Investors seek to identify companies which will be successful and from which they can benefit by acquiring a percentage of the company’s equity. These investors are prepared to accept the risk that the company will not achieve the hoped-for success, which will produce a profit far greater than the amount they invested.
The royalty investor is more conservative and seeks to benefit by acquiring a contractual right to be paid a percentage of the company’s revenues for an agreed period. Therefore, the royalty investor is assured of a return if the company generates sales during the period of the company’s royalty payment obligation.
The investor buying stock in a company benefits from the company’s achieved and predicted growth of revenues and profits, whereas the royalty investor only benefits from the assured growth of revenues. Both types of investors are basing their investments on future events and therefore there is a risk of loss.
A royalty payment guarantee, offered by a financially responsible guarantor, can eliminate the royalty investor’s risk of loss and therefore increase the attraction of the investment. A royalty where the investor’s capital is protected would allow investors serving in a fiduciary capacity to participate in the success of companies generating increasing revenues, without having the risk of capital loss.
Of course, companies offering principal-guaranteed royalties would benefit from obtaining the expansion capital they seek at a lower royalty rate percentage of revenues, due to the mitigation of prospective investor loss.
There are two approaches which can be used for eliminating the downside for the royalty investor. The first is that the royalty issuing company pays a fee, at the closing of the royalty purchase transaction, to a royalty payment guarantor to guarantee the royalty investor that they will receive a minimum royalty payment during an agreed period. This could be that the royalty investors would be guaranteed to receive royalty payments of the cumulative amount of the investor’s cost by the end of 60 months, leaving the investor holding the remaining royalty payment obligations for the balance of the longer-term royalty.
The second possible approach would be that the royalty payment guarantor provides the investor with a put option agreement requiring the payment for the royalty of the cumulative amount of royalties not already received by the investor offsetting the cost of the royalty. If the investor choses to exercise the put the investor will consequently receive a full return of the amount used to buy the royalty. The guarantor will then acquire the royalty and all of the possible benefits of the royalty for the remaining period of the royalty. Of course, it is possible the put’s exercise price could be for more than the net cost paid for the royalty.
In either case, the investor is depending on the ability of the guarantor to fully honor its contractual obligation to make up the difference in royalty payments or to consummate the put option.
It is likely that royalty payment guarantees will initially only be available to established companies, having a history of revenues and most probably increasing revenues. Therefore, the guarantor’s liability, which is reduced by every royalty payment to the investor, will be minimal except in the case of an unexpected cataclysmic event. In some cases, the royalty issuing companies may be required to obtain insurance naming the guarantor as a beneficiary.
It does seem to be a win for all concerned as the investor’s capital risk is mitigated and the issuers overall cost of money is reduced. The case for reducing the royalty rate is clear, as the investors capital risk has been shifted to the guarantor. The guarantor will be motivated by the prospect of receipt of a fee, issuer indemnification and obtaining a royalty on favorable terms.
We look forward to assisting in structuring the terms of royalties including royalty payment guarantees.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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