Revenue royalties (royalties), a percentage of defined sales, during an agreed period, are not securities. Royalties are purchased by the investor and sold by the company generating the revenues. The amount to be paid for the royalty is negotiated, and depends on the anticipated revenue growth, royalty rate and term of royalty payment period.

In the royalties we recommend and structure, payments are made to the investor based on a percentage of the daily receipt of revenues. The longer the period of royalty payment obligation, the lower can be the royalty rate or percentage of revenues. We recommend either a 10- or 20-year royalty payment period.

We also recommend that the royalty issuing company have an issuer’s right of redemption, allowing the company to pay, including a credit for the cumulative royalties already paid, an agreed multiple of the investor’s cost of the royalty. This addresses the probable requirement of subsequent company financings, a public offering or sale of the company. It also allows the company the ability to terminate the royalty if the revenues are significantly greater than projected.

From the perspective of the company seeking financing through the sale of a royalty, the greatest advantage is that the royalties are not equity dilutive. Business owners, because of the sale of a royalty, do not have any reduction of the percentage of the company they own.

Royalties do not vote, and royalty holders have no ownership of the company. Therefore, they are not concerned by profit reducing actions of the company regarding executive compensation, research expenditures, staff training and retirement plans or the terms of acquisitions or sale of the company. Royalty payments are tax deductible, whereas loan repayments and dividends are not. There is no investor pressure for a continuity of per share earnings increases. Royalty investors do not have, unless negotiated, access to company personnel or company information other than that which is directly related to revenues.

From the investor’s perspective royalty payments are not dependent on reported profitability of the company, though the royalty payments will increase with revenue increases. Royalty payments received are income tax free, until the investor’s cost is recovered, and ordinary income thereafter.

Investors may sell or transfer royalties and, for tax reasons, may consider doing so on the recapture of their invested principal. It is also possible for royalties to be combined with an issuing company’s debt and other securities.

Therefore, using royalties to finance companies having significant value increase potential is a strategy which the owners should consider, as equity reducing dilution is so ownership profit reducing. As many managers of businesses will confirm, it is distracting for executives to have to deal with investors, who only bought the stock with an objective of selling it at a profit, based on the company’s reported profitability,

Also, from the investor’s perspective, it is generally thought easier to predict a trend of company revenues, than future per share earnings.

As with all contractual agreements, the terms can be changed by the parties to the contract, when the parties find it to be in their mutual best interest. In situations of company success equity investors are likely to be more difficult and expensive to deal with than royalty investors, especially if there is an issuer’s right of redemption.

 

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

 

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