The possible details of royalty investors having the option of continued participation in the growth of an issuer after their royalty has been redeemed are too complex and company specific to be more than introduced in this new idea memo. However, we would be pleased to study any specific case and develop recommended terms which would be fair and beneficial to all parties.
The inevitable and inherent conflicts of interests between private company equity investors and business founders and other early shareholders are the reason why royalties are the better way for investors to participate in early-stage companies. It is also the non-diluting of the owner’s interest which makes royalties better for successful company owners. For this reason, I have advised companies that they should not offer investors the ability to convert royalties into the stock of the privately-owned royalty issuing company.
In most cases, the underwriters of the shares of the company being taken public will advise or require that outstanding royalties be redeemed, both to increase the company’s projected earnings and to avoid the conflict between investors participating in the company’s revenue growth, as opposed to profit growth. Of course, at the time of going public the track record and prospects of the company will be better than when the royalty was created for financing the company.
Therefore, if the advice or requirement to redeem the outstanding royalties is accepted, the royalty investors’ relationship with and participation in the royalty issuing company will be terminated, resulting in an involuntary separation at a time when the future for the company appears positive.
Recognizing that the investors will have benefited from their relationship with the company and that the potential conflicts of interests will cease to exist after the redemption, the investors should want to identify other ways to participate in the ownership of the company, which they have come to know and respect.
Therefore, a possible feature to add to the royalty agreement might be the ability to acquire shares of the former issuer at the time of the underwriting, perhaps at a discount to the public offering price.
This approach would allow the calculated royalty redemption value payment to be used to buy shares in the company, at the time of the offering, at a discount of the IPO per share price. The discount might be equal to the underwriter’s discount or placement commission.
It seems to me that such a discount feature might be found attractive by investors, especially recognizing that they would already have benefited from their relationship with the company and the elimination of the royalty makes the corporate valuation and share offering more attractive.
It is also possible for the issuer to make the royalty more attractive to investors by including a time period after the redemption in which the investor could buy stock in the company on preferential terms, if and when the company has a public offering of shares.
The company could alternatively agree to issue warrants to purchase shares of the company for an agreed period after the IPO. The warrant price could be for a premium to the IPO offering price, depending on when the warrant was exercised.
It is a psychological negative to emphasize the high probability of issuers making the logical decision to exercise their right of redemption in companies which have achieved enormous revenue growth, even at investor’s high rates of return, in 3 to 5 years. Also, investors will look at the revenue growth projected and recognize that they would have been better off continuing their participation in the company. So, their ability to continue their relationship as investors by being able to buy appropriately registered shares at a better than public offering price could be appealing.
This added feature to a royalty issued by a company offering stock to the public is not likely to add any significant cost to the issuer and might well be sufficient to prompt the purchase of the royalty by the investor.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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