Royalty Based Financing: What’s In It for Entrepreneurs

 

This is Part 6 of a series on royalty based investment (or “royalty based financing”).

Now, let’s turn our heads to the fanta-bulous entrepreneurs and find out how they can benefit from royalty based financing. We’ll deal with its downsides later in the series.

More Control. Entrepreneurs aren’t forced to sell. They can maintain control and ownership of the company. This allows them to spend more energy executing on their business plan rather than chasing the all-important exit, writes Gregory T. Huang of Xconomy.

Minimal Dilution. Warrants give investors the right to purchase a certain amount of the company’s equity at a stated price so ownership dilution is minimal. This may give management more incentives to build a durable company with solid, profitable revenue streams — the most important criterion to qualify for royalty based investment.

Deductible Expenses. Just like debt, Rockwater Capital points out that payments exceeding original principal are deductible expenses for the company.

Obtain Growth Capital. Not only can entrepreneurs obtain funds that they mightn’t be able to obtain otherwise, but they can do so without requiring personal guarantees from management or equity owners, says Jeff Joseph of VenturePopulist.

“[Royalty based financing] offers growth capital to companies that can’t participate in debt or equity [financing],” commented Jeff Schrock, a VC at Intel Capital.

Andrew Clapp of royalty based investment firm Arctaris Capital Partners points out that the model is “better suited for the company needing debt to replace the bank line it may have lost or had reduced during the recession.”

Flexible Repayment. Royalty based financing “is less onerous that debt because it is variable to revenues,” notes Joseph. Instead of paying a fixed amount on a strict schedule, companies have more flexibility in the amount they repay. The more sales they make, the more they repay, vice versa.

Valuation Avoidance. Because royalty based financing is a loan at its core, the company is borrowing money instead of selling equity. So there’s no need to put a price tag on the company, which eliminates the awkward and sensitive discussion on how much the company is worth.

Royalty Based Financing vs. Other Financing Methods

A table by royalty based investment firm RevenueLoan, comparing royalty based financing to other financing methods:

Next, we’ll study the drawbacks of the approach for both investors and entrepreneurs.

What you’ve learned so far:

• Angel Investing: Exit Dependence Investment Models provides an overview of 2 exit-dependence investment models used by equity investors and addresses why some investors are testing a new investment vehicle that doesn’t depend on exits.
• Angel Investing: Royalty Based Investment Features “Built-In” Exits goes through its “build-in” exit feature and looks at an example of how the investment model works.
• Angel Investing: Components of Royalty Based Investment Model looks into the debt and equity components of the vehicle.
• Royalty Based Investment Works Best on These Companies outlines the repayment structures and some basic investment terms.
• Royalty Based Investment: What’s in It for Angel Investors breaks down why the approach may be beneficial to investors.