It costs money to raise money.
The cost includes legal and accounting fees and the fee paid to the financial intermediary identifying and attracting the investors. Those introducing investors are called investment bankers or “finders”. A finder must be affiliated with a licensed broker / dealer if any aspect of the fee is conditioned on a completed transaction.
The cost of raising money for an early stage company, including fees for the professionals and introducers of investors will run something in the area of 20% of the money raised in addition to whatever, if any, carried interest is negotiated. The carried interest can be in equity or options to acquire equity. Frequently the introducers of the money to the company also expect to be retained as consultants to the company.
There is a possible alternative to the traditional method, which is frequently unsuccessful, expensive, and usually highly equity dilutive.
The alternative is for senior officers of the company to participate in the crafting and investor presentation of a royalty offering. The royalty agreement obligates the company to the purchaser(s) of a royalty to pay an agreed percentage of revenues for an agreed period. As the holder of the patent covering approaches using royalties to finance companies British Far East Holdings Ltd. will assist the company in the structuring of a royalty. The royalty issuer will be required to pay an annual patent license fee of half of one percent (.50 basis points) of the amount received for the royalty from outstanding royalties issued by the company.
There are four primary approaches. They are as follows:
REXRoyalties.com, which is a simple agreeing as to the royalty rate, the percentage of revenues, to be paid to the holder of the royalty during the royalty payment period. The royalty rate can be modified based upon the amount of royalty paid during various periods.
REXdebt-shareRoyalties.com this approach includes the royalty issuing company to borrow the amount needed from the investor for an agreed relatively short period at an interest rate somewhat higher than a commercial bank would charge for a term loan, if the bank would make a loan which was not personally guaranteed by the controlling shareholders of the company. On the repayment of the loan a royalty having a modest royalty rate commences for an agreed period. The royalty rate is modest because on the repayment the investor no longer has a capital risk and the revenues are those, which are in excess of the revenues achieved before the company has the benefit of the amount borrowed.
REXScaledRoyalties.com is an approach where the investor and the company agree to reduce the future royalty rate if within an agreed number of years occurring during a specified period as agreed, exceed the projected revenues by an agreed percentage. If the revenues are less than projected in the same period by an agreed percentage there is a penalty. The intent of this “carrot and stick” approach is to encourage the company to make conservative revenue projections.
REX-RIAR.com is an approach which may well become the most popular as RIAR is an acronym for Royalty issuer Assured Return. In other words, the royalty issuing company agrees to the amount of royalties to be paid during a specified period. There will have to be at least an agreed amount or percentage of revenues. This minimum payment is a risk shifting from the investor to the issuer and is agreed by the company in order to pay a smaller royalty rate. The investor agrees to the lower return as the level of risk has been lessened. Of course, the factor determining the significance of the issuer’s assurance is the issuer’s ability to meet its obligations if there needs to be a payment.
There are two additional website calculators which are useful.
REXComparator.com allows two royalties of different terms as to royalty rates and maturity to be compared when using the same projected revenues.
REX-PV.com the PV is for present value and the calculator provides the results in terms of the Internal Rates of Return (IRR) for the royalties received and the premium which a secondary buyer would have to pay for the investor to achieve his targeted IRR. It also indicates the number of years the buyer must hold the investment for royalties to equal cost and the IRR, which will result, all dependent on the company’s projected revenues being at least achieved.
Of course, investors and issuers can and will combine features of the above briefly described approaches. Also it should be understood that royalty-issuing companies are going to want to terminate their royalty payment obligations through either direct negotiation, including tenders and the use of their redemption right, as every royalty payment dollar is a pre-tax profit dollar. The terms, which investors will accept, will most likely have to exceed their initially targeted IRR, including the royalties already received.
It is the inherent flexibility and assuredness of payment, which makes royalties attractive to investors. Business owners are primarily motivated by the ability to retain full ownership of the company and availability of funding on reasonable terms. Royalties are indeed the better way of both investing in and financing of privately owned companies.