secrecy of them through either employment contracts or non-disclosure agreements. If you don't maintain that as a secret, then they'll lose their value. The perfect example that people always use with regards to trade secrets is the Coca-Cola formula.

The next slide I like to use to give you an idea of different types of IP. This slide, you can see the iced tea and its sweetener. Now, obviously for those people that are in the south who drink sweet tea, that really doesn't pertain to them because they don't don't necessarily need to sweeten their iced tea.

For those others that like to sweeten their iced tea, these are some common examples of different types of sweetener. Well, I'm sure we're all familiar with Equal and Splenda and Sweet'n Low, Sugar In The Raw, and sugar by itself. You may not think of when you open a package of each one of these is that they contain IP.

I just want you to think for a second and think about the different types of IP that might be incorporated in these products. Then we're going to talk about it a little bit here on the next page. I'll give you just five or 10 seconds to think about. (silence).

The types of IP that might show up in sweetener package like this could be patents associated with the chemical composition or the manufacturing process. The trademark, which is, would be the brand of the logo. That's on the packaging. There could be trade secrets for the manual manufacturing process.

There could be knowhow, copyright for the artwork and the packaging trade dress, which would be the coloring of the package. I think you've probably seen knockoffs for Sweet'n Low, which if they're knockoffs for Sweet'n Low, then they're still in pink packaging so you can recognize the type of sweetener it is.

The purpose of this was to just talk about the fact that there are in one product there could be multiple types of IP associated with that product. I think that takes us to our first polling question, Lexi.

Lexi D'Esposito: Poll #1

David Sumner:Graham, while people are responding to that poll, in your experience, what industry has surprised you with the amount of intellectual property that it contained?

Graham Rogers:That's a good question. My answer, I think would be that it would be the non-tech types of companies or industries. At least for me, when I think of intellectual property, the first one I think of is patents. When you think of patents, the first thing you think of is high tech. I think the way I would answer that I would say it's a low tech industry.

For example, maybe retail store or even the furniture industry. There's lots of design patents within the furniture industry. They protect their designs with a design patent. In the retail space, you take a company like Walmart, for example. Walmart carries obviously products on all different price spectrums and the higher price products.

They have arrangements with their vendors to carry the high end merchandise with their trademarks and logos. Walmart also has all of their low cost, their own branded product and their own branded product can be registered for intellectual property protection as well.

I'd say I would be surprised in the retail space the amount of IP that can sit in there.

Graham Rogers:Well, that's a good mix on the answers there. The next thing we're going to talk about is how to identify and inventory your intellectual property. There are three different types of inventories that customers and companies do. The first one is what's referred to as a general purpose.

Those are for either new companies or those companies who know they have a lot of IP and want to make sure that they have good practices in place to help monetize that IP or for those companies that are getting ready to launch new products. Those are the companies that generally I work with regards to conducting inventories.

There are event-driven inventories and those are a result of some type of event like an M&A or an IPO, or a launch of a new product. For example, M&A you're usually doing the inventory and reviewing the IP as part of due diligence. The final one is referred to as a limited purpose inventory.

The limited purpose inventory is for a very specific event. For example, if I'm brought in to value a piece of IP or a technology bundle, then as part of my valuation, I'm going to do a limited purpose inventory because I basically need to accurately identify what is being valued and that includes all of the IP associated with it.

It might be two patents for various trade secrets and knowhow and one or two trademarks, but that all would need to be identified and put forth in the evaluation report that I end up delivering to the client. The different steps to a general purpose inventory would be the first step is to basically go around all aspects of the company and identify all of the intangible assets, and name those assets.

If they don't have a name, give them some type of an identifier. Very importantly, add a description to that. Also, capture the type of asset. Is it a copyright trademark or a patent? Then, how is it being used? Is it a key revenue to, is it part of the main product that the company offers?

Is it potentially for a new revenue stream that might be coming down the line in two or three years? Is it defensive? What I mean by that is you might have IP and decide to keep the IP protected and maintain it to make sure that your customers are excluded from a market. That's what's referred to as defensive IP.

