Royalty financing may be an option for entrepreneurs

While helping an average entrepreneur expand their company, Grenville Strategic Royalty Corp., a publicly traded royalty investment company, began testing out a form of financing that had historically worked well in oil and gas, mining, pharmaceuticals and film: “revenue” or “royalty” financing.

In short, Grenville found a structure that really worked — for entrepreneurs and investors!

What is Royalty Financing?

The premise behind Royalty Financing is simple: a company sells a negotiated percentage of its future revenues to an investor in exchange for a capital investment.

Today, this structure has been taken beyond oil and gas, mining, film production, pharmaceuticals and music to general small businesses (revenues up to $50 million) and it is quickly gaining considerable traction.

How does it work?

Rather than a company making fixed interest rate payments on a bank loan, Royalty Financing generates a return from a percentage of company revenues, over time. The structure is unsecured, subordinate and looks and feels a lot like good old fashioned equity — except it has a small monthly income stream to investors.

While bank loans seem less expensive and lower-risk, they can be difficult for small business owners to obtain and come with a lot of conditions like personal guarantees and pledging your business, to name a few. At the other end of the spectrum are equity investments which are about higher risk and higher return. Royalty Financing is more in the middle-ground, with a current cash stream reducing the risk as part of the structure.

An example of Royalty Financing

A basic example: A five-year old-company has $10 million of revenue. For a $1 million investment, the investment company would “purchase” 2.5 percent of the company’s revenue ($10 million of revenue times 2.5 percent = $250,000 of cash flow generated year). The net result is a stream of monthly royalties from a broad portfolio of companies and the investment company becomes the company’s champion to help them grow their revenues even higher, and the company doesn’t have $1 million to pay back.

Each Royalty Agreement is tailored according to the company’s unique business situation and the investment company works hand-in-hand with portfolio companies to collaborate in developing future buy downs and contract buyout strategies to reduce the royalty rate over time.

How is this source of capital different from other forms of financing?

This type of capital aligns with a company’s plans for growth. However, business owners retain clear control of their businesses; there are no onerous financial covenants, no board seats, and no dilution of ownership associated with the Royalty Financing investment.

Whereas traditional forms of financing, like equity and debt, can be expensive and dilutive, this model is about letting management stay in charge of their company. No security is demanded and no restrictive covenants are imposed.

Value for shareholders?

Put simply, Grenville has built up a portfolio of highly diversified cash-flow generating, long-term focused investments for its shareholders by investing in a mix of businesses which in turn, balances the portfolio and maintains stability. It’s also developed a source of capital for companies that often fits much better than traditional equity or debt, which works well for entrepreneurs, as shareholders and investors in their companies.

In Glenville’s history, fast forward almost three years and the company has found something that is working extremely well in a mix of businesses like financial services, software, health care, infrastructure, construction and various service sectors.

 

Bill Tharp, CEO and co-founder of Grenville Strategic Royalty Corp., has been building and investing in companies and select entrepreneurs for close to 20 years, after a successful 10 year investment banking career in both Canada and the United Kingdom. As CEO of Climate Change Infrastructure and a leadership focus on low-carbon, water-constrained, alternative energy and efficiency investments, he founded and launched Quantum Leap Asset Management, which successfully invested and exited E2 Venture Fund (the alternative energy and efficiency portion of the Covington Venture Fund), Venture Partners Balance and Equity Funds and also the Renewable Power Funds Series I, II and III, which became Sprott Power. 

Is your organization big data ready?

Big data is a game-changer in the world of business. Many CEOs across different industries have been paying attention to this new technology landscape. While several organizations are already known for their impactful big data best practices, many are just starting this long journey.

As the big data ecosystem grows every year, it is important to understand some of the prerequisites that are critical in embracing big data and data-driven decision-making culture in an organization.

Big data is not a “Plug and Play” technology. It involves a number of managerial and technological steps that are critical for success. Like any other organizational technology, big data implementation requires the full endorsement of an organization’s senior management, finding the right talent, and introducing a measurement culture.

