Increasing and Protecting royalty Income Royalty auditing The

Increasing and Protecting royalty Income Royalty auditing – “The reality behind the myth” GETTING THE MOST FROM A LICENCE PORTFOLIO International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 1

Agenda 1. Post licence Management – overview, problems and benefits – practical tips to good licence management – audits as a part of licence management 2. Audits – What is the perspective to audits for European entities? ; What are the risks of implementing an audit strategy? ; How do they work, and what are the costs? 3. Managing the licensing Portfolio – the Licensor’s approach 4. Summary International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 2

IP Assets Need Managing • Each of us own some physical assets – maybe a house or flat. • We all spend time and money looking after these assets. • We do this because we know that a house/ car etc. will not maximise its value unless we look after it. • The key message of these presentations is that we need to manage our licences to get the most out of them. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 3

Licence Management - Overview Licensing contracts • Licensor is passive only granting permission • Licensee is active accepting all commercialisation responsibilities Licensor expectations • It’s taken a lot of hard work to get here little extra effort needed • This is when the money comes in with little extra effort • I can depend on the licensee to report and pay the correct amounts Reality • Audits report that 90% of royalty licences underpay • This is a global problem and crosses all technologies • Over four years one organisation recovered- $19 M. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 4

What do I gain from licence management? • Economic 1. Cash now. Audit settlements range from€ 7 k to€ 16 m 2. Cash in the future. due to better management. 3. Profit. No costs associated with extra revenues 4. Shareholder value International Conference – Paris Licensing in a Controversial Environment • 1. 2. 3. 4. Licensing Execs. & Operations Internal due diligence and protection Potential returns to meet budgets Provides lessons for future negotiations; Develops & maintains relationship with licensees- not a “sunk” relationship Royalty Income Management – Equal IP© • Corporate/Legal 1. Sarbanes Oxley – corporate obligations. Proper management of assets. 2. Better understanding of licence agreements. Amend boiler-plate clauses. 5

What should I do? Three options Nothing • My boss will never notice • What budget will be missed? Follow a reactive policy • If something comes to my attention I’ll deal with it. Follow a pro-active plan • Sounds interesting but have been too busy to think about it • Give me some practical tips • Where does audit fit in? International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 6

Pro-active Licence Management? Six steps to a healthy portfolio Basics • Credit control • License monitoring system – financial and non-financial • Visibility to the licensee – have they met you? • Ability to react to events And also • An understanding of the risks of each licence • Audit strategy based around these risks International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 7

Practical tips – the basics Get control of credit control • Make sure they know what they should be collecting – Royalties, interest, downpayments, milestones • Are they passing information on to you? How good is your licence monitoring system? • Royalties, guaranteed sums • Non-date milestones • Expiry dates • Changes in royalty, options etc Make sure the licensee knows who you are • These are the guys making you money not taking it International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 8

Risk Assessment and audit Purpose of Risk assessment • The aim of risk assessment is to work out which licensees are most likely to be underpaying • Depending on the outcome you can decide how best to deal with this e. g. carry out an audit • It should help you earn money by taking the right steps at the right time • It should help you keep costs down by avoiding unnecessary audits International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 9

Risk Assessment and audit Issues integral to the licence Complex technology • Licensed Product Definition Product development • New lines • New uses Contracts misunderstood or not relevant • “Make use and sell“ • Compound products • Complex royalty provisions e. g. choice of royalty International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 10

Risk Assessment and audit External Licensee Issues • Big organisations more likely to underpay than small ones • Changes in people • Restructurings, acquisitions and mergers • Relocations • Systems “upgrades” International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 11

Risk Assessment and audit Practical Issues Size • High earning licences – risk of significant revenue loss Time • How long since we last audited? • Limitations – how far back can I collect royalties? • Audit Restrictions – how far back can I check? Expiry • Key patents – technological; should they still be paying? • Key patents – geographical; which territories are still infringing? Royalty Payment History • Late payers • Lumpy royalties International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 12

Proportionate Response Hopefully you can now stratify your licences • High risk – high potential loss • High risk – low potential loss • Low risk – high potential loss • Low risk – low potential loss International Conference – Paris Licensing in a Controversial Environment And decide on the right measures • A letter – easy sets out your position in writing and very cheap • A phone call – a gentle reminder and very cheap • A visit – an opportunity to sort out problems normally quite cheap • An audit – a proper review, not cheap but effective and usuallyl very lucrative Royalty Income Management – Equal IP© 13

What is an audit and what will it achieve? An audit • Process to achieve a given aim – ensure licence is complied with • Audit Guidelines – allow broad lines of enquiry • An element of contract law • Varies in effort and cost depending on licence Outcomes • Money – audit yields 10 -45% sometimes higher (16, 000%) • One licence over 95% of royalties came from audit • Equalise the relationship between licensor and licensee • Enable the licensor to maximise the value of the licence • Provide comfort and protection internally that the assets of the entity are being protected; • Send a message to other licensees – we take income protection seriously. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 14

