Royalties are based on projected revenues. Projecting revenues, even for established companies, is not easy. How then can a pre-revenue company make credible revenue projections?
First, there has to be a verifiable interest on the part of prospective product purchasers and service receivers. This potential interest is dependent on the predicted value of the product to the purchaser. That value can be based on acquisition cost or enablement to do something not doable before or something better, faster, cheaper than was the case before the availability of the product.
Therefore, it should be possible, in discussion with the prospective customer to both ascertain acceptable product pricing and possible magnitude of annual purchase, assuming the product is delivered as indicated. If the first-year revenue from a single prospective customer can be estimated, then the initial responses of other customers for the same product might be fairly estimated. The response from the potential customer can be “we don’t believe that you can deliver what you estimate you can at the price you say, but if you can we might become a significant purchaser”, is fully acceptable though non-committing.
Of course, a revenue discount should be applied as all things being developed and produced seem to cost more and take longer than planned.
Though in some cases, it is not necessary to attempt to project specific revenues for future years after the first year, because using the Compound Annual Growth Rate (CAGR) calculating feature of our websites, the user only has to estimate the percentage of minimum annual revenue change, in three future year periods and the calculator does all of the rest of the number crunching. See the samples at REX-Basic.com.
Are there reasonable reasons to believe the company will be able to produce and sell at least 50% more in each of the next three years and then for the next 5 years grow revenues at a minimum rate of 25% a year, with a minimum CAGR of 15% in the remaining years of the royalty payment period?
If so, the projections are complete and the initially proposed royalty terms can be developed, permitting negotiation of the terms of the royalty to begin.
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Arthur Lipper, Chairman
British Far East Holdings Ltd.
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Blog Management: Viktor Filiba