Some investors considering purchasing royalties from companies that present large revenue projections will, as a result of studying the justification of the projections, come to believe in the possibility of the company actually achieving big earning gains. This has resulted in the investor wanting both the natural risk reduction benefit of a royalty and also the market valuation change benefit of an equity. The royalty “tail” is conceived as an incremental investor benefit, prompting investment and justifying more favorable terms for the royalty issuing company.
The investors will understand that royalty issuing companies want to have an ability to redeem their royalty obligations earlier than the maturity of the contract and on a known valuation basis. Of course, the investors will want the royalty payment period to continue for as long as possible. The investors will believe that they accepted significant risk in making the investment and want the fullest return possible for having identified a super winner.
However, some royalty issuing companies will naturally want to be able to reduce or cancel their royalty payment obligation in the event they become involved in a sale of a significant part of the company’s equity, initiate a new financing or offering of registered securities. It is also possible that if the company is doing well the owners will want to repurchase the royalty in order to and stop having to pay the topline percentage of gross revenues, which reduces net earnings and the valuation of the company.
Conversely, the investors will prefer to not be required to sell their royalties, on the terms previously agreed, especially when things are going well for the company. In other words, the investors will want to be able to renegotiate the terms of any sale of the royalty and not be tied to terms previously agreed.
The royalty tail will be a fully negotiable contract, in which the royalty issuing company agrees to commence paying the royalty tail holder an agreed percentage of the company’s then much larger revenues, for an agreed period, after the original term of the royalty has been completed. The royalty tail would not be redeemable and therefore could only be terminated by the company buying the royalty tail or making some other arrangement with the owner of the royalty tall. The royalty tail is a valuable contract which the royalty issuing company will have to honor or to buy for whatever amount is negotiated, with a to be defined agreed minimum number of the outstanding royalty tails, as they can’t be redeemed.
Royalty investors will know that companies which have sold royalties will usually be interested in repurchasing them at some point. Also, as the royalty issuing companies will know the identities of the investors owning their royalties, bids and offers can be easily communicated in confidence. It is also likely that we and others will be able to assist both investors and issuers in arriving at a fair deal.
The deal terms we will likely recommend will feature a declining royalty rate depending on the amount and timing of royalty payments made during annual periods of 10 to 20 years. The royalty tail would begin paying the agreed percentage of the company’s revenues after the terms of the original royalty had been concluded, perhaps resulting in the payment of an agreed minimum multiple of the amount paid for the royalty.
As there will be no royalty redemption right associated with the royalty tail, there will be a natural, free market valuation of the royalty tail. All royalty tail owners will become entitled recipients of the agreed percentage of the royalty twin’s issuing company’s revenues at the same time, and the terms of twin contract will be similar to that of the original royalty, except that the royalty twin will be non-redeemable.
As all of the terms of the royalty twin will be negotiated at the time the original royalty is negotiated, the royalty twin can be issued at the time of the royalty purchase. As the royalty tail is not attached to the royalty, a free market value of the royalty tail will likely develop, with an increased value being reflected as each royalty payment is made, and the commencement of tail payments nears. The royalty investor, initially holding both the royalty and the royalty tail, will determine when or if to sell the royalty tail.
At some point, we may develop new calculators or modify the existing REX website calculators to work with tail royalties. However, currently it is not necessary for us to create analytics for the royalty tail as they simply provide a potentially valuable additional royalty participation in the revenues of royalty issuing companies, which will have already proven themselves to be successful, with far greater revenue levels than in the initial period, and proven stable growth.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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