Let’s assume that we were in the following situation:

We had worked in some aspect of the investment business.

We were frequently pitched by those seeking funding for interesting startup companies with the potential for making a lot of money.

There were other investors seeking high returns and willing to accept the risk of investing in new companies, since the possible rewards were touted as being so much greater than the risk of losing the amount invested.

We had existing relationships with some of these investors, and there were organizations who, for fees and benefits, were in the business of persuading investors to invest in companies they recommended.

We formed a company to invest in some of the startup companies we researched. We also would advise the companies in which we invested as well as advising those investing in the company we controlled.

Recognizing that banks were reluctant to lend money to startup companies, we created a relationship with a new bank specializing in lending to the startups that we invested in and advised.

The bank was tacitly assured that we would do whatever might be necessary so that the startups in which we had invested would be able to repay the bank when loans became due.

The bank was able to grow and profit from the interest on loans made to the startup companies, which other banks would not have made.

The bank increased its own capital so that it could expand its lending operations. The loans made by banks, using mostly the money of depositors, substantially exceeded their own capital, traditionally justified by borrower recoverable assets, called collateral, and breadth of diversification.

In this case, the borrower collateral assets were less than other banks would have required, due to the bank’s understanding of our relationship. Therefore, the bank was more highly leveraged than many other banks. The bank’s major depositors were aware of the relationships through which the bank was formed and operating, and they were consequently quick to remove their deposits in the case of concern.

The net result of the situation is that as the bank became larger, the more dependent it became on its relationship with those of us involved with the bank’s borrowers. It would only take a single case of a repayment problem among the bank’s depositors for investors to race for the exit.

Were early-stage companies to be financed by the sale of royalties, rather than by debt, the capital provider could have greater levels of profit and protective covenants similar to debt, but without  the same infectious result of one or more calls on bank loans.

We are able and eager to help companies and investors in the structuring of royalties.

 

 

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