Neil Johnson is the CEO and founder of London-listed Duke Royalty Limited
The odds are that if you live in the UK and rest of Europe you have never heard of royalty finance. However, more than a decade after the 2008 financial crisis and on the back of a recent sell-off in global equity markets, the word around royalty financing is inevitably spreading rapidly. This is helped by the fact that royalty finance represents a £50 billion market in North America, meaning that it is now well-recognised as a very viable way of funding growth across a range of sectors.
Royalty finance sees well-established small and medium-sized enterprises (SMEs) receive capital in return for a slice of their revenues. Models can vary, but typically royalty financing works as a type of ‘corporate mortgage’, where a business exchanges a small percentage of its revenues over a long period of time in exchange for capital today.
Royalty financing may be a new concept to the UK and Europe, but providers, such as London Stock Exchange-listed Duke Royalty, are now starting to gain traction. That is because the advantages are clear: unlike other options, royalty financing enables businesses to realise their long-term business goals without compromising owner control, diluting equity shares or adding debt to the business.
Since the royalty company is taking a slice of revenue from the business, it also means that the interest of the two partners are aligned (arguably, unlike other traditional finance methods), with the repayment percentage adjusted annually to reflect any movement in an investee’s revenues.
On top of that benefit, the company’s repayments cover the principle as well as the interest.
Many companies use the money to replace existing short-term debt to allow them to grow. Royalty financing eliminates re-financing risk because it has a payback over decades, hence the analogy to a ‘corporate mortgage’.
Stock shock and nervous banks
There are, of course, other options for businesses to raise capital. They can float on a stock market, for instance. But given the global equity market sell-off, which saw some of the world’s leading indices and companies like Netflix and Alphabet take a dive, the landscape is looking unclear. That is without taking into consideration how much management and owner control is diluted.
Elsewhere, banks seem somewhat nervous to lend to SMEs. In May, the UK’s Federation of Small Business (FSB) reported that small credit business approvals had fallen to a 30-month low. With only 60% of small firms that applied for credit being successful. The worrying statistic reinforced a sentiment that is already widely known and reported on in the country, being the ‘SME funding gap’.
This gap is a major concern for the financial sector as SMEs employ 60% of the UK’s private sector workers. Despite this concern, in March 2018, pressure group the SME Alliance, which represents thousands of small businesses, told MPs on the House of Commons Treasury Select Committee that they are finding it more difficult than ever to take out loans with banks.
While a recent report from the Treasury Committee on SME Finance found that the percentage of SMEs using external finance has stalled in recent years, sitting at 38% in 2017, compared to 37% in 2014, 2015 and 2016.
While this stagnation in traditional banks’ lending to SMEs makes for concerning reading, it also highlights the opportunity for alternative finance solutions like Duke Royalty.
Although royalty financing may still be in its infancy the UK, as more SMEs are educated and learn about its benefits, it will continue to play an ever-growing role in lending to businesses that traditional banks are increasingly ignoring. Duke Royalty, for example, has deployed £43m in the last 18 months alone through five new investments, and three follow-on investments.
Amid a quickly changing finance environment among SMEs in particular, royalty financing is set to grow from strength the strength across the UK and Europe.