From the top on down

The lessons learned from implementation failures of enterprise-wide systems such as ERP, CRM and SCM in many large or mid-size organizations indicate that executive sponsorship is the starting point for such large-scale undertakings. Big data introduces a whole new decision-making culture to an organization that cannot happen overnight.

Depending on the history of the organization, this change management journey could be very long. Nevertheless, senior management can play an important role in this journey. The management must lead by example with a clear understanding of the huge impact of big data on the organization’s information sharing and decision-making culture.

The alignment of the organization’s strategy, operational visibility, and investments in big-data related technologies can only be materialized when senior management fully understands the scope and challenges of this process and makes it easy for employees and stakeholders to embrace it.

Data-driven culture transforms organizations from a reactive to a proactive mode of operations, and brings transparency, accountability and speedy decisions. Incorporating this culture is not feasible through a bottom-up approach.

It is unlikely that individual employees or even division managers can change the whole organization by being the main advocates and activists. This approach may in fact lead to isolated or disconnected data-driven initiatives in organizations. Therefore, senior management must be ready to bring these fundamental changes from the top.

Investment is critical

Another critical area of readiness is the investment required to adopt big data technologies. Long-term vision and the need to know the scope of implementation are important here.

Yet, the cost of big data technologies may not be as big as the name sounds. This is mainly because there is a major shift of burden from hardware to software requirements due to the parallel and distributed processing architecture of big data and the use of commodity machines in the process.

In addition, many big data technologies are open source, one of their several appealing features. While a solution such as Apache Hadoop is not necessarily a complete answer in the big data ecosystem, there are many other big data platforms and tools that are also open source. Organizations can take advantage of these opportunities to get started.

However, this does not mean organizations do not need anything in particular or even proprietary to meet their specific needs. In addition to a foundation such as Hadoop, organizations may need several specific analytical capabilities from the tools segment of the software market. Therefore, management’s role in the investment decision is to focus on the prioritization and allocation of their investments in the areas of hardware, software and human talent.

Analytics is a team effort and finding the right talent to address the different needs is a major challenge for organizations.

On one hand, the team needs individuals who have a strong knowledge of the big data ecosystem and understand algorithms and statistics. On the other hand, the team needs individuals who have strong domain knowledge and experience in the industry in which they are competing.

Best practices indicate that the co-existence of these two different types of talent better equips organizations to practice data-driven decision-making more responsibly and within constraints and government regulations. It also helps to generate more effective business decisions and actions for senior management to understand the business value of big data.

Measurement culture

Big data also brings with it a new measurement culture. Management must define or redefine the measurement framework that incorporates appropriate incentives to mobilize the management team, employees and other stakeholders.

The new challenge in this frontier is the high expectation for business agility.

To avoid latency in every step of an organization’s competition, measurements and incentives must reflect the appropriate speed at the operational level and the mechanisms to synchronize with the tactical and strategic directions of the organization at the corporate level.

Entering the world of big data is very tempting when looking at its potential. It offers great opportunities for those organizations that are lagging behind, looking for improvements in efficiency, or even for trying to maintain their leadership in their competition. Yet, regardless of their reasons for adopting a big data strategy, organizations must first be ready in the above-mentioned key areas, among other things.

Anteneh Ayanso is an associate professor of Information Systems at Brock University’s Goodman School of Business. He teaches and researches in the areas of data management, business analytics, electronic commerce, and electronic government. He can be contacted at (905) 688 5550 ext. 3498 or [email protected]

Eight straightforward rules define smart dividend investing

The potential of a reduction in quantitative easing by the Federal Reserve has lead value and income investors to be wary of future bond yields. Likewise, the extremely low CD rates have caused investors to begin exploring other avenues of attaining consistent interest rates while mitigating risk.

I have found that value based dividend investing can be a good strategy to cushion your portfolio while allowing you to balance risk while outperforming other more secure options. There are eight straightforward rules to dividend investing to meet these objectives:

What to buy

  1. Quality

Common Sense Idea: Invest in great businesses that have a proven long-term record of stability, growth and profitability. There is no reason to own a so-so business when you can own a great business for a very long time.

Financial Rule: Invest only in stocks with 25 or more years of payments without a reduction.

