Mod 8 - Royalty Financing

Question 1

Define Royalty financing?

Answer 1

“A type of financing where a company agrees to share a percentage of future revenues with an investor in exchange for capital.
Rates are typically higher but allows for maintaining ownership and accessible for companies without tangibles. “

Question 2

Royalty financing suitable for?

Answer 2

“• Industries without many hard assets.
• Royalty financing may tend to work best for small businesses that have some elasticity
in pricing, so that they can raise prices to cover a percentage of royalties without
losing customers. Royalty financing is also suitable for companies for which increased
marketing efforts have an immediate impact on sales.
• Compared to debt financing, royalty financing provides more convenient payback terms
and less severe penalties for default.
• Institutional investors that have already funded a company may prefer a royalty-type
of financing
• Appropriate for companies looking for more funding but that want to prevent lower
valuation.”

Question 3

Characteristics of companies for royalty financing?

Answer 3

“• Profitable or nearing profitability;
• Possess high gross margins above 40%; and
• Be forecasting growth”

Question 4

Four fundamental items of royalty agreement?

Answer 4

“The process assumes that investors and business owners agree on four fundamental items:

1. The principal amount of the investment and overall multiple to be returned.
2. The time frame for returning the original principal investment (typically 18-48
   months) .
3. The time frame for providing the remaining investment return (typically 4-6 years).
4. The maximum contractual time to provide the total investment return (often 8+ years).”

Question 5

IRR sought by lender depends on what factors

Answer 5

“IRR usually between high teens to 30_40% for newer.
Other factors to consider:
• the stage of the company;
• the maturity and experience of management and the completeness of the management
team,
• the size of market;
• volatility or concentration of sales;
• competitive risk;
• patents or knowhow;
• the sales pipeline and outlook for prospects;
• the history as well as forecast for profit and loss;
• the urgency of the company’s funding need;
• the state of the capital market; as well as
• the national economy.”

Question 6

Debt agreement terms that need to be defined for royalty financing, include:

Answer 6

“• Financing or Loan Amount (e.g., the principal) — the amount borrowed or the amount still
owed on a loan, separate from interest.
• Repayment Terms — usually takes the form of periodic payments that normally include
part principal plus interest in each payment.
• Maturity Date — the date on which the principal amount of a loan becomes due and is
repaid to the investor and interest payments stop.
• Event of Default — an action or circumstance that causes a lender to demand full
repayment of an outstanding balance sooner than it was originally due.
• Default Remedies — the actions a lender may take in case of default or breach of the
loan agreement.
• Representations and Warranties — usually cover whether a borrower is legally capable of
entering into finance agreements and the nature of the borrower’s business.”