DOWNLOAD the Royalty Unit Note (RUN):
The RUN includes a Primer with an overview of how the instrument works.
HOW it works:
I - Investment made in Company
2 - Royalty Units issued to Investor
1 Royalty Unit = 0.01% Revenue
1,000 Royalty Units = 10.00% Revenue
3 - Quarterly Royalty paid to Investor
4 - Royalty Units Repurchased by Company after the Investor’s royalty cap is reached
Company and Investor pre-determine the maximum return on investment (Cap).
After royalty payments to Investor reach the Royalty Cap, Company repurchases the Royalty Units for amount of the original investment.
Standard Cap is:
2x the Investment Amount, plus
an additional 0.5x for each year outstanding after 3rd year
This structure is intended to allow a return of capital from Company to Investor in a tax free manner, after the return on investment has been paid. The return of capital (which is the repurchase amount) is still paid out by the Company as a royalty payment in the same manner, but stops after the original investment amount is returned in full as a repurchase.
ABOUT the Royalty Unit Note (RUN):
The Royalty Unit Note (RUN) allows a company to raise capital from investors through the sale of royalty units, which give the investor a right to receive quarterly payments tied to the company’s revenue. The investor’s royalty entitlement is capped at a pre-determined multiple, that increases the longer the RUN remains outstanding. After the cap is reached, the royalty units get repurchased by the company with a return of capital to the investor paid through the same royalty structure.
Benefits to the Company
Little to no legal fees.
“Non-equity based”, means: non-dilutive, no control given, no voting rights offered.
Reduces pressure from investors to pursue major liquidity events (“exit”).
Allows companies that are not fit for traditional venture capital to raise capital with ease.
Capped royalty entitlement allows for financial forecasting and modeling.
Allows for single investor transaction or multiple investor transactions.
Benefits to the Investor
Passive income stream model with a return of capital mechanism built in.
Faster liquidity when compared to equity.
Lower risk financing structure that can return capital even in companies with uncertain “exit” prospects.
Suitable for any industry and any type of business, including businesses unfit for traditional venture capital (service businesses, impact companies, brick and mortar, non-profits etc.).
Allows for assignment of right to income to increase negotiable value of instrument.
FREQUENTLY ASKED QUESTIONS:
1. What is a Royalty Unit?
A Royalty Unit entitles the holder to receive a percentage of the issuer’s gross revenue on a quarterly basis.
It is not a form of equity (shares / stock), and it is not a form of debt.
2. Why is the royalty tied to Gross Revenue?
There is less room for dispute when calculating Gross Revenue. It is easy to calculate and verify.
3. How is “Gross Revenue” defined?
Quite simply, all top-line revenue.
The following are deducted / excluded:
(a) taxes, refunds, and other similar government charges; and
(b) any amounts received by the company through a financing event.
4. How many Royalty Units should I issue?
This is negotiated between the investor and the company. Each company has different financial constraints to consider when granting royalties. We would expect that there would be higher royalties with companies of higher risk (earlier stage, pre-revenue, or experiencing financial distress, for example).
5. Can I change the Royalty Entitlement Cap?
Yes. While the RUN has a 2x multiple pre-set (with the 0.5x increase on each year after the 3rd year), the investor and company can certainly negotiate a change to this multiple.
6. Is the RUN a security?
Yes. As a result, it is important that you understand the legal and regulatory requirements in your jurisdiction prior to using the RUN. All jurisdictions have restrictions on the issuance and trade of securities. Seek legal counsel prior to using the RUN to ensure you’re complying with all applicable laws and regulations.
7. What is a RUN Series and what is the RUN Series Royalty Unit Cap ?
Often times, a company raises capital from more than one investor on the same terms. The RUN was designed to be usable for a single investor transaction and also for a multiple investor transaction.
In either case, prior to a RUN financing, the company determines the aggregate percent of its Gross Revenue it wishes to offer to investors. Each Royalty Unit under a RUN entitles an investor to a Royalty Entitlement equal to 0.01% of the Company’s Gross Revenue. Therefore, by determining the aggregate percent for offering, the company can determine the RUN Series Royalty Unit Cap, which is the maximum number of Royalty Units available for purchase under that Royalty Series.
If the RUN financing is with a single investor only, the RUN Series Royalty Unit Cap will be equal to the number of Royalty Units purchased by the investor.
8. What happens after the investor receives the Royalty Entitlement Cap?
The Investor and the Company pre-determine the return on investment prior to the investment being made. That is the Royalty Entitlement Cap.
Once the Investor receives the Royalty Entitlement Cap, the Royalty Units are automatically redeemed and repurchased by the Company for the amount originally invested by the investor under that RUN (the Redemption Price). This results in a “return of capital” to the Investor, which is intended to benefit the Investor from a tax perspective. The Redemption Price is paid through continued royalty payments in the same structure as prior to the redemption and repurchase.
For example, if an Investor invests $100,000 for 1,000 Royalty Units (10% royalty right) under the standard RUN, the Investor would be entitled to receive up to $200,000 in royalty payments while holding the Royalty Units (at the 2x multiple during the first 3 years). After receiving $200,000 in aggregate royalty payments in the first 3 years, the Royalty Units would be automatically repurchased by the Company for a price of $100,000, which will be paid by the Company through continued royalty payments until that amount is paid in full. This would result in the Investor receiving $200,000 in royalty payments in addition to the return of their $100,000 investment.
9. Why does the Royalty Entitlement Cap increase after 3 years?
The longer it takes to return capital to an Investor, the greater the return needs to be for the investment to be worth while.
Here’s an example of how that works: If an Investor invests $100,000 for 1,000 Royalty Units (10% royalty right) under the standard RUN, the Investor would be entitled to receive up to $200,000 in royalty payments while holding the Royalty Units (at the 2x multiple during the first 3 years). However, if the Investor has not received royalty payments up to that Cap during those first 3 years, under the standard RUN, the multiple will increase by 0.5x increments per year thereafter. This multiple is always against the initial investment amount, not against the outstanding amount owing. Therefore, in the 4th year, the Cap moves to $250,000; in the 5th year, the Cap moves to $300,000; and so forth.
10. When does the RUN end?
On the first of the following to occur:
(a) the redemption and repurchase of the Royalty Units by the Company, fully paid, according to the RUN terms;
(b) the Company paying to the investor the Buyout Price; or
(c) the Company cashing out the investor, in priority, in the event of a Liquidity Event.
Legal Notice
The RUN may not be suitable for all financing situations. It is provided as a reference and sample only. The terms were intended to be balanced, taking into account both the company’s and the investors’ interests. Your use of the RUN is at your sole risk. As with any financing instrument, structure and strategy, you should consult legal counsel prior to using the RUN. Ink LLP (nor any of its supporting partners) does not assume responsibility for the consequence of using any version of the RUN.