Royalty Funding – Why Is It So Rare
So is the man in the picture taking or replacing the golden egg? Depends. Is he the investor or the entrepreneur? Park the question for now.
Here’s a true story you may find familiar: a young CEO is running an exciting start-up in the field of agriculture, having solid IP (a patent portfolio) with a possible future of a billion-dollar in revenue. He’s a longtime friend of mine in fact and has “suffered” my advice for almost a decade on raising capital and using royalties if possible as the preferred structure. When in fact he did raise about a million dollar in angel capital, fully aware of the complications, he agreed to an equity sale with a pre-money valuation around $10 Million. Why didn’t he insist on a revenue participation (royalty funding) contract and avoid giving away any equity?
So I asked him why? His answer was “This is what the investor wanted. Simple as that.”
The “golden rule” at work.
And this is understandable. If I’d had a chance to ask the investor why he insisted on buying stock (even just 10% of the stock) he might have answered:
“I don’t need or want my money back in the next few years. I’d rather wait five to ten years, whatever it takes, and make a killing, or nothing at all and write it all off;” and,
“If and when the company is sold, having a stock certificate gives me an ironclad claim on my share of the proceeds.” The fact that there are many ways controlling shareholders can screw minority shareholders was not apparently known to this amateur investor.
You’re convinced until you hear the next investor explanation:
“Having stock ownership, even 10%, gives me a great deal of control and influence. I sit on the board, see all the financials and details behind them, see the decisions that management make in their best interest, not mine, make friends with the other board members to increase my power, and then I can threaten the CEO with firing or legal action (a stockholder lawsuit) if he doesn’t take the actions necessary to sell the company in a reasonable time frame.”
Again, as an amateur, this investor may overestimate his powers to threaten the CEO when owning only 10% but the threat is real. Investors 30% or 40% have even greater powers to interfere. So why would you let an investor take 10% of your “golden eggs” you worked so hard to produce or have control over your destiny if you did not have to?
So the onus may fall on you, the entrepreneur, to insist on selling a royalty agreement for all the good reasons previously stated in this blog. For a review of these reasons, see the previous blog on royalties.
Arthur Lipper, Intelliversity Board of Advisors Chairman, Wall Street guru and previously owner/publisher of Venture (the magazine for 450,000 business owners and entrepreneurs) began publicly advocating royalties (aka revenue participation) in the mid-1980’s as a better way to finance business. In a recent blog article published within the last few weeks. Arthur answers, in an entertaining way, the question why few business owners yet insist on royalties when seeking investment in their businesses. And then he answers these objections.
While you’re there, be sure to review all the writings on the site. The following are the most recent:
Larry and Barry Wonder about the Acceptance of Royalties
Larry and Barry Discuss a Bad Idea for the Terms of a Royalty
Using Revenue Royalties to Acquire and Market Assets
Scaled Royalties Shortfalls: A Discussion with Larry and Barry
Taken together and with my earlier blog summary of the benefits of royalties, you’ll have a good feeling and rationale for offering royalties rather than equity to prospective investors. For a full and fun read on the subject, check out my eBook on royalties The Road Less Traveled, which you can download for free on the Intelliversity site. You’ll find it in the Library along the right side of the site.
For further discussion on royalties, with respect to your particular situation and financing needs, set up a telephone meeting with me by reserving a slot in my calendar.
Key Takeaway: The onus may be on you to insist on a royalty agreement when financing your company. Get clear on why. Also get clear on how to demonstrate for investors why royalties may be a better choice for them as well. Then connect with us by telephone to design a royalty agreement that fits your needs.