whether or not to buy a longer-term royalty from a highly promising company which provides for a 5 -year right of redemption. The issuer’s exercise of the right will force investors to sell back their royalties for more than a 40% IRR, including royalties already paid. However, the involuntary sale will cap the possibility of the investors receiving a far greater return over the course of the royalty’s originally longer payment period.
Of course, for the company to exercise its right of redemption positive events will have had to occur or be in prospect. These could include the achievement of revenue projections, going public or completing some other form of additional financing. Therefore, the investor will, as is always the case with royalty purchasing decisions, have to believe the company will be successful in achieving its revenue projections.
However, it is the royalty issuer’s right of redemption which makes the royalties we recommend different and attractive to company owners who really believe in their likely success. The owners justify the high cost of money, which they receive for the royalty sold, by knowing they can terminate the financial strain caused by the investor-favorable terms of the royalty.
Of course, it is possible the royalty investor will be able to negotiate the buy-back of individual investor-owned royalties without triggering the need or opportunity to repurchase all of the outstanding royalties. It is also possible that the royalty investor will be able to negotiate a conversion of the royalty and the remaining royalty payment obligations into equity of the royalty issuing company.
Professional investors usually claim to be long-term investors but they also have portfolio liquidity and performance needs relating to the investors whom they represent. The effective capping of returns may make a royalty less attractive to an investor, but the level of IRR suggested is also very appealing to portfolio managers. The decision to invest assumes considerable success by the royalty issuer and presents to the investor a delicious and elegant problem.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
+1 858 793 7100
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