Fortunately, royalties, as we structure them, are also far superior to securities for investors, many of whom are beginning to realize that assured levels of returns are preferable to betting on stock valuations which are dependent on reported profitability.
In buying a royalty from an established company the investor is primarily wagering that the company’s revenues will at least be sustainable and more likely grow Increasing revenues are an indication that the company provides relative value to customers. Due to business and tax strategies, which are fully legal, privately owned companies have an ability to take a longer-term perspective and are not under pressure to enhance their reported profitability.
The reality for a company selling a royalty is that the better the company does, the more the company’s owners will want to redeem the royalty because each dollar paid in a royalty is a pre-tax profit dollar. Also, a profit-reducing royalty will often need to be eliminated when there is an additional financing, merger or sale of the company.
In all of these cases, the business owner will be better off by having financed the growth of the business using a non-equity dilutive royalty, while maintaining full ownership of the business and also enjoying the many possible perks of private ownership.
The royalties we structure include an issuer’s right of redemption. This provides for the right to repurchase outstanding royalties at an agreed multiple of the amount paid by the investor to the company, less the amount of royalties already paid to the investor.
Of course, the company exercising its redemption right is capping the investor’s potential cumulative royalty payments, depending on the timing of the exercise. A possible repurchase formula would be a redemption value of 5 times the cost of the royalty if exercised within 5 years and 10 times if within 10 years, in both cases, less the royalties already paid to the investor. The investor’s minimum Internal Rate of Return would be 38% in the case of a 5-year exercise and 26% in the case of a 10-year exercise. The reason we call it a “minimum” return is that the royalties paid to the investor before the exercise could have been invested by the investor in something else having a different level of return.
Royalty investors and issuers negotiate the terms of a royalty and issuers are always able to contact the royalty investors in an attempt to repurchase the royalties.
As will be discussed in a future positing, successful investing in securities has been an exercise in the greater fool theory of investment, whereas investing in royalties is a revenue sharing arrangement of benefit to both the issuer and investor.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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