Two final tips Reacting to Issues • Make sure you have a system in place to react to information. • Experience of a couple of nightmare scenarios where the licensor failed to react and lost €ms Early Stage Audits • You don’t come back with much money but you save a fortune later on. • You develop a relationship with the relevant people • You prevent disputes/litigation later on • Early stage audits are probably cheaper • You get your money when you should ITS ALL EASY COMPARED TO EVERYTHING ELSE • Royalty audit is best business model in IP International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 15

Level of awareness on “audits”@ LES Paris • 1. 2. 3. 4. 5. 6. 7. European and Nordic Perception Agreements are very short – 3 pages Recognise, that parameters are very wide and subject to challenge @ future date – focus on deal now, most of them “will be fine”. Main issues surround a possible take-over of licensor who may have different strategy. Individuals not aware that audits were actually carried out (even though, included in agreement). Trusting relationship. That the IP management responsibilities are not segregated from business units (BASF, Nestle)– But, who will take the lead? Non aggressive approach to licensing (Thomson)- can mean a similar approach to post deal management. Knowing what you know now, do you still have the same perspective? International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 16

Issues surrounding commencement of an audit • Commercial – Relationship issues – positive and negative- What are they? – Professionalism & business ethics, familiarity – audit is normal, if you don’t what’s the message? – Trust : (do you check your cash at the cash point or bank statement for interest charges – people and systems change) – If a non-exclusive arrangement, consider auditing a number of licensees – they do not feel specifically targeted. – Select your auditors that share your approach- a long term proactive relationship- knowledge based – Issues of negligence – internal, 3 rd party • Internal budgets • • Every year there seems to be an incremental budget for revenues – how do you achieve this? Be seen to be protecting all aspects of IP portfolio. • Time and resource – An effective audit will need dedicated internal time and a budget – bye in from the top. • External and other costs – External auditors costs – Independent legal or technology opinions, travel costs to negotiate settlements. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 17

Audit clause- start on the right footing • • • − • The word audit Access to – Relevant records, locations, subsidiaries, sub-contractors & relevant parties Relevant employees To review all Licence grant activities: – All disposals- (use, or otherwise disposed off, manufacture, lease) – All manufacturing sites & all sub licensees (or sites where they have the rights to “have made”) – All information relating to the use of the licensed products To gather information by – The right to take copies of documents – The right to question people Things to water down − The period under review should ideally have no limitation − Remember companies normally required to keep records for six years − Limited period of review does not limit liability for debts Choice of auditor – Ideally no choice – Conflicts of interest governed by audit firms’ ethical standards Other clauses to think about – Costs of the audit recovered – only if findings > 5 % – Interest on all underpayments – COMPOUND, monthly – Penalties - the Inland Revenue charges them International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 18

Preparation for the audit? • Legal , Technical and business review – License grant - what are the rights licensed – Interpretation issues ( precedence and legal) – The IPR covering the licensed product (What constitutes an infringing activity? ) • Internal review – Sensitivities on the assignment – Review and document - internal file - any impact on the audit ? – Market and competitor data – Copies of returns. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 19

Audit schedule & timeframes • Timelines – Audit initiation letter – response time between 2 weeks and 2 months, correspondence and getting on site; – Site audit – do the royalty payments tie in with the obligations? Communications, access, relationship – Final report – Negotiation (slightly overlaps with the above) – Whole process can last between six months and two years BUT try going to court. Rolling programme to audit – recognise this as a long term business activity. International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 20

The costs of an audit Costs will vary and depend on the following: • • • The choice of auditor – consider very carefully (significant IP specific issues) The remuneration method The complexity of the agreement and sites to visit Organizational preferences: 1. 2. 3. Large Corporates SME and “Governmental” organisations and contingent fees Individuals (and sometimes multi- nationals) - Usually on hourly charge basis; Hybrid basis – mixture of lower hourly rates Full contingent fees (issues of conflicts) Types of costs: a) b) • • • Contingent fees Hourly rate charges (there will be variances on these rates) In Europe € 25 K to € 50 K In the US € 30 K to € 60 K In the Far East € 50 K to € 75 K Royalty Income Management – Equal IP© Slide No. 21

Points to take away • All assets need maintenance to maximise value • Post-licence management is an added value function • A strategy for licence management and audit is important – for maximising value – properly maintaining assets – avoiding accusations of negligence • If you sit on your rights you lose them • Many problems can be rectified by simple actions • Audits are the best and most cost effective method in some cases International Conference – Paris Licensing in a Controversial Environment Royalty Income Management – Equal IP© 22