You maintain the IP and the monopolization aspect of IP can allow you to exclude certain competitors. You may not practice it, but you may keep it for defensive purposes. The final one, which is also very important is maybe it's not being used at all. If it's not being used at all, then you can make the decision again, one to keep it or two to discard it.

The reason that can be important is because there are the maintenance fees that you have to pay for these pieces of intellectual property. There's a lot of them and they can be costly, especially for example, if you have a patent that has been issued in the U.S., but you also get an international patent.

You then apply it in multiple countries, you have to pay a maintenance fees for that, and that can get expensive. Also, as part of the inventory, you want to make sure you capture ownership. My recommendation is when you capture ownership, you're actually taking it down to the name of a person as opposed to the position that they're in.

If there's no owner, you need to make sure that you assign it. Also, the thing that keep in mind is that if you're licensing IP from another company that should be carried on your inventory as well.Ownership should be with that party or that third party company that is providing the IP to you.

Once you gather all this information, you should be keeping it in a some form of a tracking tool. The tracking tools that I would most recommend would be either an Excel spreadsheet or some type of an Access database. The differences depend on how much IP we're talking about, the complexities of the IP within a company.

Everything may be able to be covered within a simple Excel spreadsheet, but just make sure that you have a plan in place. Make sure that you populate that because then that tool can then be used to come back and check it periodically over time. Most importantly, to ensure that the ownership of the IP remains intact.

People move on, people retire. If people leave the company, get promoted or retire, that ownership of that IP can be severed. That's what I see happen most often is that somebody leaves for whatever reason, they had responsibilities for a certain piece of IP, the turnover wasn't great between that person and the next person to take that position.

The ownership of I IP gets severed and over a period of time it could get lost. The person who takes the place of the person who had the ownership may not ever realize that they're supposed to have responsibility from that IP. It's important to review this thing, the inventory periodically to make sure everything's still intact.

The final thing is to make sure that you have an appropriate protection plan in place. For protection plans, probably the easiest way to describe it would be for example on trade secrets. Lots of times trade secrets are protected by employment contracts or non-disclosure agreements.

A periodic basis, you should be working with either inside or outside council to ensure that your employment contracts are updated, accurate with regards to IP. Make sure you have everybody who assigned them, whether they're internal personnel or vendors that you might be sharing with or joint venture partners.

That's going to help identify or keep track of and protect the IP that the company has. Following your inventory, the main thing is you want to make sure that you do it on a recurring basis. What I recommend is if your company does fraud risk assessments, maybe in conjunction with an annual audit, that might be the perfect time to do an update of the inventory to make sure that everything's still intact.

Make sure you don't need to add some IP. Maybe you've decided in the last year to change the direction of the company. Therefore, maybe you will want to abandon certain IP and no longer pay the maintenance fees. I just think it's a good time. Annually is a good time to review it.

In conjunction with the fraud risk assessment or the audit is a good time. The reasons why you want to do an inventory, the first one that I list there is with regards to trade secrets. I think I mentioned early on that I do get involved with a lot of damages cases with regards to trade secrets or IP in general.

Misappropriation trade secrets is probably the hardest for an attorney to prove up. I'm not an attorney, but dealt with enough trade secret matters that I have an understanding that for the lawyers to win on the liability aspect of trade secret matters, they need to have a trade secret that has been identified.

They need to have the trade secret and show that not only is it identified, but that it has a protection plan or had a protection plan in place and it was still misappropriated. It's a lot easier to do that when you have an inventory, identifying what those trade secrets are within a company as compared to doing it after somebody walks out the door with a customer list or something like that.

Now, you're identifying that as a trade secret. That's a big benefit to having an inventory. Other benefit is it allows you to identify new revenue streams. I talked about the fact that new products that come on online may have IP associated with it. Being able to track that in the inventory is important.

In a merger or acquisition, it's important to have an inventory because that could be the key ingredient that allows you a strong negotiation position to maximize the company's value or the shareholders' value. Then finally, we talked about the fact that if you no longer use IP, there's nothing wrong with discarding that IP and you can gain cost savings from that.

