The ability to raise money is the difference between success and failure for a growing business. Start-ups in particular often find it difficult to raise money.
An asset often overlooked as a funding source is intellectual property. Licensing is one of the easiest and fastest ways for turning IP, such as patents, copyrights and trademarks, into revenues. These royalty revenues streams are now being recognized by the financial markets as a financing resource. Royalties financing converts a future income stream generated from a licensing agreement into cash today.
Royalty financing offers a number of benefits including a flexible source of financing, lower cost of capital, an alternative to conventional financing, a more attractive investor option, immediate cash flow, and a way to leverage the value of your intellectual property assets.
In royalty financing transactions, the IP owner sells (or assigns) all or part of the royalty streams to a buyer (funding source) in return for cash paid up front. Royalty payments go into a lock box, with a percentage paid out to the investors, and the rest (if any) going back to the IP owner. In return, the IP owner receives the minimum guaranteed payments from a licensing contract upfront than over the term of the licensing agreement.
The size of the royalty financing market is growing. According to research from the Association of University Technology Managers, these type of financing deals are growing and now exceed $5 billion. Driving the growth are more investors and facilitators, such as consultants and investment bankers, who understand the royalty financing market.
Royalty financing structures are flexible. For example, these types of transactions can include all or part of the royalty stream. It can limit the royalty interest to certain products, territories or periods of time. The transactions can be a straight sale or structured, such as only a percentage of the royalty payments. Once the agreement term finishes, all royalty payments go back to the IP owner.
For start-up companies, royalty based financing is a good way to attract investor capital. It’s often a better source of funding, since valuation isn’t an issue. Instead of selling equity, investors receive a percentage of the royalty revenue. The advantage for the investor is they don’t have to wait for a buyout or IPO to get their money back.
Royalty financing costs are typically a percentage of the total minimum guarantee amount of the licensing agreement, which is the return to the investors providing the royalty funding. Royalty financing transactions vary in size from a minimum of $5 million (in royalty guarantees) to hundreds of millions. The financing is completed through a private placement, which can provide funding in as little as 30 days. The investors in these private placements are pension funds, insurance companies and private investors.
There are few restrictions on using royalty financing. Pharmaceutical companies often use this financing tool to pay investors while their drugs are still in development. Sears used their core brands to recapitalize the company by licensing them back from an SPV (special purpose vehicle), and secured investor financing against future royalties.
It’s also attractive to investors as a way to reduce their investment risk. It shifts future revenue streams to the investor, allowing for greater predictability of cash flows. Bowie Bonds were one of the first royalty financing deals, raising $55 million in 1997 through a bond offering backed by future royalties from 25 record albums.
The terms for royalty financing transactions include three significant requirements : 1) an assignment of/or an absolute and unconditional promise to pay from an investment grade licensee, 2) a predictable cash flow, and 3) specific dates for payments.
Royalty financing is a source of financing available to any business with intellectual property assets. Your business keeps control of its IP while using the future cash flow value of your licensing deals. It’s a low-cost alternative to conventional financing, and its flexible structure can be tailored to your exact financing needs. Royalty financing is often a better source of funding, especially for start-ups with limited access to capital, since valuation isn’t an issue in royalty financing. It’s also attractive to investors as a way to decrease the risks inherent in investing in a product or company.
By exploring the real value of your IP assets and the revenue opportunities they offer, you can find yourself with a treasure trove of unrealized value and a potential funding source.