While it certainly has its flaws, Shark Tank is a favorite background tv show of mine. Kevin O’Leary frequently offers royalty deals with an equity kicker and claims his deal is better because he takes less equity than the other investors. For example, he will offer a 10% royalty that drops down to 5% (based on revenue) after a certain benchmark has been met, and ask for 3% equity ontop. The competing “shark” will offer just a simply 20% equity offer.
Ignoring the issues it poses in terms of growth, my concern is that yes you don’t have to give up equity, but you are giving up value. Say 20 years down the line, you can either pay out 20% of profits to your investor or 5% of revenue. Chances are (especially for retail companies that show up on Shark Tank) the first one is far more sustainable. Walmart, which is an extreme example of a super stable company in retail with probably lower margins than most, only has a FCF margin of roughly 3.3%. Mathematically, this is the max royalty they can support and even be a viable business. However, that leaves zero payout for the equity holders of Walmart.
This is my point. The value of Walmart to the equity holders is zero, because the present value of future free cash flows is 0. Even if they own 97% of the equity, they get no dividends. In the simple equity offer, they get 80% of their FCF in a given year. That is a much better deal.
My TLDR is a royalty deal is not just a problem because it restricts growth, it actually can steal more value than equity. The math does not lie.