A Conversation Regarding How Best to Acquire from Partners and Others All of Their shares in a Privately-Owned Company

CEO: For a lot of reasons, I now want to be the sole proprietor of my company. Therefore, I want to acquire all of the shares of the company owned by others. I also believe that they will be happier no longer being minority interest holders in a privately-owned company, as I am not interested in selling the company or going public. I just want the sole ability to make decisions without needing Board approval and to enjoy the perks of ownership.

Advisor: You could arrange for the company to offer to buy their shares. Of course, there is the issue of valuation and some of the owners who wanted to retain their shares, might not want to have the company doing whatever was necessary to get the funds to make the buy-out offer.

CEO: Both are problems as the business is doing ok and is about to get a lot better. We have good prospects, which I will disclose to the investors, so the valuation would have to be very high, all based on our prospects.

Advisor: It would be possible to offer a royalty/equity exchange offer, conditioned on all of the shareholders accepting the deal.

CEO: Why do I need all of the shares to accept and how might a majority of shareholders deal with the holdouts if there were any?

Advisor: For starters, you do not want to be in the position of having fiduciary obligations to other owners when you decide on executive compensation, employee benefit programs, travel and entertainment policies and the terms of employment for those you want to be involved in and with the company. You want to own 100% to fully enjoy the prerogatives of proprietorship.

Founder and CEO: What about the hold-outs in most of the shareholders want to take the deal offered?

Advisor: The natural thing is for those wanting the deal is to buy the shares of the hold-outs. If the shares of the hold-out cannot be obtained you can either abandon the deal or utilize other strategies for dealing with unreasonable minority shareholders. However, the royalty we can design can be so attractive that it is likely to be acceptable to all of the shareholders.

CEO: Ok, where do we start and what is the deal you suggest?

Advisor: First we need to fill in the blanks in the website calculator REXRoyalties.com. This is an analytical tool which we can use to see what works best for the company, as the royalty Issuer and for the shareholders who wish become royalty Investors.

You will have to provide conservative revenue projections for the next 20 years. Really, we only need the specific revenue projections for the next few years, as we can then utilize the Compound Annual Growth Rate (CAGR) of revenues feature, where for various periods the percentage increase in annual revenues is estimated.

CEO: Let’s use $10.0 million for year 1 and a 50% increase in the 2nd year and then a 25% CAGR for years 3 to year 8 and then a CAGR of 15% for the next 7 years and then for the final 5 years only a 10% CAGR.

Advisor: I will create a RexRoyalties.com presentation using buyout as both the username and password, showing all that we are suggesting.

CEO: These revenue projections should be easy to exceed the way the business is going, but I don’t want any royalty hanging over my head for 20 years. How much will the royalty have to be recognizing the investors only put up a total of $6.0 million? How short can be the period of royalty payment obligation?

Advisor: The longer the royalty payment period the lower can be the royalty rate. Let’s try 5% until they receive three times their money back or $12.0 million and then 3%. Also, there will be a right of redemption agreed at the time of the transaction establishing the amount to be paid to terminate the royalties if done in agreed periods. In other words, assuming the projected revenues are achieved, the royalties could be redeemed for let’s say 5 times the investor’s cost of $6.0 million, less the amount of royalties paid in the 5 years or 10 times in 10 years. Of course, you or the company can try to buy the royalties from the investors whenever you want and for whatever terms can be agreed.

CEO: Anything else? The Pre-tax profit margin should be 40% and the Net-After-Tax margin about 25%

Advisor: Yes, to get them to accept the profit they could make on their shares the company should agree that in 10 years the royalty payments will have been at least 3 times the $6.0 million. The royalty payments may be federal income tax deductible to the company.

CEO: Ok so what’s the REXRoyalties analytics show?

Advisor: If the revenue projections are, at least achieved, the 20-year results summarized are: Revenues $245 million, Royalties Paid $67 million, Business value $919 million, Royalty Investor IRR 25%+

In the 10th year, the investors have received 3+ times their investment.

