Royalties — Why China

Why China is the most logical place
for the first International Royalties Exchange

China plays a key role in the future for everyone. It is the largest country, making the most rapid and significant social and financial progress.

The Chinese have a tradition of entrepreneurship, reflected in the rate of new business formation. This has been true, both in China and wherever there is an overseas Chinese population. So the need for financing of emerging businesses in China is intense, and that need is not being fully met by traditional equity and debt markets.

There are many reasons why China is a good site for a new financial exchange, focused on royalty investment.

Chopsticks-Geometry-webWe have identified five principles on which the Exchange would be founded:

1. There is a very high family savings rate in China, and the commercial banks, in which most of the savings are deposited, pay a very low rate of interest. Official economic policy in China encourages the people to invest and spend their savings, so considerable domestic investment resources are available, for the right opportunities. The Royalty Exchange will help deploy those resources productively into the economy, creating new jobs and rapid business expansion.

2. In China, companies in the early entrepreneurial stage and even established privately owned companies have difficulty borrowing funds needed to fuel their growth. A private market for loans exists, but interest rates are unreasonably high, and economic growth is therefore slowed. Royalties are not subject to these limitations.

3. Many owners of China’s growing businesses do not wish to share ownership of their businesses, at least not until they reach the size and maturity where they can be responsibly presented to public investors through an initial public offering on one of the stock exchanges. Royalties present an attractive alternative to selling debt or shares in the private market.

4. An increase in properly qualified international investment in Chinese companies is a high priority of policy of the central government. However, there is an ever-present concern about the loss of control of the companies that offer shares to foreign investors. With royalty financing there is no equity transfer, so there is no loss of control.

5. With many areas of rapid growth and differing systems of accounting and business practice, investors are concerned about the accuracy of reported earnings for many companies. Under the royalty finance program, earnings are not reported — only gross revenues. Royalty payments are drawn for the investor immediately, as revenues are generated, so the flow of investor return is direct and transparent. The task of government regulation is greatly simplified, since the royalty owner is not directly concerned with the reported profitability of the royalty issuer. He wants to immediately and accurately know the company’s revenues, which he hopes will increase over time. This information can be efficiently delivered and monitored by the appropriately chartered and regulated Royalty Exchange.

Royalties — specifically, an agreed share of the issuer’s revenues, for an agree period of time, for an agreed amount of investment, successfully answer the principles identified.

The Need for an International Royalty Exchange

Royalty investors currently require a higher percentage of a company’s revenues than would be required were the royalties to be liquid, and traded on a public exchange.

If the percentage of revenues needed to attract investors were lower, then more companies would use royalties as a means of financing. More investors would be able to invest in growing companies, using royalties — a more straightforward, conservative method.

Globe-sphere-waterdrop-webStrategic Considerations for China

The opportunity for China is to become the primary source of royalty funding worldwide, both from Chinese investors and as a facilitator of investment by international investors. This would be achieved by opening the China Royalty Exchange to international issuers. It is perfectly reasonable to believe that an international royalties exchange located in China may one day become the world’s largest financial exchange, since there are so many more privately owned companies than publicly traded companies.

Other nations and their financial exchanges will carefully observe what China does as an innovator in this new area. When they see a large opportunity to which China is committed, they may act to develop their own royalty exchanges or collaborate with China.

If China has already announced and implemented a broad international strategy, these international players may be more likely to join in support, than to seek to compete. Therefore, to demonstrate leadership, it is advisable for China to move quickly and comprehensively with its commitment to a Royalty Exchange.

It is our vision and wish: that China will become the place where the world’s private businesses are financed. This will produce social and economic benefit for all concerned.

Arthur Lipper, Chairman
British Far East Holdings Ltd.
February 18, 2013

Michael North
America-China Bridge