Being a Shark Tank US Fan, whenever I hear the word Royalty, I always think of Mr. Wonderful (in the image below) and his Sharky Royalty Deals which he is widely known for.
Look at the smile on his face when someone offers him Royalty! Surely he must be making a good amount of money on his existing royalty deals. Tyke Invest which is widely popular for its CSOP Instruments (about which we have written here) in India has also brought these Royalty Deals which are currently in its beta offering to investors and attracting users with >20% XIRR deals, sometimes even showing range from 0% - 651% XIRR as your max gain.
Looking at a 3-digit XIRR number being marketed to attract investors like me, I thought I would become a Mr. Wonderful in my own right out of India until I looked into the deal specifics/terms and conditions and ran the numbers on an Excel spreadsheet. Let's get into the pros and cons of this product in this article so you can make that decision for yourself as well.
Also, if you prefer watching a video on this topic rather than reading a blog, here is our Youtube video discussing the deal.
What is a Royalty Deal?
There is a genuine reason why sharks like Mr. Wonderful love Royalty Deals, primarily due to the following:
It gives them a piece of the Net Revenue which the company can realize as Cost of Goods Sold in their books.
Royalty deals are paid first, ahead of debt and equity holders. As soon as a company makes a sale, you make money.
These deals are generally for perpetuity (for life) or until the initial investments are recouped making it safer for your investment.
The investor has a growing incentive to help the startup grow in terms of revenue over time.
Here is how Tyke founder Karan Mehra explains it:
According to Tyke, the benefits are the following:
Stable Predefined % Revenue Indefinitely of the company based on your initial investment amount. As the company grows, your payout grows as well.
The product is asset-backed, so the principal (initial investment) is safe at all times.
Special discounts for investors to companies products, special access to company events and exclusive discussions with the founders.
Ability to sell subscription after a 3-month lock-in period on Tyke Square if anyone else is up for buying it.
A full refund guarantee (excluding initial charges) if the company goes bust or decides to end the agreement after 12 months.
Let's Look at a Sample Deal
As of 13th October 2023, Tyke is running a Royalty Deal on Attitudist which is available on this campaign page. To view this page, you need to have a Tyke account. Below is what the deal page looks like and I have highlighted the key figures.
As per Tyke's deal page, Royalty is a contractual agreement executed between a subscriber and the startup that entitles the subscriber to community benefits and a grant of SAR in exchange (We have explained SAR in detail here)
The minimum subscription amount to the deal is ₹10,000 and only if the startup can grow its revenue by 8% MoM (Month on Month), you can expect an XIRR of 28.91%. Just to put it in absolute terms, that means doing roughly 2.5X of your current revenue by next year. If the startup's revenue is not able to grow at this rate, your XIRR can be much lower.
Tyke doesn't show an expected payment schedule with its calculation nor an option to play around with the MoM growth rate to check variations in XIRR which might have been very handy for investors (but they are in BETA so maybe they will add) however we have shared an Excel spreadsheet below.
Below are some other documents present on the deal page, please click on them to go to the document:
As per the Deal Highlights, the company is raising ₹50,00,000 for which they will give 0.29% of their monthly revenue to Tyke subscribers. The company has a Lockin for 12 months and they cannot prepay this principal before that. Once the lock-in is over the company is free to return the capital. A similar option however doesn't exist for the investor. Once they invest, they cannot exit voluntary, Tyke says they will bring Royalty Deals on Tyke Square (their internal exchange) where investors can choose to sell it to another buyer after 3 months of lock-in but given this investment product is in Beta, it's not going to happen anytime soon and even then you have to find a buyer willing to accept the royalty agreement.
Tyke will also charge you 3% fees + 18% GST on those fees as upfront cost as per below.
Problems with this Deal
Well, to be honest, having a first look at this the deal looks solid on paper, high XIRR, small ticket size, and new asset class exposure so why not invest?
Let's start with the elephant in the room, can you really get that kind of XIRR? Well, it all depends on what month-on-month growth rate you have assumed. Below is a simulation of different growth rates. You can download this Excel spreadsheet here and play around with numbers if you want. It also has a 2-year deal assumption schedule.