Year Projected Revenues Royalty Rate Royalty Distribution Cumulative Royalties Annual Current Yield Percent (%) of Cost Compound Annual RoR IRR (%)   Business Value
1 10,000,000 5.00% 500,000 500,000 8.3% 8.3% -91.7% -91.7   37,500,000
2 15,000,000 5.00% 750,000 1,250,000 12.5% 20.8% -54.4% -60.2   56,250,000
3 18,750,000 5.00% 937,500 2,187,500 15.6% 36.5% -28.6% -35.2   70,312,500
4 23,437,500 5.00% 1,171,875 3,359,375 19.5% 56% -13.5% -17.9   87,890,625
5 29,296,875 5.00% 1,464,844 4,824,219 24.4% 80.4% -4.3% -6   109,863,281
6 36,621,094 5.00% 1,831,055 6,655,274 30.5% 110.9% 1.7% 2.5   137,329,103
7 45,776,367 5.00% 2,288,818 8,944,092 38.1% 149.1% 5.9% 8.8   171,661,376
8 57,220,459 5.00% 2,861,023 11,805,115 47.7% 196.8% 8.8% 13.4   214,576,721
9 65,803,528 5.00% 3,290,176 15,095,291 54.8% 251.6% 10.8% 16.8   246,763,230
10 75,674,057 5.00% 3,783,703 18,878,994 63.1% 314.7% 12.1% 19.3   283,777,714
11 87,025,166 3.00% 2,610,755 21,489,749 43.5% 358.2% 12.3% 20.5   326,344,373
12 100,078,94 3.00% 3,002,368 24,492,117 50% 408.2% 12.4% 21.5   375,296,025
13 115,090,78 3.00% 3,452,723 27,944,840 57.5% 465.8% 12.6% 22.3   431,590,429
14 132,354,99 3.00% 3,970,632 31,915,472 66.2% 531.9% 12.7% 23   496,328,996
15 152,20,558 3.00% 4,566,227 36,481,699 76.1% 608% 12.8% 23.6   570,778,343
16 167,428,31 3.00% 5,022,849 41,504,548 83.7% 691.7% 12.8% 24.1   627,856,178
17 184,171,14 3.00% 5,525,134 47,029,682 92.1% 783.8% 12.9% 24.5   690,641,798
18 202,588,26 3.00% 6,077,648 53,107,330 101.3% 885.1% 12.9% 24.8   759,705,975
19 222,847,08 3.00% 6,685,413 59,792,743 111.4% 996.5% 12.9% 25.1   835,676,573
20 245,13,795 3.00% 7,353,954 67,146,697 122.6% 1119.1% 12.8% 25.3   919,244,231


Advisor: Of course, the projected revenues are achieved the company will most likely wish to acquire and then terminate the outstanding royalties as soon as possible and can do so in several ways. The company can, at any time contact any of the investors and offer them whatever amount and on whatever terms the company wants. The company can also make a tender offer to all of the investors. The company might also, perhaps periodically, offer a specific amount which will be used to buy the least expensive royalties. This is called a “Dutch” auction and results in a competition between the investors as to who will accept the least amount for their royalty. Finally, the company can exercise its redemption right and require that all of the investors accept the redemption terms originally agreed.

CEO: What would be the terms of the redemption right?

Advisor: Whatever, is negotiated and agreed at the time of the original transaction. Sometimes it’s five-time if in five years and ten times if in 10 years. It could be in all cash or cash and a note combination and the multiples can be whatever is agreed and include the cumulative value of the royalties already paid.

CEO: Ok, it sounds reasonable as I get all of the benefits of being a sole owner and the investors get a very fair deal, which they should jump at understanding I don’t want to sell or go public.

Advisor: Yes, and if you change your mind about selling you are not prevented from doing so you would just have to terminate the royalties either by buying and terminating them.

CEO: I like it. No one gets hurt and all of us benefit.

Arthur Lipper, Chairman, British Far East Holdings Ltd.

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