Lexi D'Esposito: Poll #2

David Sumner:Graham, while people are filling that poll question out, it shouldn't take too long. Just thought I'd ask you, what is the most unusual intellectual property asset that you've ever worked with a client on?

Graham Rogers:Well, I think I'm going to answer that two different ways. First of all, I think the first answer would be any IP that's associated with a product that is defining a new space. There's nothing available out there may be with regards to research in the space.

A new product, a new niche example of that is recently did evaluation of IP that sits within a cryptocurrency company. They mentored tokens to be used on the Ethereum network. It was challenging because with it being so new and niche, there weren't any research analysts that were covering the market yet or there are not any.

Just recently did this valuation. I think that's probably the most unusual ones you get involved with is when they are so cutting edge that markets and industry experts haven't caught up with it and haven't started tracking things yet. Moving on.

Graham Rogers:Good answer for most people it is false that you do need to worry about trade secrets, especially with regards to litigation and just also protecting your assets of your company. Remember people might choose not to patent things and choose to keep of things as trade secrets.

I didn't talk about this earlier, but let me just address that real quick. What I mean by that is when you file a patent, it becomes public knowledge. And so people can review and mine, the USPTO for patent applications, which are public companies and/or countries can mine that.

Potentially, reverse engineer some stuff based on what might be available in patent applications because of that, I think I've seen more and more people choose not to patent these days and to try to maintain things through trade secrets instead. Again, trade secret is only valuable as long as it can be identified and protected, and that you maintain that protection.

Real quick. We're going to talk about intellectual valuing intellectual property. We're going to spend more time on this in about a month. We're going to have another one of these seminars where we talk about, go more in depth in devaluing intellectual property and from evaluation standpoint, but also from a damages' aspect too.

I believe we'll have counsel join us at that point. It will be a moderated discussion that where we can talk between ourselves and the attorney and get both the legal and the economic side of it as well. Look for that to come out, I think it's about a month. I don't know if we have a date yet, but I'm sure you'll start hearing that information soon.

With regards to IP valuation, there's a variety of reasons why you may want or need a valuation. I'm just going to touch on a couple of them here. In a transaction, we talked about M&A's, the IP might be a very key component to the value of an organization. You might be selling the IP in and of itself, or you might be selling the company where the IP is embedded in the value of the company.

Excuse me. For in income tax purposes, there's transfer pricing issues, there's IP migration. I've been recently involved in a lot of IP migration. I've done one recently where we've moved IP from, I think it was Switzerland into the U.S. There's the taxing authorities want to see the valuation of the IP as it's leaving whatever country and moving into another country.

Most recently, I'm working on one for Ghana in a financial tech space. They're moving IP from Ghana to the U.S. Again, and the taxing authorities want to see the value of that IP as it's leaving one geographic jurisdiction and going into another. Litigation and damages again, we're not going to talk about that much here.

The only thing I want to point out the difference with damages and valuation, damages is looking for what has happened in the past. Valuation is looking more forward. We'll talk about that more next time. Again, damages is looking at something, an event that happened in the past and how you were hurt by that.

Valuation is forward looking. Looking at the future benefits of the intellectual property, and then present, valuing that back to today's dollars. In licensing, there's lots of steps that we take in doing a valuation. One of the steps is to help you identify what the pricing of the IP should be. The pricing can be used in licensing.

Don't see this much anymore, but we used to do donations for intellectual property. Somebody has decided to abandon it, but it still has some value to somebody. I did valuation for a donation with an oil and gas company. They had a polymer type of fabric that they had created some IP around.

Obviously, the oil and gas company, wasn't going to keep that to practice it for themselves, so they donated it to a textile university so that they could work with it. There are different standards of value. The one that we deal with most often is the bottom one, the fair market value. There are other ones that you need to make sure that you're aware of.

Intrinsic value that's value in the eye of the beholder. You might have a set of IP and you may want to acquire IP to basically finish the package of IP associated with that. You may place a value on that piece of IP to help you finish that puzzle piece, if you will, whatever that might be.

