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. What is often overlooked as a potential 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 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 is a multi-billion dollar market that’s still in its first stages. It’s been widely used in the pharmaceutical and biotech sector, and now businesses from many other industries are using their IP to take advantage of this funding option. Royalty financing is getting more attention as an alternative funding source, especially for small businesses and start-ups, where IP often comprises the bulk of their assets.

Royalty financing has been used since the 1990’s, but there were only a handful of companies offering this financing tool. It’s attractive to investors as a way to cut 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. In 2005, interest increased and some hedge funds started getting into the mix. Since then, the number of funds has grown significantly, with many focused on royalty financing including KKR&Co. Apollo Global Management, Blackstone Group and TPG Capital.

The size of the royalty financing market is unknown. In 1997, there was about US$380 million of known intellectual property royalty financing, all based on music and film royalties. In 2000, the volume increased to about US$840 million, including royalties from music, film and pharmaceutical patent licenses. 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.

IP Financing is widely used in the health care industry, particularly pharmaceutical and biotech sector. With long R&D cycles and regulatory approvals before it reaches the commercial marketplace, it allows them to fund their R&D and clinical trials, which are capital intensive. But it is not limited to them. More and more businesses from other industrial sectors, as well as research institutions and universities, are taking full advantage of the opportunities offered to them by IP Financing. One recent example is UCLA, which received over $500 million for its royalty rights to a cancer drug. 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.

Using royalties to raise capital 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.

Here’s how it works. 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.

Royalty financing is flexible. It can include all or part of the royalty stream, or 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. The amount of royalty revenue required starts with a minimum of $5 million to hundreds of millions. The financing is created through a private placement that can be done in as little as 30 days. The investors in these private placements are pension funds, insurance companies and private investors.

There are a few restrictions on using royalty financing. Some of these include restrictions on selling the IP, keeping the IP maintenance fees current, and securing the IP in a holding company. The terms for royalty financing transactions include three significant requirements : 1) an assignment or 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.

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