Key Takeaways

  • Royalty financing offers flexible repayment based on revenue performance, without diluting equity or needing personal guarantees.
  • A royalty loan agreement formalizes this arrangement and outlines payment caps, terms, and conditions.
  • Unlike debt or equity financing, royalty financing provides cash without giving up control or assuming traditional debt burdens.
  • It's particularly useful for companies with high-margin products, recurring revenue, or limited access to traditional funding.
  • Terms vary, but key elements include payment percentages, repayment caps, duration, and exit provisions.
  • Legal review of royalty loan agreements is essential to ensure enforceability and alignment with business goals.

Royalty Financing: What Is It?

Royalty financing is a type of investment where the business gets money based on future revenue. It's similar to an advance on a paycheck. The investors get their money back through royalties that are a percentage of the company's revenue. 

The repayment terms and the total amount repaid are negotiated at the start of the loan. The company's income and revenue determine how long it takes to repay the loan, which in turn affects the final repayment amount. However, a cap will be placed on the repayment amount during the initial negotiations.

Royalty financing is usually used for companies with large revenue streams. Less profitable companies wouldn't be able to repay the loan plus pay their business expenses. 

The concept of royalty financing began with Bart Goodwin and Ed Mello when they saw a gap in the market for this type of investment opportunity. Their company, Cypress Growth Capital, decided to take a percentage of the borrower's monthly revenue instead of the traditional equity stake.

Royalty financing was first popular in industries such as oil and gas, pharmaceuticals, film, and even mining. However, companies like Cypress Growth Capital, Barkerville, Osisko, and Grenville Strategic Royalty Corporation have expanded their investment model into new industries. 

Royalty Financing Versus Debt and Equity Financing

Debt financing means getting a traditional loan in which you don't give up any ownership of your business.

Equity financing, on the other hand, requires you to give up stocks in your company to the investors. When you give up this ownership, you risk losing some control over your business and its finances.

Royalty financing is a sort of compromise between the two. Investors see greater returns than they would with a traditional loan, and companies don't have to trade equity for financing.

When deciding which type of financing is right for you, keep the following facts in mind:

  • Businesses that plan on selling eventually offering an IPO are more likely to attract equity financing.
  • Lines of credit or debt financing is harder to get since the financial crisis in 2008.
  • Debt financing requires fixed payments which might be challenging for companies in the early stages.
  • Royalty Financing is relevant to companies that work seasonally since the revenues vary greatly during the year.
  • Royalty and debt payments typically are tax-deductible while equity financing doesn't affect taxes.
  • Flexibility is highest for royalty financing, while equity is less flexible and debt financing is very limited.

Reasons to Consider Using Royalty Financing

Investors

The investors see a faster return with royalty financing. In some cases, they start receiving money immediately. In other cases, the business must reach a certain amount of revenue before it begins repaying the loan. Either way, investors receive their return faster than an initial public offering or other, more traditional types of loans. With these other options, it often takes longer than five years for an investor to start getting money back. 

Other advantages include the following:

  • Investors get their money back regardless of how well the business does.
  • Royalty financing comes with a lower risk of default because the payments are much more flexible.
  • If the company does default, the investors get paid back before those with a stake in the business.
  • Investors are guaranteed a certain amount of profit with royalty financing. 

Investees

For investees, royalty financing is attractive because it does not depend on exits or equity ownership. The business owners stay in control and don't have to bend their business plan to please the investors. Royalty financing doesn't fall under state and federal security laws, which saves time and money on complicated filings. 

The following features of royalty financing also make it more flexible and less risky for businesses:

  • No minimum payments
  • No personal guarantees
  • No fixed loan terms
  • No lump sum payments
  • No restrictive conditions

Although small business loans cost less, those loans can be difficult to get. Also, because the royalty payments don't show up as debt the way interest would, companies may find it easier to attract more investors if they choose royalty financing.

Reasons to Consider Not Using Royalty Financing

Investors

Since the returns are capped, there is a limit to how much an investor can profit, and repayment is sometimes slow depending on the amount of revenue the business earns. Also, royalty financing requires a hands-off approach. Investors can't interfere with the business decisions of the company or liquidate the company if they want or need to. 

Investees

For investees, royalty financing can negatively impact their company's growth because a percentage of revenue goes back to the investor instead of being reinvested in the company. This type of financing can also make it harder to pay off other debt. If the company has small profit margins, it might not be able to spare the money to pay back the loan.

With royalty financing, investors typically don't make future investments into the company, but the company still has to pay back investors even if it isn't profitable. Royalty financing is a loan, and if the company can't pay back the loan, it would have to sell its assets to make those payments. 

