Lipper Formula for calculating a royalty issuer’s right of redemption
The once broadly used Lehman Formula was the standard basis for compensating investment bankers for raising capital is described as follows:
5% of the first amount raised from investors
4% of the second amount raised from investors
3% of the third amount raised from investors
2% of the fourth amount raised from investors
1% of everything above an amount raised from investors.
The 5-4-3-2-1 approach was not specific as to the form of investment and started when $1.0 million was a significant initial amount. Due to inflation, the formula was increasingly applied to larger initial amounts.
The expected to become broadly used Lipper Formula for calculating the royalty issuer’s redemption rate, is based on the multiples of the investor’s cost, including royalties previously received by the investor, is as follows:
| Period of Redemption (Years) | Months | % Multiple of Cost | Investor’s Annual IRR* |
|---|---|---|---|
| 1 | 12 | 200% | 100% |
| 2 | 24 | 200% | 41% |
| 3 | 36 | 300% | 44% |
| 4 | 48 | 400% | 41% |
| 5 | 60 | 500% | 38% |
| 6 | 72 | 600% | 35% |
| 7 | 84 | 700% | 32% |
| 8 | 96 | 800% | 30% |
| 9 | 108 | 900% | 28% |
| 10 | 120 | 1000% | 26% |
* The Lipper Formula assumes that the Multiple of Investor’s Cost will include the royalties received by the investor. Therefore, the redemption payment actually to be made by the royalty issuer is the difference between that already paid and the agreed multiple of investors cost.
It is important to note that the Reinvested Royalty Rate of Return (RRRR), which is the investor’s return, if the royalty payments received by the investor are invested at the fixed rate indicated as being available by the investor, for the balance of the royalty payment period. The RRRR will always be greater than the IRR resulting from non-dividend paying equity investments, due to the reinvestment of the received royalty payments.
As the use of the Lipper Formula effectively caps the investor’s return to the cumulative payment of the multiple, an additional redemption premium will likely be negotiated to make the initial more attractive to investors.
The Lipper Formula assumes a 20-year royalty payment period with the redemption right being limited to 10 years.
Of course, as each royalty is different, reflecting the terms negotiated by the investors and the royalty issuing companies, the concept of the Lipper Formula, much as with the Lehman Formula, can be used as a point of departure approach, with different amounts and payment periods agreed.
It is the flexibility of royalties as well as the inherent fairness of the approach, which makes then the better way of both investing in and financing of privately-owned companies.
The Lipper Formulas will also be useful in structuring the terms of Self-Liquidating Royalties (SLR), the new concept developed to address the concerns of investors when considering “Credited” royalties, as described in the Royalty Issuer Assured Return approach and at REX-RIAR.com. Credited royalty investors are paid a significantly higher royalty rate for allowing the royalty issuer to defer payment until the end of an agreed period. In SLR concept, the royalty issuing company agrees to repurchase, through required periodic redemption, sufficient royalties to result in there being none outstanding at the maturity of the royalty payment period. The maximum redemption value and redemption frequency are requirements specified in the royalty agreement. Fiduciary investors are likely to find the SLR approach attractive, as it addresses both the liquidity and contractual compliance issues.
Arthur Lipper, Chairman British Far East Holdings Ltd.
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All rights reserved. June 8, 2019