Lawrence (Larry) Lion and Bernard (Barry) Beaver have been used to illustrate the reactions of growth-focused entrepreneurs to new ideas. Larry and Barry first appeared in my monthly Chairman’s / Editor-In-Chief column of Venture, The Magazine for Business Owners and Entrepreneurs. I have also used them in several books on entrepreneurship and royalties, as well as in many columns.
Larry: It just keeps happening.
Barry: What’s that?
Larry: Royalties, they keep getting better for both investors and business-owners.
Barry: How so?
Minimum payments
Larry: Well, first of all there can be reduced investor risk by changing the terms of the royalties offered by royalty issuing companies. The companies can agree to pay minimum amounts, regardless of the revenue levels, either in specified periods or cumulatively by the end of the royalty payment period.
Barry: That’s nice, but what if the companies themselves are not able to make those minimum payments?
Royalty payment Assurer
Larry: If that happened, it would be a default in the royalty agreement and the payments could be made by a royalty payment Assurer. The Assurer agrees to pay the royalty investors their initial investment, less any royalty payments received to date.
Barry: Who is this so-called royalty payment Assurer, who is really a guarantor, and why are they making the investment risk-free for the investor? Also, why is the Assurer taking such a risk and how do we know the Assurer can perform if needed?
Larry: The identity of the Assurer is disclosed by the royalty issuing company in the royalty agreement and the investors can satisfy themselves regarding the Assurer’s financial resources and reputation. The Assurer is paid a fee by the company. The fee can be paid all at once, or as a continuing percentage of risk being accepted. The Assurer’s risk is reduced by every royalty payment made by the company.Barry: Does the Assurer have control over assets of the company?
Larry: Yes. The Assurer has agreements with the company, protecting itself regarding the payments made to the company’s royalty investors.
Barry: Ok. So, investors can get their balance of their invested money back if the company defaults on the minimum royalty payment obligations. What’s next?
Using royalty cost multiples as minimum payments
Larry: Companies can agree that by the end of the royalty payment period, royalty payments will be a cumulative minimum multiple of the investor’s cost of the royalty.
Barry: How will investors know if the company will be able to make such a possibly large payment?
Self-Liquidating Royalties
Larry: Royalty issuing companies can agree to annually redeem a percentage of their outstanding royalties, so that by the end of the royalty payment period all of the royalties have been redeemed.
Barry: What happens if there are not enough sellers of the company’s royalties at the price the company will want to pay?
Larry: The redemption value amount is agreed in advance and if necessary, the company will make pro-rated payments to all of the involuntarily selling royalty holders and reduce their holdings proportionately. The investors will have initially agreed that the royalty issuing company may repurchase the number of royalty units owned by investors, on agreed terms, in order to redeem the required number of royalty units.
Barry: What else is new?
Short-term royalties
Larry: Setting high royalty payment terms payable in 2 and 3-year periods.
Barry: In some cases, 3 times the cost of the royalty in 3 years and in another case twice the royalty cost in 2 years. Both result in very high return levels.
Barry: That’s really just selling discounted debt contracts.
Larry: Yes, that could be the case, but these contracts require that minimum royalty payments of the stipulated multiple of the royalty’s cost be paid within the payment period.
Barry: That means the full royalty payment could be made on the last day of the contract.
Larry: Yes, that could be the case unless the contract otherwise required the royalty payments be made as the revenues are received. It is all a matter of the negotiated terms. It is the company’s agreement to pay the agreed royalty rate payments as the revenues are received which justifies a lower royalty rate.
Investor capital protection
Barry: What happens if the company doesn’t pay the required amounts? Will the investor get anything?
Larry: If the investor agrees to accept a lower multiple of the royalty’s cost, the royalty issuing company can pay a fee to an Assurer to guarantee that the investor will receive at least the cost of the royalty by the end of the royalty payment period. Alternatively, the Assurer can be required, at any time to buy the royalty from the investor for the difference between the investor’s cost and that received in royalty payments. The role of the Assurer is to eliminate the investor’s capital risk and this is accomplished if the investor wishes to exercise the option.
Barry: Yes, that makes the deal capital risk-free but doesn’t assure the investor of making a profit.
Larry: True, but if the investor waited to the end of the royalty payment period and had not received royalty payments at least equal to the cost of the royalty, the Assurer would have to make up the difference and the company would still owe the investor the balance between the net cost of the royalty and the full amount of the royalty agreement.
Conclusions
Barry: I agree there have been many new royalty terms developed.
Larry: Yes, it’s only a matter of time before royalties become the standard way of investing in privately-owned companies.
Barry: Yes, and all of these ways of protecting investor capital will also work for the businesses using royalties, as the royalty rates should be reduced when investor risks are being reduced.
Arthur Lipper, Chairman
British Far East Holdings Ltd.
chairman@REXRoyalties.com
+1 858 793 7100
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