The sale of a royalty to raise growth capital, otherwise only available by selling shares of the company, is always a good idea, unless the following statements are accurate. The business owners:
are not confident that the company’s valuation will be much greater in the future, especially even if more capital becomes available.
want to own less of the company in the future.
the terms of the deal currently available for selling equity values the company at far more than is likely to be justified by the progress which is planned.
like the idea of being responsible for the employment and management of investor’s money.
do not mind their personal and company information becoming known publicly.
like the idea their compensation and other of their benefits being openly reported.
are ok with, in many cases, with being subject to requiring board and therefore likely, investor approval.
welcome the occasional and also continuing the business advice of those directly representing and appointed by the investors.
welcome as Directors, an agreed number of investor appointees to the company’s Board of Directors.
are ok with investors having the ability to require the appointment of an increased number of Directors in certain situations.
know that if additional capital becomes necessary the terms of the then present investors will favor the new money.
are ok with a normal requirement for investors to have a payment priority and minimum investment liquidation precedence.
are ok with agreeing to the termination of their present relationship with the company if the achieved results are disappointing to the investors.
The point being that equity investors and company founders are frequently in adversarial positions and most assuredly poorly aligned if the results achieved are less than expected by the investors. It is also possible for there to be conflicts of interest when things go well, as the goal of investors, particularly professional investors, is to sell their positions to generate reportable profits.
Royalties, an agreed percentage of defined revenues, for an agreed period, on agreed terms, which include rights of redemption, are focused on revenues and not reported profits. Royalty investors are not concerned with company valuation because as they are not company owners, and have no ability to influence management. Part of the royalty agreement defines the time of receipt and depth of company information to be made available to royalty investors.
The royalty investor benefits with the royalty issuing company increasing revenues. The royalty issuing company will want to retire the outstanding royalties and the redemption rights both permit and in some cases require issuer redemption on terms which are agreed in advance and include credit for the royalties paid previously to the investors.
Therefore, if business owners are prepared to allow royalty investors to have an agreed percentage of revenues “Off The Top” (name of my newest book on royalties), growth capital can be created without the pain and ultimate dilution of profit loss inherent from selling investors stock to raise money.
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Arthur Lipper, Chairman British Far East Holdings Ltd.
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Blog Management: Viktor Filiba