Evidence: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the Standard & Poor’s 500 index over the last 10 years by 2.88 percent per year.

  1. Bargain

Common Sense Idea: Invest in businesses that pay you the most dividends so you can increase your cash flow from your investments.

Financial Rule: Rank stocks by their dividend yield.

Evidence: The highest yielding quintile of stocks outperformed the lowest yielding quintile of stocks by 1.76 percent per year from 1928 through 2013.

  1. Safety

Common Sense Idea: If a business is paying out all their profits as dividends, they will have nothing left to grow the business. When a downturn in the business occurs, they will have to cut the dividend. Invest in businesses that have much higher profits than they do dividend payments so your dividend payments are secure.

Financial Rule: Rank stocks by their payout ratios.

Evidence: High yield low payout ratio stocks outperformed high yield high payout ratio stocks by 8.2 percent per year from 1990 to 2006.

  1. Growth

Common Sense Idea: Invest in businesses that have a history of solid growth. If a business has maintained a high growth rate for several years, they are likely to continue to do so. The more a business grows, the more profitable your investment will become.

Financial Rule: Rank stocks by long-term revenue growth.

Evidence: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percent per year from 1972 to 2013.

  1. Peace of Mind

Common Sense Idea: Look for businesses that people invest in during recessions and times of panic. These businesses will have a relatively stable stock price that will make them easier to hold for the long run.

Financial Rule: Rank stocks by their long-term volatility.

Evidence: The Standard & Poor’s Low Volatility index outperformed the Standard & Poor’s 500 index by 2 percent per year for the 20 year period ending Sept. 30, 2011.

When to sell

  1. Overpriced

Common Sense Idea: If you are offered $500,000 for a $250,000 house, you take the money. It is the same with a stock. If you can sell a stock for much more than it is worth, you should. Take the money and reinvest it into businesses that pay higher dividends.

Financial Rule: Sell when the normalized P/E ratio is more than 40.

Evidence: The lowest decile of P/E stocks outperformed the highest decile by 9.02 percent per year from 1975 to 2010.

  1. Survival of the Fittest

Common Sense Idea: If a stock you own reduces its dividend, it is paying you less over time instead of more. This is the opposite of what should happen. You must admit the business has lost its safety and reinvest the proceeds of the sale into a more stable business.

Financial Rule: Sell when the dividend payment is reduced or eliminated.

Evidence: Stocks that reduced or eliminated their dividends had a zero percent return from 1972 through 2013.

Portfolio management

  1. Hedge Your Bets

Common Sense Idea: There are 10 stocks on your list each month. They are ranked in order. When you go to invest, buy the highest ranked stock of which you own the least of on the list. You will be spreading your bets over different businesses as time goes by. Better yet, you will still be investing in great businesses at fair or better prices.

Financial Rule: Buy the highest ranked stock of which you own the least.

Evidence: Ninety percent of the benefits of diversification come from owning just 12 to 18 stocks.

Umberto Fedeli is president and CEO of The Fedeli Group. He is an investor in numerous ventures and is on the boards of directors of the Cleveland Clinic Foundation, John Carroll University, the Cleveland Chapter of the Young Presidents’ Organization and The 50 Club.

The Magic Formula: A look at how to simplify ‘cheap,’ ‘good’

The Magic Formula is an abstract thought experiment, the parameters of “cheap” and “good” are both simplified. “Cheap” is taken to mean that a company, compared to other companies, trades at a price that is cheap compared to its earnings. But instead of using the simple price-to-earnings ratio, Joel Greenblatt’s Magic Formula uses the adjusted metric of EBIT/enterprise value.

“Good” is taken to mean that a company, compared to other companies, can reinvest its money at higher rates of return. The adjusted metric that the Magic Formula uses to calculate this is EBIT/(Net Working Capital + Net Fixed Assets).

What it’s all about

The Magic Formula ranks the stocks in the market by how cheap they are and how good they are and then combines these rankings to get an ordering of how cheap and good each stock is.

