Revenue royalties, which consist of a percentage of a company’s defined revenues, provide investors with increased income and wealth enhancement if the royalty issuing company’s revenues increase as projected.

It is that simple. The owner of a percentage of the royalty issuing company’s revenues benefits from the company’s revenue growth. There is no market valuation or earnings per share consideration. The royalty investor’s only concern is the progress of the company’s gross revenues.

The royalty investor prefers that the company be profitable, but investment returns are not dependent on the company’s profitability. Of course, the more profitable the company the more that can be spent on increasing revenues. Royalties can be calculated and paid daily if that is one of the agreed terms. The royalty rate can also be modified, based on the cumulative amount paid in royalties over agreed periods.

The royalty investor is not concerned about levels of executive compensation, health plans, retirement plans, staff incentives and education expenses, and other expenses, although these are critical business issues for the owners. The royalty investors are only concerned about the company’s revenues.

Royalties can be structured to meet the needs of companies at varying stages of their development. Royalties can be the source of capital which would otherwise have been equity dilutive. Royalties can also be used to finance shorter-term business requirements. Companies can deduct from their federal income tax all royalty payments, whereas only the interest paid on loans is tax deductible, not the loan principal repayments.

Royalty investors do not have any federal income tax to pay on royalties until they have recaptured their entire initial investment, and thereafter the royalty payments are considered ordinary income, much as is the case with dividends.

Royalties can have minimum royalty rate payments, justifying a lower royalty rate. Royalties can also have debt-like terms, again with the intent of justifying a lower royalty rate. In most cases, we recommend that royalty issuers negotiate an Issuer Right of Redemption, which may be necessary in the event of the company being acquired or needing further financing. The Right of Redemption, terminating the royalty, should ensure that the royalty investor receives a high-level return.

It is the inherent flexibility of royalties which makes them such a logical approach to both investing in and financing companies, with the primary issuer benefit of avoiding equity dilution. Investors should be wary of investing in companies in which management is not concerned with equity dilution.

 

Arthur Lipper, Chairman                          arthurlipper@gmail.com
British Far East Holdings Ltd.