Protection of assets has always been
Accruing wealth is all about
Those who are cautious keep their secrets hidden
or in safe places.
Those who are aggressive are prepared to share their secrets
with others for mutual benefit and the following is my secret.
The secret of success, for both royalty investors and issuers,
are the terms negotiated re the issuer’s right of redemption.
The royalty issuing company’s projection of revenues should be reasonable and based on more than hope. The issuer should be required to validate the projection of revenues as well as be able to respond satisfactorily to “what if” questions regarding possible unexpected and unwanted events.
The royalty payment period should reflect the competitive advantages and intellectual property protection of the issuer. The reality is that the longer the payment period the lower can be the royalty rate necessary to provide the investor’s target Internal Rate of Return (IRR).
The royalty rate can be fixed or variable and possibly keyed to the achievement of an agreed level of projected revenues or payment of royalties.
An additional proprietary contractual feature we almost always recommend is an issuer’s right of redemption, which terms enable the issuer to redeem all of the outstanding royalties for an agreed payment amount, which includes a time measured credit for the royalties already paid. The payment amount will be calibrated in multiples of the investor’s cost paid for the royalty and be something like 5 times the cost, if paid in 5 years, which represents a 38% IRR and 10 times if in 10 years, a 26% IRR. Of course, the real IRR or even greater Reinvested Royalty Rate of Return (RRRR) will be considerably higher, due to the payment of quarterly royalties prior to the issuer’s exercise of the right of redemption.
We also have developed an approach which requires a premium payment by the issuer because otherwise a redemption of the royalty would effectively cap the cumulative royalties paid by a successful company. The involuntary termination by the issuer of the investor’s successful investment should be fairly compensated.
It is to be expected that all issuers will want to terminate the royalty by redemption due to a desire to reduce the amount of the royalty payment obligation, or because of the requirements of an underwriter or investors in the case of a company financing, the company going public, or the conditions stipulated by an acquiror of the entire issuing company.
Therefore, the right of redemption is fair and reasonable and recognizes the reality that every royalty payment made by a profitable company would be a pre-tax profit, if it were not required to be paid.
It is also reasonable for investors to expect that the royalty issuing company, as well as others, will be interested in buying the right to participate in the issuing company’s revenues for whatever is the remaining royalty payment period. This interest will take the form of direct negotiation with the royalty investors and various forms of tenders.
Using our REX website calculators, we can pretty well determine when royalty issuers will be prompted to exercise their right of redemption and also project the returns which will be earned by the royalty investors.
Royalty issuers are going to want, for their benefit, to redeem the royalties they sold. Investors will naturally want extra benefit if they are being required to sell their royalties prior to the end of the royalty payment period. We can assist in the structuring of terms which will be fair, and also acceptable to the parties.
You will also find many of our other postings at arthurlipper.com to be of interest.
Arthur Lipper, Chairman
British Far East Holdings Ltd
858 793 7100
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