In “The Little Book That Still Beats the Market,” Greenblatt reported that the Magic Formula applied to stocks more than $50 million from 1988 to 2009 returned a total of 23.8 percent annualized. By comparison, the Standard & Poor’s 500 index returned a total of 9.5 percent annualized over that same period.

What tends to happen is this. The Magic Formula will give you a list of stocks to choose from. Most people will exercise their judgment and pick from the lists the stocks that look the safest or the most promising. They’ll purposely avoid the ugliest looking companies that they just know will lose money.

And what will happen is that the stocks that tended to look the best will actually perform the worst, and the stocks that looked the worst will perform the best.

Implementation

A few tips for implementing the Magic Formula without style drift due to behavioral error:

  1. Decide on a fixed asset allocation to the Magic Formula, and then stick with it by putting the same dollar amount into the Magic Formula every month.
  2. Don’t time the market. Concretely, this means making your contributions regularly rather than according to your whim or any other market-timing factors.
  3. Pick stocks randomly from the Magic Formula list and resist the urge to “just this once” selectively buy or not buy a stock, no matter how great your knowledge on that specific company.

The last point is the most important, and the hardest to stick with. You will end up buying a lot of stocks that look like value traps, and a lot of those stocks will in fact be value traps. The easiest way to fail, and ironically what happens to almost everyone who tries the Magic Formula, is that they just cannot stick with it in a systematic way. You will end up beating the market over the long run. That’s what will happen if you buy stocks that are both cheaper than the market and better than the market.

 

Umberto Fedeli is president and CEO of The Fedeli Group. He is an investor in numerous ventures. He is on the boards of directors of the Cleveland Clinic Foundation, John Carroll University, the Cleveland Chapter of the Young Presidents’ Organization and The 50 Club.

The art of the deal: Smart investors always have a plan for what’s next with their property

The best time to start thinking about your long-term plans for a piece of property is as soon as you buy it, if not before you even make the purchase, says Alec Pacella, managing partner and senior vice president at NAI Daus Property Management.

“Most investors don’t do this because it seems counterintuitive,” Pacella says. “You just bought a property, why would you want to think about selling it already? But this is not about doing a quick flip. You should have certain gates or periods of time that you have set up to say, ‘OK, I’m going to look at this asset in two years and again in five years and seven years.’ Have a plan in place upfront before you buy the asset.”

The benefits of being proactive are obvious: Few things in life or in business ever go exactly according to plan.

Smart Business spoke with Pacella about best practices to consider when evaluating the future of your property assets.

What’s the best way to approach the long-term plans of a property investment?
One of the keys to your approach is an understanding that managing the investment will likely be a fluid process. You can change your mind if the marketplace shifts and your original plans no longer make financial sense.

The key is to have that strategy or road map in place that keeps you connected to what’s happening. When you have a disciplined evaluation process, you know when a new interchange is being built a few miles down the highway from one of your assets that will likely become the next big development hub.

People often characterize real estate investors as being lucky, but it would be more accurate to say that luck is when preparation meets opportunity. The key to being a savvy investor is to recognize that opportunity and react appropriately.

If you’ve made a decision that you’ll sell when you have a chance to move up and acquire a bigger property, it becomes an easier decision to make when that opportunity arises. The acquisition is simply the next step toward that goal.

How does your investment base affect your thought process on property assets?

Let’s say you own a shopping center and you decide that in three years you’re going to take a look at where you’re at with the purchase. Any disposition decision that you make revolves around your investment base. If you bought the property for $1 million and believe that you could sell it today for $1.3 million, after you pay closing costs and taxes, you’re going to walk away with $1.2 million.

If you choose to do nothing at that point, you like the shopping center and its tenants and you decide to hold onto the property, you’ve re-bought it for $1.2 million. It doesn’t matter that you paid $1 million for it. That was three years ago. You’re foregoing that $1.2 million in your pocket and instead choosing to own the property for another three years. This is a critical thing for investors to try to understand.

Once you have that number, you can make an apples-to-apples comparison with other disposition options. What if you refinance it? What if you sell it outright? What if you sell it and buy another piece of real estate? What if you refinance and take the refinancing proceeds to buy another piece of real estate? If you take this option, you don’t have to worry about paying capital gains taxes.