Depending on how well the product does and the terms and conditions of the loan, royalty financing can be expensive. To even get the loan, you have to talk someone into believing your product will take off and that your company will earn enough revenue to be worth the investment.

Ways Royalty Financing Is Used

Businesses need investments for a variety of reasons, and royalty financing may provide the following opportunities:

  • A bridge to the next round of financing or investments
  • Growth capital for business owners who want to keep control and don't want to give investors a board seat
  • Preserved ownership and value for the future sale of the business
  • Acquisition capital

Common Industries and Scenarios for Royalty Loan Agreements

Royalty loan agreements are commonly applied in industries with predictable or scalable revenue models. These include:

  • Technology and Software-as-a-Service (SaaS): Companies with subscription-based models use royalty financing to scale without giving up equity.
  • Pharmaceuticals and Biotech: Firms with patented drugs or medical innovations use it to fund trials or go-to-market strategies.
  • Entertainment and Media: Film producers, musicians, and content creators may secure funding based on future royalties from streaming or distribution.
  • Natural Resources and Energy: Companies involved in oil, gas, or mineral extraction utilize this model for upfront capital while retaining operational control.
  • Franchise Expansion: Franchisors often use royalty loan agreements to finance the growth of franchised units while keeping ownership intact.

This financing method is especially suitable for businesses that anticipate growth but want to avoid the dilution associated with equity or the rigidity of traditional loans.

Ways to Get Royalty Financing

Both angel investors and private equity firms can provide royalty financing. To find opportunities, take the following steps:

  • Visit your Chamber of Commerce's Small Business Development Center.
  • Talk to bankers, lawyers, and accountants.
  • Check out the Royalty Exchange.

There are also CrowdFunding options for royalty financing:

  • AppsFunder
  • TubeStart
  • Quirky
  • RoyaltyClouds
  • Gideen.com
  • Lendpool.com

Key Terms in a Royalty Loan Agreement

When drafting or entering into a royalty loan agreement, understanding its typical terms and provisions is essential. Common components include:

  • Royalty Rate: The percentage of gross or net revenue to be paid to the investor.
  • Repayment Cap: The maximum multiple of the original investment the investor can receive (e.g., 1.5x or 2x).
  • Term Length: The duration of the agreement or until the cap is reached.
  • Revenue Definition: Whether royalties are based on gross revenue, net income, or another metric.
  • Minimum Revenue Clause: A clause that triggers adjustments if revenue falls below a certain threshold.
  • Prepayment Options: Some agreements allow early payoff, often with incentives or penalties.
  • Default Provisions: Terms outlining what happens if payments stop, including investor remedies or dispute resolution.

These terms are negotiated in advance and tailored to the business model. A carefully structured agreement ensures alignment between business performance and investor returns.

Criteria to Get Approved

To get approved for royalty financing, you must have existing sales. Investment companies need to see potential revenue and existing customers. Products with high profit margins are also desirable. 

Legal and Tax Considerations

Although royalty financing is less regulated than equity financing, royalty loan agreements still carry legal and tax implications:

  • Legal Classification: Depending on the agreement’s structure, it may be considered a security in some jurisdictions. Legal review helps ensure compliance with relevant laws.
  • Contract Enforcement: Clearly defined terms and performance triggers protect both parties and minimize future disputes.
  • Intellectual Property Rights: If royalties are tied to intellectual property (e.g., patents, trademarks), the agreement must define usage rights and transfer clauses clearly.
  • Tax Treatment: Payments made under a royalty loan agreement are generally considered deductible business expenses for the borrower. However, treatment may vary depending on structure and local laws.

Businesses should consult legal and tax professionals to ensure their agreements are compliant, enforceable, and optimized for their financial strategy. You can find experienced legal counsel for royalty financing through UpCounsel’s attorney marketplace.

Frequently Asked Questions

  1. What is a royalty loan agreement?
    A royalty loan agreement is a funding contract where repayment is tied to a percentage of the company’s future revenue, rather than fixed payments.
  2. How is a royalty loan different from a traditional loan?
    Unlike traditional loans, royalty loans have flexible repayments based on income performance and often don’t require collateral or personal guarantees.
  3. What industries benefit most from royalty financing?
    Tech startups, SaaS businesses, pharmaceuticals, entertainment, and natural resource companies often use this model due to recurring or scalable revenues.
  4. Are royalty payments tax-deductible?
    In many cases, yes. Royalty payments may be treated as operating expenses and deducted from taxable income, but this depends on the agreement's structure.
  5. Can I repay a royalty loan early?
    Many agreements allow for early repayment, sometimes with a discount or penalty. The specific terms will be outlined in the royalty loan agreement.

If you need help with royalty financing, you can post your question or concern on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or for companies like Google, Menlo Ventures, and Airbnb.