The other 97 percent
By John Hamilton
Royalty complements and extends other business financing structures, including equity.
I want to spread the seeds of royalty financing a powerful new deal structure for later-stage companies with healthy gross-profit margins. Investors, entrepreneurs and community development practitioners would be better off if they were familiar enough with the benefits and tradeoffs of royalty to apply it to a given business opportunity.
I'm not saying that royalty is better than equity financing. Equity is a great way to add fuel and expertise to early-stage companies, particularly where timing to market is critical to their success. I am grateful for equity investors and refer many good deals to angels and venture capitalists. But few companies offer the type of "hockey stick" growth and serve large-enough markets to justify becoming equity investors' best choices for maximizing return. Consequently, equity is appropriate for, at most, 3 percent of businesses.
So what are we doing about the other 97 percent? We must answer that question if we want to grow our economy.
Royalty financing is a growth-capital solution for a business with a strong team, market, and product but with no clear plan to sell the company (or "exit"); and for businesses like Blake's All Natural Foods that are looking for risk-tolerant capital to sustain long-term growth. That's because the royalty investor is paid out of the business's future cash flow (generally as a percentage of the future gross revenue) instead of from an exit or "cash out" event.
Royalty offers a way to get growth capital into established businesses that are coming off a tough couple of years and need more risk-tolerant capital than a bank can offer, but that aren't ready for or attractive to equity investors. And it offers owners of later-stage companies, who won't take on capital that requires them to give up control or sell their businesses, a way to raise capital that is not dilutive and doesn't require loss of control.
It is time for us investors to take the advice we often give entrepreneurs: When the market changes, you need to adapt and innovate. As early as 2009, a Wall Street Journal article discussed how royalty financing has emerged as an alternative to traditional equity.
Several angels who participated in Vested for Growth's most recent royalty investment had previously walked away from a deal with the same company when they could not see a clear exit even though they believed in the business's growth proposition.
A bad equity deal may be a good royalty deal and vice versa. So why not have both tools available?
John Hamilton is the Community Loan Fund's Vice President of Economic Opportunity and Vested for Growth's Managing Director.