What are the pros and cons of doing a trade?

You are able to push that tax consequence off to a future time period, which can be a good thing. You’re also getting into a new property if that’s what you’re looking for. One drawback, however, is that you get 180 days to close the deal from the IRS. That’s it. You also need to keep in mind that you’re postponing your tax consequence, not eliminating it. If you do multiple trades, that recapture keeps going up and can be massive when you finally decide to sell. ●

Insights Real Estate is brought to you by NAI Daus

Ten rules for investing success

Publisher’s Note:

This is the sixth in an ongoing series that analyzes investing from an entrepreneur’s point of view. At the end of the series, the collected columns will be available as a consolidated white paper at www.sbnonline.com

I’ve said before, investing isn’t rocket science — but it’s not easy either. Charlie Munger, Warren Buffett’s partner, has defined a number of rules that he lives by when it comes to approaching investing.

In his book review of Janet Lowe’s “Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger,” Joseph Dancy outlines Munger’s 10 Rules for Investment Success. He states that several themes appear in the book, helping to explain Munger’s incredible success accumulating wealth as an investor:

  1. Live below your means — The most difficult part of building wealth is “accumulating the first $100,000 from a standing start, with no seed money,” according to Munger. Making the first million is the next big hurdle.
  2. Understand your risk tolerance — Investors need to know the level of risk they can comfortably assume. Behavioral finance studies indicate that losses are three times as painful as gains for most investors, so many investors may want to adopt a relatively conservative strategy.
  3. Research opportunities — Investors must be able to process a massive amount of information effectively to evaluate the risks and rewards of potential investments.
  4. Invest for the long term — A long-term focus is essential when ignoring the volatility of markets and individual.
  5. Funds are no substitute — Americans are oversold on the benefit they receive from money managers, especially mutual fund managers. Transaction costs, taxes and fees can significantly reduce total returns. Munger advocates buying index funds or alternatively buying high quality stocks that are not overvalued and holding them for the long term.
  6. Patience, coupled with decisive action — Investors should continually search and evaluate opportunities. Utmost patience is required, until one is found that has extremely favorable odds of success. Extreme decisiveness, once the commitment is made, dramatically improves financial results over a lifetime.
  7. Tax planning —As a lawyer drawing an income, Munger was subject to relatively high income tax rates, significantly above what he paid on capital gains, which reduces the ability to build wealth. The recognition of any capital gains on investments many times can be delayed or offset by investment losses, allowing the investment to compound at an accelerated rate.
  8. Love the process — Because investors must initially be willing to live below their means and do a massive amounts of work, he or she must love the evaluation and investment process.
  9. Pay a reasonable price — While value is important, investors should buy good businesses that are in sectors that exhibit favorable business characteristics. Management can only do so much with a company in a declining industry.
  10. Choose good partners — Every investor relies on the advice of others in making investment decisions. Successful investors will have top quality investment partners.

In the end, investors benefit from developing their own checklists based on their own criteria, experiences and circles of competence.

Next month: Part 7 — Five areas to consider for value investing

 

Umberto P. Fedeli is the president and CEO, The Fedeli Group. He is an investor in numerous ventures. He is on the boards of directors of the Cleveland Clinic Foundation, John Carroll University, the Cleveland chapter of the Young Presidents’ Organization and The 50 Club. Visit www.thefedeligroup.com

 

Carlyle Group cuts minimum investment to $50,000 in new buyout fund

NEW YORK, Wed Mar 13, 2013 — Carlyle Group LP will now allow people to invest as little as $50,000 in its new buyout fund, a regulatory filing showed, as private equity firms look to widen their customer base in search of new sources of funding.

The lowered entry point is down from Carlyle’s earlier minimum investment of between $5 million and $20 million, according to a filing made with the U.S. Securities and Exchange Commission (SEC) in January.

The opportunity to invest in the new Carlyle buyout fund will be available to “accredited investors,” who are defined as having a net worth in excess of $1 million, or income in excess of $200,000 in each of the two preceding years prior to the investment.