The above assumes that the deal will be bought back in one year (from the start of the first payment) because if the company keeps on growing that much in revenue, it will be beneficial for them to buy back the existing contract and re-negotiate terms with Tyke to offer lower revenue. Even if Tyke in the above video claims Royalty deals are indefinite, they are most likely not. They will only be indefinite when the company is actually losing revenue and doesn't want to buy back its contract as it has access to lower-cost capital.
Their agreement is extremely vague and very difficult to exercise in legal court if things go wrong. Some fundamental issues I have are:
On the deal page, Tyke mentions the grant of SAR (Security Appreciation Rights) which is done in CSOPs as well, but none of it is mentioned anywhere in the agreement.
You are again not buying any security here, in other Revenue Based Financing deals, you generally get a debenture, here in this deal, it's a referral agreement where the investor is supposed to provide a referral of potential customers or clients to the company. Wait what? Do I really have to do that to get my payouts?
This is purely in the unregulated category of investment and as an investor, you won't have much rights if things go wrong.
This agreement is not on a stamp paper which is always preferred to stay on the safer side of the law.
Although Tyke is charging us a 2% fee as a money-back guarantee, nowhere in the agreement it's mentioned what will Tyke's responsibilities be in terms of the company going bust. There is not even a definition of what going bust would mean.
There is no mention of how Tyke will resolve disputes if the company fails to pay back a defined % of the revenues to the investor. Tyke has not even mentioned how are they securing the assets for which they are charging a decent fee.
There is no defined timeline for an exit for you as an investor but that option exists for the company again proving the deal benefits the company more than you. As I mentioned above, if the company performs poorly, it will hold onto your capital for a long time and not show they are going bust on paper. So you don't know when will you see your principal amount back.
Tyke in their video mentions that their investors will receive special discounts from the company they subscribe to, do founder meet sessions, etc but this is again nowhere mentioned in the agreement and talking to existing Royalty deal subscribers within our community, I understand this has not yet happened.
Risks with this Product
Although Tyke claims on their deal page that there is no "almost no risk" involved in this deal, we think it's a gross misrepresentation of some actual risks.
Some of the risks are (and sorry for being repetitive but they are important):
It's an unregulated referral contract where as per the contract you are supposed to get business to the company, if you don't it can be challenged that they don't owe you any royalty.
You don't know the timeline of when you will get your money back, this creates duration risk in your overall portfolio.
The legal agreement is very loosely worded in terms of what happens when actual default happens and what rights you will have.
RoC (Registrar of Companies) might consider this again as a security being offered to more than 200 people given Tyke is treating this as a SAR. The same has happened with CSOPs in the Sustvest case. You can access this case here.
Again, we emphasize this in every article we write: please don't blindly trust platforms when they promote high XIRR figures and encourage you to invest in those deals. Make sure to understand the agreements, focus on determining what rights you have when things go wrong, and investigate whether those high XIRR numbers will actually translate into benefits for you, given the risks you will be taking.
In my opinion, I wouldn't invest in the current royalty structure due to the risks I've highlighted. Personally, I prefer having certainty in my cash flow and considering the vagueness of the agreement, I would steer clear of it.
Other platforms in this space, such as Klub actually issue debentures with fixed coupons, as well as a share of the startup's revenue. You can access one of their sample deal documents here to compare it with Tyke's. They also have a SEBI-approved trustee in this model and have proper escrow accounts in place. Although the investment size may be slightly larger, it's a safer option than this model, and I would choose to invest my money there if necessary.
Anyway, Thank you so much for reading this article, again to clarify, no personal vendetta against Tyke or its founders, our job is to highlight the risks appropriately in the deals and let you make your own decision. In any case, we hope your money grows in alternative space!
If you have any questions on this article or any other articles on the blog, you can drop me a note at email@example.com or join our Whatsapp community here where you can ask all questions to community members.
Please note that this is an opinion blog and not official research advice. I am not a registered RIA in India, and none of these views reflect those of my current employer. This blog aims to promote informed decision-making and does not discourage you from investing in any deals.
We plan to come up with more blogs discussing different types of instruments available in the world of startup investing, write on due diligence for some platforms, and also existing and upcoming alt investment deals in the Indian market. If you want to stay updated on the latest blogs, please subscribe to our newsletter so you get notified automatically.
Thank you for reading and hope to see you in the next one!