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Royalty in Perpetuity stands for R.I.P.

royalty in perpetuity

This guest post was written by Julie Busha, Food Marketing Pro extraordinaire at Nicole Foods, the makers of America’s hottest new condiment: Slawsa. If you are an entrepreneur with a food product you want to market, take my advice: look at what Julie has done with Slawsa in only one year with a limited marketing budget, and do what she did! Julie appeared in Shark Tank episode 510 in Season 5. She didn’t get a deal, but she is a HUGE Shark Tank Success Story!

As someone who has stepped into the Shark Tank, I cringe at the thought of any business owner accepting a royalty in perpetuity offer from an investor, particularly if they have launched a CPG.

To back up, let me explain what CPG stands for: Consumer Packaged Good.  Any item that could be purchased on a consistent basis or used daily would be considered a consumer packaged good.  My brand, Slawsa, is in the grocery industry and just about everything you’d find in a grocery store would be considered a CPG.

Alternatively, an automobile or piece of luggage would not be a CPG.  Our goal is not to sell our products a few times in a consumer’s lifetime, but often (referred to as household turn).  On the positive note, our products are more recession-proof.  On the negative note, because our industry is highly competitive since we work off higher volumes, we also work off lower margins.  Remember that.

 Slawsa Didn’t Want a Royalty in Perpetuity Offer

While it did not make the edit, I very clearly stated during my time with the Sharks that “I would never consider a royalty in perpetuity” offer.  At that point, I knew I probably lost Mr. Wonderful … and while I would have loved to have had his business savvy on my side, I know my first obligation is to serve in the best interest of my brand to give my business the best possible opportunity for success.

Even though mine are stronger, the average gross margin for grocery is around 35% (and it varies slightly based on perishability, placement, space requirements, etc).  Given that the grocery industry works off lower gross margins, think about what a per unit or gross sales royalty in perpetuity would potentially do to the bottom line … it could potentially wipe out a substantial portion of the net profits.

CPG Margins

CPG’s offer variable pricing depending if they’re working directly with the retailer (which yield the highest margins), through a wholesale distributor or possibly through a specialty distributor (which yield the lowest margins). What happens if your CPG is more reliant on distributors?  We are fortunate that 70% of our sales are through direct relationships with our retail partners.  Distributors are always needed, as many of the smaller chains cannot support the quantities you may need to ship minimum volumes, and many start-up food companies almost exclusively work through distributors.

It’s also likely that if they are in the gourmet space, they’re working with “specialty” food distributors (which take the highest margins) versus wholesale distributors.  Remember, every piece of the pie that you’re either paying out or subsequently having to reduce your margins so your end cost to the consumer is not overpriced, means your net gets smaller and smaller.  A royalty in perpetuity offer on a high volume, low margin product doesn’t sound as good, anymore, does it?

Major corporations will spend millions of dollars in marketing to launch a new brand.  Small businesses like mine, particularly in the CPG grocery industry, have to invest a significant amount of marketing dollars to grow trial and gain those loyal consumers.  A commitment to marketing is the number one selling point a buyer will consider when adding new products.  As you heard when I pitched, I sacrificed any personal compensation so I could purposefully reinvest those profits right back into marketing and am willing to do that for years to come. Yes, years to come.

Long Term Effects = R.I.P.

People don’t seem to grasp the concept of how important it is for my industry specifically.  I liken the approach to someone funding their retirement.  If they can max out when they are 20 years old versus waiting until they are 30 to begin retirement savings (even though their salary is likely higher 10 years later), getting that jump-start will make a bigger difference down the road.  An investment in marketing is how you grow a CPG brand, and it’s how Slawsa had placement in over 5,000 retail stores by our air date … about two years after our launch.

Now, what would paying someone a royalty in perpetuity do with those marketing dollars intended to promote and grow the brand in the hearts of the consumers?  It would drastically slow growth at the same time as open the barrier of entry for other competitors in your space.  I hold a great deal of respect for the few Sharks who have never made a royalty in perpetuity offer in the CPG space because they understand how counterproductive taking money away from marketing is for the growth, or in some cases survival, of these companies.

Know what perpetuity means: FOREVER … yup, and not just for your lifetime or your investor’s lifetime but into eternity.  One thing I never want to do with my business is to close the door on an opportunity before it has a chance to present itself … it’s why I entered the Tank with an open mind about all of the Sharks.

The reality is, no one can predict the future.  You don’t know if there is a possibility of a larger company looking to acquire your brand at some point in the future, so consider this scenario:  You’ve been convinced to give up a royalty of 5% in perpetuity, but you retain 100% equity.  The investor would tell you what a generous deal it is because you retain 100% equity.

It doesn’t matter if the royalty was 5% gross sales or 5% net sales. With either scenario, it’s likely that the acquiring company doesn’t want to have to pay those royalties out in perpetuity to your investor partner.  It either turns them off altogether or the acquiring company will likely have to pay out more, yes I said more, to buy your investor out of his/her perpetuity clause than they would have to pay you out for your 100% equity ownership.  Does that seem fair?  You’ve paid your investor throughout your relationship and now he/she can come out better than you when you decide to sell?  Rest in peace my friend, rest in peace.

There are very few scenarios where anyone should give up to a royalty in perpetuity, and in my opinion, it should never be done with a CPG grocery item.  If you are in a different industry and your investor can bring something of significant value beyond the investment to the table (perhaps something that only he/she can do) and there’s no possibility of your company being sold to a larger entity, it might be considered if you run the numbers and it makes fiscal sense.  However, if you have a CPG brand and accept a RIP offer, I’ll lend you a shovel.  You’re likely going to need it.

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