The new closed-end fund – known as CPG Carlyle Private Equity Fund LLC – has signed up Central Park Advisers LLC as investment adviser, which means Carlyle will not directly deal with individual investors.

Carlyle’s competitors, KKR & Co, Blackstone and Apollo Global Management LLC have already launched mutual funds targeting retail investors through their institutional asset management platforms. Those funds will invest in credit products.

Carlyle, however, will be the first big private equity firm to allow relatively small investors to invest directly in buyout funds.

Gauge of U.S. business investment plans edges lower

WASHINGTON, Mon Feb 4, 2013 — A gauge of U.S. business investment plans dropped in December, a possible sign companies were losing confidence in the economy’s strength due to fears over tighter fiscal policy, government data showed on Monday.

The data from the Commerce Department also gave some positive signals, with a big jump in defense industry orders suggesting some of the surprise fall in U.S. economic output late last year was poised to reverse.

Many economists have expected businesses to invest more timidly because of uncertainty over government spending cuts and tax increases, which had been scheduled to kick in last month. Congress ultimately struck a last-minute deal to avoid or postpone many of the austerity measures.

Signs of any blow to confidence have been difficult to discern from economic data, but Monday’s data provided a hint of weakness in December.

The government issued a revised estimate for capital goods orders outside of the defense and aircraft industries, showing they edged 0.3 percent lower in December.

Gauge of investment plans flat, orders for durables up

WASHINGTON, Thu Oct 25, 2012 – A gauge of planned business spending was flat in September, a sign that heightened uncertainty is weighing on factories although new orders for long-lasting manufactured goods increased during the month.

The Commerce Department said on Thursday that non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending plans, was unchanged last month at $60.3 billion. That was short of economists’ expectations for a 0.7 percent gain.

Many economists believe companies are holding back investments due to fears the U.S. Congress could fail to avert sharp tax hikes and spending cuts in 2013, which threaten to send the U.S. economy back into recession.

The reading on investment plans was part of a larger report on long-lasting factory goods, which showed new durable goods orders posting their biggest gain last month since January 2010.

New orders for durables rose 9.9 percent, partially reversing a sharp loss in August. Wild fluctuations in aircraft orders have generated much of the volatility.

Economists polled by Reuters had expected orders for durable goods – items from toasters to aircraft that are meant to last at least three years – to rise 7.1 percent.

Boeing received 143 orders in September, up from just one in August, according to information posted on the plane maker’s website.

Fundamentals falter … But fears fade

Bob Leggett, CFA, Senior Investment Strategist, FirstMerit Wealth Management Services

Every quarter, FirstMerit sends a newsletter to all its wealth management clients. In the Fall 2012 edition, Bob Leggett, CFA, Senior Investment Strategist, FirstMerit Wealth Management Services, discusses the year-long battle between fears and fundamentals.

Here’s an excerpt from the newsletter:

For the past year, we have been harping on the need to downplay fears and focus on fundamentals. Our point was that fundamentals were at least okay and might actually surprise the consensus to the upside. The fears were not unreasonable, but appeared to us to have low probabilities of occurring within our tactical time horizon. Thus, a total focus on the downside risks of fearsome outcomes (such as a U.S. recession, the Fiscal Cliff, the European crisis, or a China hard landing) could — and did — cause many investors to miss the opportunity to participate in a bull market.

Market returns were very good through Q3 and the S&P 500 led the way with a 16.4 percent total return. Midsized and smaller stocks were up about 14 percent and despite U.S. Dollar strength and European leadership’s determination to shoot themselves in the foot, EAFE was +10 percent and Emerging Markets +12 percent. Fixed Income returns weren’t bad either (although Treasury returns were only low single-digits), as “spread product” such as Corporates (+7.1 percent) and High Yield (+12.1 percent) continued to do well. Somewhat ominously, TIPS did much better than non-inflation protected Treasuries.

Read the entire newsletter here: 10629_Fall2012_MM_r4

Bob Leggett, CFA, is the Senior Investment Strategist at FirstMerit Wealth Management Services. Reach him at [email protected] or follow him on Twitter @firstmerit_mkt.