On the other side of that spectrum, you might be looking at acquiring IP where you have no inroads to that area. You don't have a real strong desire, you don't have a real strong reason to bid out and overbid somebody else. You just want to maybe bid and see if you can get in. Your intrinsic value might be lower than somebody who wants to basically finish the puzzle, if you will, for an IP package.

Liquidation value has to do with lots of times, you'll see it in bankruptcy. It's the asset needs to move quickly and so you're willing to take potentially a lower value than you would normally get and a fair market value dealing. The rest of the thing we're we'll talk about is fair market value.

Fair market value is basically defined by revenue ruling as a willing buyer, a willing seller. Both parties having all of the information they need to make a decision, and neither none of them having a compulsion to make the deal. That's paraphrased, obviously, but that it gives you an idea of the types of valuation.

We're looking at a negotiation between two different parties. There are three different valuation methodologies. The first one is a cost approach and the business valuation side. You might consider that the asset approach. There's the market approach and the income approach. The income approach is the future value of cash flows. Present value back to today.

IP can create value in one of three ways. It allows you to charge a higher price for a product. It allows you based on a monopolistic protection. It allows you to maybe exclude others and gain additional market share than you otherwise wouldn't have been able to gain, and/or it also could provide you a cost reduction.

Any of those three ways can be valued. A revenue stream can be valued and can be present valued back to today's dollars. The final one that's not on here, which is also a very important type of methodology is referred to as a relief from royalty approach. It's basically a hybrid between the market and income approach.

The premise of that is that I don't own the intellectual property. I want to figure out how much it would cost me if I needed to license the technology from somebody else, or if I wanted to license it out to somebody else. You're really looking at valuing the future stream of a reasonable royalty payment.

As the part of that, you need to identify the pricing of the intellectual property. The pricing would be in that case, a royalty rate, potentially a percentage of sales or per unit sales. Applying that to a forecast for products. You can come up with a revenue stream and you can present value that back to today.

It's important that when you're looking at the valuation of intellectual property to understand what intellectual property that you have, and what data that might be available. What I normally see in valuation of intellectual property is that there's usually information available to do or conduct, or recreate a cost approach.

There's usually potentially one to three different methodologies of an income approach. The market approach is usually not used in valuing intellectual property because intellectual property in and of itself is unique. Since it's unique, you wouldn't be able to have intellectual property protection if there was products that were so similar to the one in question.

You're not generally going to find comparable products being sold and be able to use those comparable numbers to come up with a market value approach. That's why there's the hybrid approach between the market and the income referred to as the relief from royalty. The final thing with regards to the valuation is to synthesize whatever values that you get, whatever value indicators that you have.

You might have a cost approach. You might have two or three different income approaches. The final piece is to reconcile the value values of those into a single point value. In a full valuation, you're looking at all the different multiple valuation methodologies. In a calculation of value, you only need to look at one of the methodologies.

The distinction with the calculation of value is the result might end up in a range of value as opposed to a pinpoint value. The other thing to point out with regards to a calculation of value is usually the banks or the taxing authorities won't accept a calculation of value report as strong enough in evidence to determine the value.

There are instances where a calculation of value is perfectly fine and very useful. Lexi, I think we're at the next polling question.

Lexi D'Esposito:Poll #3

David Sumner:Graham, you touched on this a couple times, but I just want to make sure. What IP asset that is the most difficult to value?

Graham Rogers:Well, I would say that's probably easily the trade secret. Trade secrets because of the fact that a lot of our clients don't have well defined trade secrets. You're usually trying to work with them, whether it's in litigation or outside litigation to help define what that trade secret is.

The trade secrets that I'm usually dealing with are things like an employee left and took the customer list or took a pricing list that they've been developing over years and years. Being able to identify what the effect of that particular piece of IP, the trade secret, has on the entire value of the product that's being sold or the service that's being delivered.

The trade secret may only be a small component of the product or of the sale. You have to portion the value away from maybe the whole value of what the product or the services. You have to portion it directly to your IP, in this case, the trade secret in question. That's probably the most difficult thing to do.

David Sumner:Thanks.

Graham Rogers:Nelson and David, I think that's your cue for the discussion on the royalty audit.

