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Royalty Based Financing Explained Royalty Based Financing is an exciting alternative to traditional equity venture capital investing. It provides superior risk-adjusted returns, has tremendous repayment flexibility and features a built-in exit strategy. How does it work? Royalty Based Financing creates a favorable trade-off between investors and business owners. Instead of giving investors a traditional equity ownership stake, business owners agree to return the original principal investment plus a multiple of that investment, over a specified period of time, based on regular periodic payments (royalties) equal to an agreed upon percentage of the gross receipts of the company. In some cases the royalty is based on a percentage of sales of an individual product or set of products. Investors deploying Royalty Based Financing do not push business owners to be acquired or to launch an IPO. Rather, business owners are encouraged to maintain ownership and to grow and develop successful, long-lasting enterprises with solid, profitable revenue streams. For the investor, this prosperity translates into quick and regular royalty payments. What are the benefits? For the investor, Royalty Based Financing ends the conflict over valuation and the need for a single event “exit strategy” (IPO or sale); Provides regular payment distributions to investors from royalty receipts; Earns superior risk adjusted rates of return; Offers access to diversified and profitable deals with industry leaders; and Provides support & guidance throughout the life of the investment with the Royalty Capital New England, LLC (“RCNE”) Advisory Board. For the business owner/entrepreneur, Royalty Based Financing… Minimizes ownership dilution, promoting management & employee ownership; Provides access to growth capital with flexible repayment terms; Ends conflict over valuation - eliminates disruptive exit strategy; Enhances effectiveness of management team through industry contacts; Reduces capital cost through interest deductibility by up to 40%; Requires no personal guarantees; Contributes to building more durable businesses and communities. Why is Royalty Based Financing increasingly popular? Royalty Based Financing has been a successful investment model for decades in mining, intellectual property, movies, music and other industries. Its flexibility makes it an ideal vehicle for deploying mid-sized loans through an investment fund. The need for such flexibility and access to growth capital is apparent everywhere. According to the Bank Administration Institute, more than 30,000 commercial loan applications are declined every day in the United States. Those who do receive loans must provide personal guarantees, and are usually subject to other restrictive covenants in order to obtain credit enhancements. Borrowers then must make fixed monthly payments regardless of whether the company has revenue to cover those payments. Individual investors/angels typically don’t invest more than $100,000 on a single investment and entrepreneurs seldom receive more than $1 million via organized small angel investor groups. On the larger scale, fewer than one percent of businesses looking for venture capital ever get it – and many venture capital firms seek minimum investments of $5,000,000 or more. Recent data from “Venture Economics” indicate that the average new venture capital investment in the first quarter of 2001 was over $14,000,000. This “opportunity gap” – the difference between what individual investors will finance and what venture capital firms will consider – is the perfect niche for Royalty Based Financing. What sorts of companies fit the Royalty Based Financing profile? Royalty Based Financing can serve a wide range of businesses previously ignored by more traditional funding sources. The typical Royalty Based Financing investor is looking for industry-leading businesses with an existing annual revenue stream, or a revenue stream that will be activated with a new capital infusion. These companies should have substantial gross profit margins, sufficient to pay royalties. Qualified companies will also demonstrate the potential for rapid profitable growth through the addition of new capital and ongoing management assistance. Some of the ways in which these companies will use Royalty Based Financing include: Expansion from regional to national/international marketing/sales strategy or new product roll out Equity substitute for a management led leveraged buyout Equity substitute for intra-family generation ownership transfer Buyouts of stranded venture capital equity investments with conversion to Royalty Based Financing investment mode. What are the mechanics? Based on formulas unique to each situation, the investment principal repayment and the agreed upon multiple will commence via a stream of royalty payments derived from gross sales. The process assumes that investors and business owners agree on four fundamental items: The principal amount of the investment and overall multiple to be returned The time frame for returning the original principal investment (typically, 18 to 48 months) The time frame for providing the remaining investment return (typically 4 to 6 years) and The maximum contractual time to provide the total investment return (typically 8 to 13 years). Royalty Based Financing can be structured either on a secured or an unsecured basis, but is typically positioned as long term-subordinated debt with warrants. Payments exceeding original principal are deductible expenses for the company, with the principal amount normally recorded as a long-term liability on the company’s balance sheet. Investments are typically disbursed through one or more staged drawdowns. These staged disbursements may correspond with specific business activities, revenue growth milestones, working capital requirements, or other special events or achievements. |