The advantages of a portfolio of royalties becomes important to understand for all those seeking higher returns with less risk, especially during periods when investors have experienced significant capital losses.
Royalties, which are an agreed percent of a company’s defined revenues, can be structured to generate a range of return of results based on projected and future revenues. In the investor’s negotiation of royalty terms with royalty issuers the greater the investor’s reliance on the projected results, the greater the risk. If the investor’s risk is reduced, perhaps using some of the techniques to be described below, the investor’s returns will also be reduced as a result of the additional expenses necessary for the issuer.
As is always the case, the lower the risk, the lower the return. The royalty issuer can agree to pay minimum royalty payments, either for specific periods or cumulatively for other periods.
The quarterly royalty payment of a minimum amount can also be financially assured by an accredited entity that is independent of the issuer. The assured amount received by the royalty investor can be fixed or be set as an agreed percentage in excess of the government obligation rate for the same time period as the royalty.
To accomplish the assurance necessary for the protection of the investor the royalty issuing company pays the assuring entity a fee to provide the minimum royalty payment assurance. If the investor does not want or need to set a floor return through an assurance scheme, the return to the investor would be significantly higher.
Were the assurance level to be reduced the investor’s return would be increased. One possible modification could be a recapture limitation to the amount of investment. Another modification could be that of an agreed grace period for the payment of any delinquency in royalty payments necessary to produce a recapture of all funds invested in the royalty.
Another approach could be an issuer’s royalty repurchase requirement or “put”, set at an amount resulting in an agreed minimum Internal Rate of Return (IRR), including credit for royalty payments already paid. The put would only be triggered by a failure to make the minimum royalty payments anticipated. In other words, the investor can demand payment of the amount invested, less the payments made, plus if necessary, a payment to bring the overall transaction back up to an agreed level of IRR.
Although, the focus of the foregoing has been on risk avoidance, the primary investor benefit of royalties is the revenue sharing in companies likely to have increasing revenues for many years to come.
Royalties are also better for business owners because through the sale of a royalty they are able to obtain growth capital without the loss of ownership in their companies. It’s a win-win.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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