Nelson Luis:Thank you very much. We're going to shift over now and talking about the successful royalty audit strategies. 

We wanted to just quickly mention is we're going to go through this, which I think is perhaps a little different from what you might see out there with number of other accounting firms is that our contract compliance and royalty audit group sit within our forensic and litigation practice within the firm. I get that question sometimes of, "Why is that?"

What we're going to be getting into here shortly as when conducting these royalty audit and royalty examinations, we normally exercise a lot of professional skepticism when we're performing these examinations. The teams that do these types of normally have to have a really good understanding of how to review contractual language and provisions.

Skilled negotiators because of the potential need to negotiate and having that behavioral interviewing skillset it might be useful. As well as if things go south, which hopefully they do not, but inevitably, if you have a scenario where you are identifying under-reported revenues either through error or by fraud, there could be a contentious situation that might end up in litigation.

Having a team in place that is accustomed to working under privilege and under litigation setting might be very useful and advantageous. I'm going to turn it to David here and he's going to go through a few slides. I'll be back shortly. David.

David Sumner:Thanks, Nelson. My name's David Sumner and I've been involved in royalty audits and compliance and forensic investigations for over 20 years. What we're going to be talking about in our final topic today is that as Nelson and Graham indicated, we're going to be talking about royalty audits.

What we're looking for here is Graham talked earlier about unused intellectual property. One way an organization can monetize their unused intellectual property is by licensing its use to a third party. The parties will enter into a licensing agreement, which spells out the terms of this arrangement.

As Nelson hinted towards these contracts can be fairly complex, and as they need to outline all the conditions for the use of the licenser's intellectual property by the licensee. Potential complications may include multiple products, geographies, and different sales channels. All of which may have different royalty rates.

From the license source perspective. They want to make sure that they receive the correct amount of enumeration from the licensee while still protecting their intellectual property. The licensee on the other hand is looking to the agreement to help define what they may or may not do with that intellectual property.

What rights and protections they have under the contract. Many times the licensee will make significant investments to launch products with this licensed intellectual property. The contract is there to help that investment, but to help protect investment by the licensee.

As you can imagine, the licenser has a very distinct interest in making sure that the licensee is following the terms of the contract. The best method they can do this is through a right to audit clause. A right to audit clause is a means by which the licenser can make sure that the relevant sales may and accurately reported.

A royalty audit is simply trust, but verify in action. These clauses will provide a framework for the audits. To be quite honest, when Nelson and I do one of these, one of the first things that we look at is the audit clause. These audit clauses will help us understand how many years can be reviewed? How often can the reviews happen?

Who can perform the audit? Where can it take place? How many days notice does the licensee have? Lastly, even some agreements have a financial responsibility clause, which kicks in if the audit findings are in excess of particular percentage of sales or of the rebates, or the royalties due.

That's almost like in that instance, what would happen is if the findings were in excess of that threshold, the licensee would be responsible for the fees incurred for the audit. Some very brief best practices for you to consider when you're thinking about royalty audits. If you're negotiating your first licensing agreement, make sure that you consult with people who have experience with these arrangements.

Including those who have conducted audits. Just in the last few months, we've encountered a couple instances where the audit clause language was unclear in a couple instances. The audit has been delayed significantly, and the parties have incurred additional legal costs as they worked out a compromise to allow the audit to go forward.

One very recent example, the language didn't define in the audit clause how far back the audit could go, but this was year eight of a contract, and there were no other prior audits. The licensor, as you can imagine, wanted all eight years audited, but the licensee was objecting because of the difficulty in providing all the required documentation going back eight years.

Just so you know, the attorneys are still talking about this six months later. Another consideration regarding royalty audits is who should complete the audit. Some licensors use their internal resources, most notably internal audit, while others will use an outside consultant. Costs and benefits and strengths and weaknesses to both approaches.

Just want to make sure you understand when you make that decision that you should be considering cost, resource availability, the expertise, and the independence. I think you pretty much understand what I mean by cost and resource availability and expertise. In terms of independence, I want to highlight that using an outside consulting or accounting firm can be seen by the licensee as a less biased intermediary for the audit.

