In the startup world, funding is often the ultimate goal. Investor funding usually means the startup founders giving up equity. An alternative, often overlooked by investors and founders, is royalty financing.
An “R round” investment will be paid back by a startup company based on the percentage of future earnings at a negotiated interest rate—usually in the 5-10% range. A startup only pays back the loan in the months when there is net profit. If the business isn’t making money, then the lender doesn’t get repaid that month. This is pay when you have net income arrangement is different than a traditional small business loan. The latter requires a monthly payment regardless profitability.
Investors and startups should consider this alternative to equity funding. For investors, the return comes with a guaranteed rate of return. Over the short and moderate term, the R round financing structure provides a relatively predictable repayment and rate of return on investment. There are also advantages to founders. Specifically, founders can get funded without having to give up equity which becomes more valuable as the company matures. A second advantage is the founders do not give up control due to losing equity.
One wrinkle worth considering that can be added to royalty financing is a convertible equity option. A convertible option allows the royalty lender to elect to convert they debt into equity by a certain date.
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