Royalty-Based Financing: Long-Term Royalty Deals Versus Selling Equity

In a royalty deal an investor pays cash now and receives a percentage of the revenue from a defined source for a long period. The source can be a single product, a catalog, or the whole company. The company keeps its shares. What it gives up is a slice of revenue, sometimes with an end date and sometimes without one.

Short, capped deals that behave like loans are covered in our guide to revenue-based financing, which shows how the effective APR moves with growth. This guide is about the longer versions: tiered royalties tied to one drug, catalogs of music rights, perpetual royalties with a buyout, and how any of them compare with selling shares when the company exits. Loans for companies with venture backing are in venture debt for startups.

Three ways to build the deal

The choice sets who carries which risk. A cap limits the investor's upside and gives the company a known maximum cost. A tiered term with no cap leaves the investor with the upside if the product sells far more than expected, and the rate steps down so the company keeps most of that growth. A perpetual royalty leaves the upside with the investor for as long as the business exists, which is why the buyout formula is the most negotiated clause.

Life sciences: the Revolution Medicines deal

The clearest public example is the funding agreement between Revolution Medicines and Royalty Pharma announced in June 2025. Per Revolution Medicines' announcement, the agreement provides $2 billion in committed capital: up to $1.25 billion of synthetic royalty funding and a term loan for the remainder. Of the total, $1.25 billion is optional for the company, released as it hits milestones. The royalty covers worldwide annual net sales of the cancer drug daraxonrasib for 15 years. It is split into five tranches of $250 million, and the rate steps down as sales rise, reaching zero above $8 billion a year.

After the second tranche was funded in 2026, Royalty Pharma's entitlement, per its SEC filing, became 4.55% on annual sales up to $2 billion, 2.50% on sales from $2 billion to $4 billion, and 1.00% on sales from $4 billion to $8 billion. If the company draws all remaining tranches, the rates rise to 7.80%, 4.55%, and 2.40% on the same bands.

Illustration: applying those published tiers, the royalty for the first two tranches is $46 million at $1 billion of annual sales, $91 million at $2 billion, $141 million at $4 billion, and $181 million at $8 billion or more. The blended rate falls from 4.55% to 3.53% to 2.26% across those levels. With all five tranches drawn, the royalty at $8 billion is $343 million, a 4.29% blend. The company pays little if the drug is a modest seller and a shrinking share of a very large number if it is a blockbuster, and its bill is bounded by the 15-year term.

The buyer of these royalties is a specialist that treats them as investments. Royalty Pharma's second-quarter 2026 report shows the scale: $349 million of capital deployed in the quarter and over $1 billion for the year to date, mostly for daraxonrasib royalty funding and R&D funding for other programs. It also bought part of Neurimmune's royalty interest in AstraZeneca's cliramitug in July 2026 for up to $425 million, including $125 million upfront. The diligence in these deals is about the asset: its clinical data, patents, and the sales forecast.

A sales-based royalty like this only suits assets big enough to attract that kind of buyer. For an early-stage software company, the equivalent choice is between a short capped deal and equity.

Music and other rights

Royalty streams from songs are also traded as financial assets. In July 2024 Blackstone completed its acquisition of the London-listed Hipgnosis Songs Fund, a vehicle that held music catalogs, after it had launched a $1 billion partnership with Hipgnosis' management in 2021, as Billboard reported. For an artist or a small label, the equivalent deal is the sale or pledge of a share of future royalties for cash. The same questions apply as in any royalty deal: how the royalty base is defined, how long it lasts, and whether the seller can buy it back.

Franchise royalties are a different thing

A franchisee's royalty is a fee for using the brand and system, usually a percentage of sales, not financing. The FTC's consumer guide says franchisees may owe royalties based on gross income and typically must pay them "even if you are losing money". Under the FTC Franchise Rule (16 CFR Part 436), recurring fees appear in Item 6 of the franchise disclosure document, but there is no federal cap on the rate, since the rule governs disclosure, not price. The point for a financing comparison is that a royalty on sales comes off the top before rent, labor, and debt service. That is the same structural feature that makes any revenue-based payment heavier for thin-margin businesses, and it is why the definition of "gross sales" in the contract matters as much as the percentage.