Especially, when the accounting firm is compensated in a time and materials basis, instead of a percentage of findings. We've also found that even pre-COVID, a great deal of royalty exams could be done with a mix of in the field work, and then also back in the office, and then the post COVID world, we found that for the most part royalty audits or exams can be accomplished almost entirely remotely.

One last thing that I would like to highlight is we find a very effective procedure in that we share our draft findings with a licensee prior to sharing them with our client. We do this because that allows the licensee to correct any mistakes or misunderstandings. They get buy-in and they understand how the findings were calculated. They're not surprised.

Lastly, if there was any confidential information that we saw, they can also see whether or not they can take comfort that we're not sharing inappropriate information. This becomes very important in certain licensing arrangements. For example, in the pharma industry, where it's very common when a drug is being licensed to a competitor.

That competitor is very protective of their own internal financial and doctor and customer data. Having an independent party in between there could be very effective. Lastly, just want to very quickly go through what the key events are in a royalty audit. There's the initial fact gathering stage where agreements may be signed and basic information request may occur.

The second phase is where interviews and walkthroughs may occur as well as the detailed testing. The third phase is where we will try to put together all the findings from the testing. We'll try to calculate what we feel the under or over-reported royalties are. This is where we would be sharing the report draft with the licensee.

Then lastly, the settlement and ongoing monitoring. One thing that I would like to point out is that many times we'll have a very confident and accurate finding, but that doesn't necessarily mean what the exact check will be cut between the two parties. At the end of the day, these are two business partners.

If it's in the best interest of both parties to agree to a lesser amount along with some changes within the licensee and/or the licenser, that's the best way forward in order to maintain a healthy relationship between the two parties.

Lexi D'Esposito:Poll #4

David Sumner:Nelson, while people are responding to that question, could you just let everyone know what you think the most unusual finding that you've had during the royalty exam.

Nelson Luis:I'd say one, we were supporting a client in the pharma industry, and we were looking into a cost sharing sales and marketing agreement that they had. We had to analyze how they were developing these pharmacological agents. What was unique was that a lot of these agents were being created all over the globe in many different countries.

The amount of information that had to go into all the cost sharing on how these pieces of the puzzle were put together was extremely complex. Not only were you building on the cost, but then you were having to deal with currency exchange and conversions. That was probably one of the most complex and interesting ones that we've done in a while.

Nelson Luis:It sounds like there's a lot of opportunity for our audience here to learn and get into the benefits of royalty exams, which I will conclude with here. Really, following up on some of the points that David was raising, we want to highlight if you do get into performing the royalty exam.

Either internally or having an external firm assist you, we want to arm you with some questions and some things for you to think about what you might want to either do yourselves or what you might want to ask. One component of that certainly should deal with how do you analyze the data?

Normally these types of assessments are very data intensive, a lot of volume. As opposed to a financial statement audit that you have random sampling at times, these types of examinations are very targeted. On that spectrum that David just covered on how you go through an actual royalty exam, when you're making your selection, then where you're going to be testing, and the types of queries you're going to be running.

The types of questions you're going to be asking, you really want to hone in on the areas that are of greatest and highest risk starting at the contract level, as something as simple as how do you define sales. Then you work your way down until you get to where you're actually going to test from.

As this slide shows, you want to have a systematic approach so that you are able to ingest large volumes of data and efficiently analyze them. Now, through all the different forms of analytic capabilities that are out there on how you can actually even visualize and demonstrate the data is something you may want to consider.

Especially, if you're going to be building a contract compliance program where you might not solely be looking at one contract, but maybe multiple for your organization. You want to be able to have a good playbook in place of how you're going to define those questions. How you're going to collect that data and identify those needles in the haystack.

How you're going to run all your analytics and run your testing to find those answers. Then some form of visualization or risk ranking so that you're not spending time in areas that you really don't need to be. Lastly, having a framework so that when you do that assessment for another business partner or for that same business partner, but in the subsequent year or in years, you have a case management system that you can revert back to.

