If money is loaned, the expectation is full repayment in an agreed time, with interest or some other benefit to be paid the lender by the borrower.
If money is donated, there is no expectation of receiving a specific return, even though there is a donor benefit of supporting a favored cause.
When money is invested in purchasing a share in a commercial enterprise, there is an expectation that the value of that share will increase.
None of this is new or difficult to understand. It is the traditional use of money by those who have a surplus and an interest in providing a benefit to those needing capital while profiting themselves.
Focusing on the possible increase in value requires an acceptance of the risk of purchasing stock in a business. If the per share earnings remain constant and the investor paid a P/E of 25 for the shares, it will take 25 years for the investor to gain a proportional benefit in the business.
However, if the EPS do not increase significantly, it is likely the market valuation of the business will decline, and the investor will have a loss. Of course, if the EPS increase by the amount investors find encouraging of even more increases, the company’s valuation will increase, and the investor will profit.
Therefore, the investors’ belief, estimate, guess, bet must be that the company’s EPS will significantly increase and that investors will then, at the time, believe, estimate, guess, bet that the company’s EPS will continue to improve.
This is what has happened in the case of some of the important companies like Apple, Amazon, Google, Microsoft that we all currently recognize. Unfortunately, it is not what has happened to the vast number of publicly traded companies selling at high P/E’s over the years. Buying high P/E priced stocks has been a risky business. The investor experience in buying shares in privately owned companies has been generally disappointing, with some outstanding wins.
There is a better way of investing in the growth of companies, particularly companies not having the investor benefit of being publicly traded.
The better way is by investing in the ownership of a percentage of the company’s revenues, not its stock. Revenue royalties can be structured to meet the needs of both royalty owning investors and royalty issuing companies. The royalty payment period, royalty rate and all relevant details are negotiable. The royalty is a contract, the terms of which are agreed by the parties. As with any contract, the parties can agree to change the terms at any time during the contract period.
Royalties can be for 10 or 20 years, usually with the longer the royalty payment period the lesser the royalty rate. Royalties can be terminated on agreed terms. Royalties can have royalty rates which are lowered on the payment of an agreed cumulative amount of royalty payments within an agreed period. Royalties can also terminate on the payment of an agreed cumulative amount in an agreed period.
The royalty investor is relying on the minimum revenues projected by the royalty offering company. There can be provisions for revenue projections to be assured, with appropriate premiums or discounts in royalty rates depending on the achievement levels versus those projected.
Royalties can be paid whenever the royalty issuing company receives revenues. No profit related calculations are necessary. The amount of revenue is that received, and the amount of payment is the agreed percentage of the revenues.
For American companies, royalties paid are federal income tax deductible, and royalty payments are tax-free for investors until they recapture their investment.
Royalties are a simpler and fairer means of a company acquiring non-equity-dilutive funding.
Royalty investors are not in a position of being able to influence management, they are not owners of any part of the business, except for the percentage of revenues agreed.
We need only a limited amount of information from companies to create draft royalty structures which, we believe investors will find compelling if they are comfortable with the projected revenues and terms of the transaction we suggest.
Arthur Lipper, Chairman arthurlipper@gmail.com
British Far East Holdings Ltd.