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Watching Shark Tank, how does equity differ from royalty?
Ok, I know royalty means a person gets a percentage of a sale forever. However, how would that be different than owning equity? After all, how value is the company if all the profits come from sales?
For example : inventions such as coffee Joulies, Teddy Needs a Bath, Classroom Jams..etc, are examples of investors offering to invest in exchange for royalty in perpetuity, instead of taking equity.
If the company only makes money by sales (whether retail or wholesale), what else is the equity worth if it's not ultimately in a form of royalty or profit split?
Why would a person choose 5% royalty (no matter how long) when he can 40% equity? How else is 40% equity evaluated if it's not based on sales? If it's based on sales, isn't 40% equity essentially letting the person collect 40% royalty on every sale?
If I was giving away 5% royalty on all sales forever, can't it be represented as "5% equity"?
3 Answers
- ?Lv 78 years agoFavorite Answer
Equity is ownership of a corporation. Royalty is ownership of a product, design or service.
- xcnicoLv 48 years ago
The basic answers is risk vs. reward.
If you think about most of the times that they choose a royalty is because they are not as confident in the person's invention. They choose royalties because there is less risk involved. For an example: If the company doesn't do well they will still receive a check... it will just be smaller. On the other hand, let's say the company has a valuable intangible asset.
Knowledge, or a patent. Over time this intangible asset would be worth tons! If you sold your portion of equity, it would include a portion of this intangible asset!
Let's say that someone invest 100K into a company for 40% equity.
1. Their investment is less liquid. They don't get a check every month. If they want to take out their investment they need to sell it back to the company or sell it to another investment.
2. With Equity, you on a portion of the company. So, you also share a portion of the company's assets, liabilities, profits....etc.
3. What happens if that company does poorly. The company is valuated and now the company is actually worth less than when it started. Do I pull the money out now and cut my losses? Or do, I put in my hard time and work to try and keep the company afloat?
4. A lot of times, the sharks are purely just lazy. If they own a portion of equity they are going to check up with the owner/inventor. If they collect a royalty, they could care less. They know that the they are going to receive a check each month.
Basic simple answer is the more risk = the potential for more reward.
Source(s): Finance Graduate and Shark tank enthusiast