You will see that after a while, you'll start to build a library. Here is an example of a library of a variety of different issues that we have identified while performing these types of exams. While I'm not going to cover all of them, I wanted to highlight a few of them. You see the categories towards the top. One would be on sales reporting.

One thing that you want to make sure you're looking into is are all the product types included? Are some of them potentially excluded? Normally, we find that there might be a timing issue here. If your agreement was set in place at a certain point in time, and then new products have come on, and maybe there have been new amendments that have been added on, you want to make sure or that all those different product type are included in sales.

Second there, you have accounting irregularities. Interestingly, when we do these assignments, we're normally not identifying fraud. Hopefully, that's not the case with your business partners that they are under reporting intentionally. Normally, it's mathematical errors, it's formula errors. It's a lot of spreadsheets.

It's a lot of pulling of data from different systems. How is that then being pieced together, and many instances it's being done manually by your business partner. You want to make sure that all those pieces of the puzzle are being performed correctly. Normally, we see a lot of mathematical errors in the formulas in things like Excel.

Revenue sharing, pursuant to what the agreement states. There might be different allocations that might be done incorrectly from a cost perspective, really understanding where there might be formula errors and incorrectly pulling of cost data from different sources.

Sometimes we see this very frequently when you have a contract that's been going on multiple years. One of the individuals responsible for all the calculations of the royalties or licensing fees by your business partner leaves the company, and then someone new comes in.

The person prior to is doing things in a specific manner, and then things slip through the cracks, and then you get errors. Normally, if there's a cost component, that's an area where it's very easily one can pull data from different and wrong sources. You want to be aware of what your true up schedules are, inventory evaluations.

That could be an area of potential miscalculation. The last two is where we see a lot of different errors is really what is the definition of sales and how is that being interpreted amongst the parties differently? Lastly, has your business partner changed accounting softwares?

That normally creates havoc in ultimate calculations, changes in product classifications. Of course, anything that has to do with manual processes and a lot of spreadsheets. It just normally creates potential for errors. One of the things that we hear a lot is, "Well, we don't want to do an assessment like this because we don't want to harm the relationship that we have with our business partner."

What we often find at times is that there's benefits to both parties here. Clearly, our clients are receiving benefits because they're gaining access to information that they normally don't get access to. Normally, we hear that our clients get a check every quarter, maybe they get a spreadsheet, high level summary, and that's all they get.

They really don't have the chance to have someone come in and look under the hood. That's one key benefit is keeping your business partner honest by making sure that they're abiding by the contract terms. Of course, you have the potential for monetary recovery. You can enhance that business relationship.

You have the opportunity to lead, to improve reporting processes. It might improve the partner relationship, especially if you're finding an error early on that, then doesn't snowball year after year after year. You want to try to catch potential errors earlier on in the contract than later. Then, the last thing which I think David hinted on is it could be fee-neutral.

Many contracts, if you don't have this in now, I would suggest you go and check it, or if you're going to be executing a new agreement shortly, include provisions that allow for you to recoup your audit costs if certain error rates are detected in terms of overcharges. We've seen for example, 2%.

If an error rate of over 2% is identified, your business partner would be responsible for the audit costs, attorney fees, et cetera that might be responsible for that actual assessment. Lastly, on the other side, on your business partner, you are through this assessment helping them strengthen their operational internal controls.

You might be identifying clerical procedure errors that not only helps your current contract, but that might have implications for errors that they might be doing with other business partners that they might be unaware of. Your assessment might help them strengthen their controls across the board in other types of business arrangements that they may have.

You're doing it rather objectively. Most instances, you try to do these assessments on a time and materials basis rather than on a contingency. We've seen it both ways, but normally it allows for a non-bias, if you do it on a time and materials basis. Timing, you do it around their calendar. You don't want it to drive on for months, but you try to minimize the disruption to their company.

Clearly, you want to have processes in place to maintain the information confidential, such as executing a nondisclosure agreement. I know we've come up on time. This essentially summarizes our conclusions here, but want to leave any questions that we might have or what we would do next steps for those that participated.

^{Transcribed by Rev.com}