The terms we recommend for revenue royalty (royalty) investors who are considering investing in pre-revenue companies by purchasing a royalty include the following terms and considerations.

The investor should have a sound basis for believing the company has the potential for increasing revenues, if adequately funded, and will benefit from having and retaining a competent management.

The amount received for the sale of a percentage of defined revenues, occurring during a defined period, should be sufficient for the company to achieve a positive cash flow. If the company requires additional financing, there will probably be a requirement that the royalty be subordinated or eliminated. Therefore, we recommend the use of an issuer’s right of redemption, which sets forth the terms of the company redeeming the royalty, and thereby terminating further royalty payments. The amount to be paid, including cumulative royalty payments paid, should be a multiple of the cost paid by the investor for the royalty. Royalty payments made by the company are tax deductible for the company, which is not the case for loan repayments or dividends.

The longer the period of revenue sharing the lesser can be the percentage of revenues necessary to attract investors. It all becomes a matter of the Internal Rate of Return (IRR) earned by the investor. We believe that the investor in a royalty issued by a company which has not yet generated revenues should be significant.

We also believe that if the revenues projected by the company are achieved the investor should be able to recapture, tax free, the amount invested in about 5 years, leaving a sufficient balance of remaining years of revenue sharing to make the transaction attractive.

Therefore, the following are the general terms recommended:

Period of royalty payment 10 to 20 years, recognizing the possible presence of a royalty issuer’s right of redemption.

Royalty rate, the percentage of revenues to be paid to the investor, should be at least sufficient to allow the investor to recapture the amount invested in 5/6 years. The investor will incur a federal income tax liability for royalty payments received after there has been a full recapture of the amount invested. The investor can transfer the ownership of a royalty at any time.

Royalty rate can be reduced, based on the cumulative amount of royalty payments received in defined periods. There can also be royalty issuer penalties, if revenues fail, by an agreed percentage, to achieve the projected levels of royalty payments.

We believe it reasonable for royalty investors to accept the risk, which can be modified by royalty payment guarantees, of purchasing royalties from early-stage, pre-revenue companies to earn an IRR of at least 15% and much more if the royalty payment period is reduced through a company early redemption.

Royalty investment is an opportunity for sophisticated investors to earn higher returns, with less risk, than is generally available in alternative investing. It is also serves a social good, as the funds invested are used to increase employment, expand facilities, and to develop products and services not yet available to prospective users.

Royalty investors should review the above with their tax and legal advisors.

We are the U.S. patent holders for some of the royalty approaches we recommend, and we seek to provide professional assistance in structuring royalties.

 

Arthur Lipper, Chairman                          arthurlipper@gmail.com
British Far East Holdings Ltd.                 858 793 7100 PST

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