Innovative financing of enterprise

The financial bedrock of all active enterprise is risk capital, and the lack of risk capital on suitable terms can all too often frustrate the ambitions of very able and motivated people, observes Ian Whalley, in ‘ Creating Risk Capital: A royalty fund solution to the ownership and financing of enterprise' ( www.visionbooksindia.com ). Much worse, the lack of risk capital can lead them into unsuitable arrangements, often followed by debt and distress for themselves and for others involved in their enterprises, he rues.

The royalty funding approach discussed in the book is about hiring risk capital under contract as an alternative to issuing equity capital. The author speaks of investors owning assets directly, rather than indirectly through shares in a company, placing them in a fund and licensing their use to the company in exchange for royalties. “Such assets may be tangible, like plant and machinery, intangible like intellectual property, or circulating, as in the case of assets which make up the working capital.”

Licensing, franchising, turnover leasing, asset management, and consignment of stock are listed in the book as the building blocks for the royalty fund system. Though simple in concept, licensing can be a complex subject, the author cautions. This complexity depends mainly on the nature of the property, which may for example consist of statutory rights under various national laws, and the impact of government regulations and conventions affecting property and its use, he explains. As for the form of organisation, Whalley mentions both the conventional ones such as limited liability company set up like an investment trust, and other forms like limited partnerships similar to what are used by venture capital and private equity funds. And the financial structure, he advises, must be suitable for an investment organisation which is established to provide risk capital on a medium- to long-term basis. “This implies a financial structure made up of equity in the early stages. The advantage of equity funding is that it is permanent, and therefore the royalty funder will have no difficulty in matching the term of the funds it provides.”

An important feature of royalty funding highlighted in the book is that it is for the long-term, but unlike an equity share, it is not designed to be permanent. Thus, as the author elaborates, on the achievement of an agreed target of royalties, indicating a highly successful investment, the property in the royalty fund would pass at no further cost to the user enterprise. “Conversely, if an agreed minimum level of royalties is not achieved, indicating a low level of use of the property involved and an unsuccessful investment, the royalty funder may take the property back for more effective use or for sale elsewhere.”

An insightful section in the book is about the comparison of royalty funding with private equity (PE) and venture capital (VC). In the case of PE or VC, investors typically seek to make relatively few and highly selective investments, often in large amounts and with hands-on involvement, in companies which offer the prospect of very high returns over relatively short periods, culminating perhaps in a lucrative stock market flotation, the author distinguishes. “In sharp contrast, royalty funding is designed for much wider use in enterprises which have no need or wish for the hands-on involvement of the investor and will generally seek good but less spectacular returns over a longer period.”

Instructive read for finance professionals.

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