Royalty cost against equity dilution at an exit

Royalty deals are often sold as equity protection. The comparison below shows when that holds.

Illustration: a company raises $5 million. It has $8 million of revenue in its first year after funding and is sold at the end of year 6 for a multiple of its year-6 revenue. Three ways to raise the money, all with terms we assumed for the exercise:

• Capped royalty: 6% of revenue until $10 million (2.0x) has been paid, with any unpaid balance due when the company is sold.
• Perpetual royalty: 2% of revenue with no cap, which the company can buy out at the sale for 3.0x the amount invested ($15 million) on top of royalties already paid.
• Equity: 20% of the company for $5 million.

If revenue grows 30% a year, revenue reaches $29.7 million in year 6:

Equity costs the owners less than the capped royalty when the sale price is under $50 million ($10 million divided by 20%), and more above it. The perpetual royalty with a $15 million buyout beats equity only above about $85 million. The cap made the cost of the royalty independent of how well the company did, and for the investor a fixed 15.8% instead of a return that varies from 10% to 35%.

The result flips in a weak outcome. If revenue stays flat at $8 million for six years and the company sells for 1.5 times revenue, or $12 million:

Here the capped royalty takes 83% of the sale price, while equity takes 20%. Equity's cost shrinks when the company does badly; a royalty's does not, which is why it is "protection" only for the owners of a company that succeeds. The same table for 15% annual growth puts the sale price at which the royalty and equity cost the same at $50 million for the capped royalty and $82 million for the perpetual one. The break-even for the capped deal is fixed by the cap and the equity percentage, and only the perpetual deal moves with growth because its cost includes the royalties paid.

We chose these terms; they are not market quotes. Two features do the work in any real deal: whether a change of control accelerates the cap, and how the buyout is priced. Read both before any percentage.

How the deals are accounted for

A royalty investment can show up on the company's balance sheet as debt, even without a loan. US GAAP addresses sales of future revenue in ASC 470-10-25, and Deloitte's roadmap describes the test. If a company receives cash and agrees to pay a specified percentage of revenue from a product line, segment, or patent for a defined period, it decides whether the proceeds are debt or deferred income. Any one of six factors creates a rebuttable presumption of debt:

• The deal is not a sale in form.
• The company keeps significant continuing involvement in generating the revenue.
• Either side can cancel with a lump-sum payment.
• The investor's return is limited, explicitly or implicitly.
• Revenue changes have only a trifling effect on the investor's return.
• The investor has recourse to the company for the payments.

A capped deal meets the fourth factor on its face, so it is likely to be classified as debt, and the interest method then applies. A company that keeps selling the product will also meet the second. That can affect covenant ratios in other loans, so tell your accountant before signing. Tax treatment is a separate question; the same transaction can be debt for GAAP and something else for tax.

What to negotiate

• The revenue definition. Gross sales, net sales, and cash received are three different numbers, and refunds, taxes, and channel fees may or may not be deducted.
• Step-downs and cutoffs, as in the tiered example above, and whether the rate rises if sales fall short of an agreed level.
• Change of control. Does the royalty go away, transfer to the buyer, or accelerate to the cap? This decides your exit cost.
• The buyout price and when you can exercise it, stated as a formula you can compute in advance.
• Assignment. The investor may be able to sell the royalty to another party, and you may not be able to choose who.
• Restrictions on selling or licensing the product, entering new lines, or taking other revenue-based financing.
• Audit rights and reporting frequency.

When it fits and when it does not

A royalty deal fits when revenue comes from an identifiable asset that a specialist can value, when the company would prefer to sell a slice of revenue rather than shares, and when the founders expect the company to be worth much more than the price of the round. It fits poorly when margins are thin, when the outcome is likely to be a modest sale, or when a later equity investor would balk at a claim on revenue with no end date. It is also a poor match if you plan to raise other capital soon, because an existing royalty holder can complicate diligence for a lender or a buyer.

This article is educational and does not replace advice from a lawyer, accountant, or tax professional who has read the actual agreement.