A primary belief of those who provide capital by buying securities in privately owned companies is that corporate revenues will grow, profits will be generated, and the company will either be acquired or go public, allowing shares to be sold at a profit. In either event, the shareholders of the business will be enriched.

In many cases, this is exactly what has happened. However, in many more cases, revenue and profit growth have either not occurred, without the company being required to obtain more funding, or just not occurred at all, with the company failing. Of course, the additional funding would have been equity dilutive. It is also frequently the case that the IPO price of shares is higher than when original shareholders are permitted to sell their shares in the market.

It is not unusual for new companies to be able to create products and develop revenues, but at higher cost and lower profits than envisioned.

Were the company to have raised the necessary capital by selling investors a revenue royalty, which is a percentage of defined revenues or an agreed cumulative payment, for an agreed period, the investors would have been better served, and so would be the business founders if the company was successful. Equity dilution is the enemy of wealth enhancement for business founders of successful companies.

Investor stock market losses are also going to negatively impact the attitude of investors when evaluating the risk-versus-reward potential of early-stage private company investment. Business founders are likely to be faced with higher demands and greater restrictions than was the case when stock markets were generating profits for investors.

Royalties can be structured to address risks and royalty investors can be assured benefit from good things happening to the royalty issuing companies. Owning a percentage of a company’s revenues is in many ways better than owning an interest in the company.

 

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