TDD FYI: Equity vs. Royalty: What’s the Difference? - 07 / 7 / 15

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Having another company offer financial support for your own is a double-edged sword that all entrepreneurs should pay for. On one hand, it’s great to know that someone sees enough potential in your business to want to take it to the next level. On the other hand, it can be a struggle to determine just how much to give, while also maintaining control over the company you’ve worked so hard to build.

In the event that a potential investor is interested in your business, they may offer financial support in return for equity stakes or a returned royalty. Both of these forms of repayment offer varying considerations that need to be made before agreeing to terms. If an entrepreneur fails to do such, they may end up with unfavorable conditions while working on something that was once considered solely theirs.

In order to determine which is best for you, here is a look at equity vs. royalty and an explanation of what the difference is.

Equity – A Set Deal

Equity is commonly a set deal that offers financial support in exchange for a stake or percentage in the company. For example, an investor may offer $25,000 in exchange for a percentage of the company based on an evaluation that they consider being fair. It’s up to the entrepreneur to determine whether or not they value the company at the same rate, or if they are willing to give up a percentage of their company for financial support.

equity-trading-250x250As the business grows, that stake that the investor has can be very important. That can lead to more control over decisions, as well as a larger repayment in the event that the company explodes and becomes very popular.

It’s important to note that giving up equity in exchange for financial support is something that many entrepreneurs must do if they want their idea to succeed. While it may be difficult to consider giving up part of a company, it’s often the only option that will help avoid failure.

Royalty – A Proportionate Repayment

With a royalty, there is also an investor who will offer financial support to the company. However, what changes is that the return for the investment comes in the form of a percentage based off sales. For example, an investor may offer $25,000 in exchange for a percentage of all sales moving forward. That percentage does not have to be tied to any control over the company, but instead just acts as a financial return on an investment.

A royalty gets tricky because it can be ideal for small business’ that do not have a lot of sales. However, if you end up agreeing to a royalty payment and then your product explodes, the returned profits can quickly become disproportionate in relation to the initial $25,000 investment. To avoid this, companies should consider multiple tiers and other levels of payouts, in the event that a royalty payment is the decided upon option.

What’s Best For Your Business?investment

Now that you know the difference between equity and royalty, the question remains as to which is best for your business. While this will depend greatly on your own circumstances, consider the information presented here when determining which option will provide you with the best chances for success moving forward with your company and your dreams.