Royalties are payments made by a royalty issuing entity, usually a company, of a percentage of the issuer’s defined revenues. The definition of revenues can be based on specific product, geographic region, time period, specific customer or some other distinction from regular or normal revenues.
Royalties are paid for specific time periods and for agreed royalty rate percentages, which can be modified, as agreed, according to the amount of revenue generated in a defined period.
The payment of royalties can also be assured by the royalty issuer or third parties as to periodic or total cumulative payment.
The payment of royalties can be contractually required: immediately on the issuer’s receipt or bank deposit of revenue, at the end of specific time periods or on achieving an agreed amount of cumulative revenues.
Of course, the currency and mechanism of payment must be specified.
The negotiation of a royalty will likely require a projection of anticipated revenues, and one of the approaches facilitated by the several website calculators that we have developed and are found at http://rex-basic.com/ will show the results of achieving projections as to investor returns and capital valuation.
Royalty investors may assign the royalties due.
The assets of royalty issuers may be used to assure the performance of the issuer in honoring their obligations to royalty investors. In the event of a royalty issuer failing to pay royalties, which are due to the royalty investors, the assets of the issuer which have been contingently transferred or assigned to the investor at the time of the royalty purchase transaction, will be transferred to the investors. There may be a UCC filing or escrowing of the assets with a conditional licensing or exclusive use by the issuer. The holding of the assets of the issuer can be modified based on the amount of royalties received by the investors.
Royalty investors may also advise and otherwise assist royalty issuers and are entitled to receive financial and other information about issuer activities as agreed.
Royalty payments made by issuers are U.S. federal income tax deductible as being expenses incurred in the normal course of business.
Royalty payments received by U.S. taxpayers are a return of capital until they receive the amount paid to the issuer for the royalty and will be taxed as ordinary income after the initial cost of their investment has been received.
Royalty investors have no ownership interest in the royalty issuing company and have no vote or other means of influencing the management of the royalty issuing entity. In certain cases, royalties can be convertible into shares, debt or other arrangements with the royalty issuer. Also, it is possible that certain actions of the royalty issuer will require an agreed percentage of approval from outstanding royalty investors.
Royalties can be combined with debt, either provided by the royalty investor or possibly in collaboration with the investor.
Royalties can also allow a staging of issuer royalty rates aimed at producing greater cumulative royalty payments than flat rates and with a penalty for paying less than anticipated, by agreed percentages in both cases.
Royalty issuers may also have a Right of Redemption, if exercised within a specified period, permitting the termination of the royalty, in exchange for the payment of an agreed amount. The amount due to the investor includes that already received by the investor in royalty payments. The Right of Redemption, if exercised, caps the investor’s return and the issuer’s cost of capital.
Shares of company ownership sold by companies are securities and therefore require standard legal documentation and filing of forms with regulatory agencies. There are also continuing company obligations regarding the provision of periodic financial information.
Shareholders also are entitled to vote on and approve a range of company actions including who serves as members of the company’s Board of Directors. It is the Board of Directors that determines those serving as Officers of the company and their terms of employment.
If the company is profitable it may but is not required to pay dividends to its shareholders, except in the case of preferred stock. Dividends are not deductible to companies and are taxed federally and also, in some cases by states, as ordinary income to the shareholders.
Those loaning money to companies become company debt holders and typically receive interest payments which are taxable. The company is able to deduct the interest payments from their federal income taxes, but not the principal repayment amounts.
The advice of both counsel and accounting advisors should be sought in determining if royalties or securities are better for you and your company in raising expansion capital. Are you building your company to be a keeper or a flipper? How confident are you as to the company’s likely success and what might be the magnitude of that success? Are the possible perks of private company ownership important to you? It is important to negotiate a realistic Right of Redemption as it is likely that success will prompt a desire to terminate the royalty. A royalty may be a logical approach in the development of your company and can be as flexible in terms as the parties agree.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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