Using a Combination of the Known to Move Forward Into the Unknown

Royalties can be negotiated and structured to meet the needs of both investors and royalty issuing companies seeking funds. The objective of the funding is the development of innovative products and services that believed, if successful, are believed to significantly increase company revenues and profits. However, the specific magnitude of the revenue increase is not easily estimated in advance. This is particularly the case when early stage and pre-revenue companies use royalties as a means of obtaining non-equity-diluting financing.

Some of the possible areas of royalty structuring flexibilities include:

There can be agreed terms for the possible investment of additional funds. The terms can include changes in the: royalty rate, maturity of the royalty, assets pledged or transferred assuring contractual compliance, managerial supervision and restrictions, and modification of the rights of redemption.

The royalty payment period can be extended or shortened, depending on the defined success or failure in achieving the originally anticipated results.

The royalty rate can be increased or decreased in different periods and applicable to different geographic areas, depending on the timing and amounts of royalty payments made,

The commencement of the royalty payment period and royalty rate can be based on the achievement of a specific level of revenue generation or royalty payment.

The faster the royalty issuing company is successful, the sooner the company will wish to redeem the royalty. Therefore, the redemption right can be based on the timing and amounts of royalty payments received, up to that point, by the royalty investors.

It is also possible for debt and royalties to be combined, with the royalty commencing upon the repayment of the debt.

Advisors to the royalty investors can be required to become Observers of the royalty issuing company’s Board of Directors meetings and receive all information made available to members of the Board of Directors, in the event the company fails to achieve agreed levels of progress. The company can be required to reimburse the expenses of the Observers and pay an agreed amount of fees to the Observers.

It is noted that the above possible areas of flexibility reflect the fact most early stage company managers underestimate the time and money necessary to reach the level of projected revenue generation and that more money is frequently needed. We are not suggesting that the royalty investor be the required or exclusive source of additional financing. However, it is possible to negotiate terms for possibly providing additional funds, as well as for modifying the terms of the initial royalty investment, in the event of failure to achieve that which has been projected, it is possible that shareholders of the company may have to use equity and probably highly diluting, convertible preferred shares and/or stock options, in order to attract the necessary additional funds. The investors of the additional funds raised may also require the buy-back by the company of the outstanding royalty.

The royalty investor’s protections benefit the royalty issuer as they both prompt investment and also provide a justification for attempting to negotiate lower royalty rates. As the institutional royalty investor will intend to hold the royalty for the full royalty payment period. There can be terms rewarding the royalty issuer when the Internal Rate of Return exceeds an agreed level.

In the new concept of Self-Liquidating Royalties (SLR), where the royalty issuer’s required annual redemptions of the number of royalty units necessary for full retirement by the end of an agreed period, liquidity is provided and the investor’s risk is shifted to the issuer. SLR permit royalty issuing companies to pay a higher royalty rate in return for a retention of the quarterly royalty payments until the end of the royalty payment period.

If the company fails to generate any revenues the investor’s capital will be at risk, unless the company is reorganized, requiring the assets held by an independent party for the benefit of the investor, in the event the company is not able to comply with its obligations. Of course, it is also possible the return of the invested capital can be assured by a third-party.

We are not suggesting that royalty financing is ideal for all companies and in all cases. We do believe, however, that royalties are better for both the investors and the business owners, especially if the company is realistically projected to be successful in achieving the benefits expected from the royalty financing, use of proceeds received from the sale of the royalty.



Arthur Lipper Chairman British Far East Holdings Ltd.
© Copyright 2019 British Far East Holdings Ltd.. All rights reserved.
June 20, 2019.

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