Equity vs Royalty: What Are the Main Differences?

Equity and royalty are both common ways to benefit from a company’s success, but there are significant differences between equity vs royalty.

Royalty represents payments made by the company to use certain intangible assets that are owned by other individuals or corporations. 

While equity represents ownership of the company. Investors are rewarded as owners of a part of a company, which means they will share the company profits by receiving dividends.

In this article, we will look at some of the key differences between equity and royalty

What is equity?

In the business world, equity is a term used to describe the value of a company's ownership stake. Equity can be represented in a number of ways, including shares of stock, warrants, and options. 

When a company goes public, it sells equity to investors in order to raise money to grow the business. 

Equity is the value of a company's assets minus its liabilities. Equity represents the owners' residual interest in a company's assets after liabilities are paid. 

It is calculated by subtracting total liabilities from total assets. Equity can be increased through the issuance of new shares or decreased through the repurchase or redemption of shares. 

What is royalty?

In the simplest terms, royalty refers to payments made to people who own a piece of intellectual property. 

This can include anything from a patent on a new invention to the rights to a song or book. 

In most cases, the person or company who licenses the property pays a royalty fee to the owner in exchange for using it. 

The amount of this fee can vary depending on the type of property and how it's being used.

Royalty deals are common when it comes to patents, copyrighted intellectual property, and franchises.

Main differences between equity and royalty

The main differences between equity and royalty are the following:

• Ownership
• Returns
• Types
• Risks
• Transactions

Ownership

If you own equity in a company you essentially own a part of the business. In order to receive a royalty you own a certain patent or have rights to intellectual property. This is a clear difference between equity vs royalties. 

While owning equity has several advantages because you essentially own part of the company, it also has its disadvantages if the company goes under.

On the other royalties usually do not come with any ownership of the business. 

Returns

In a similar way, if you own certain intangible assets, that allow you to receive royalties, you are less exposed to what happens to the company. This means your risk level will be lower, but your potential returns will most likely also be lower.

While royalties are usually the only way to receive compensation for the ownership of intellectual property or intangible assets, if you own equity in a business there are multiple ways to generate returns. You can either receive dividends, special dividends, buybacks, or capital gains.

Royalties also tend to be a fixed percentage of sales, while the returns generated through equity investment can vary depending on the profitability of the company.

Types

There are several types of equity investments, and this can limit your voting rights for example. While most royalties tend to have a similar structure, equity investments tend to be more complex and offer different advantages and disadvantages.

Risks

Overall equity comes with a lot more risk since you have you own part of a company that has several factors that can impact its long-term success. Owning intangible assets tends to offer less risk since the royalty payments you will receive are not directly dependent on how the company performs financially.

Transactions

Lastly, equity tends to be easier to transact. In case you want to dispose of equity investment, it is fairly easy to sell it to other investors. Even if it is not a public company, an equity investment is easier to value and determine a price.

While intangible assets can be difficult not only to value but also to transact. This lower liquidity is directly translated into the price and the value of intangible assets, and equity.

Advantages and disadvantages of equity

Equity ownership means that you own part of the company. This has both advantages and disadvantages since if the company is profitable you will share those profits. 

On the other hand, if the company is unprofitable, your investment might not be valued in the same way.

Here are some of the main advantages of equity:

• Part-ownership in the company
• Voting rights and the ability to influence the company’s future
• Easier to sell or transact than royalties
• Easier to value than royalties
• It can generate higher returns

Some of the main disadvantages of equity include:

• Your equity in the company might be diluted
• The company might lose money
• The company might go bankrupt, and you can lose your investment
• Returns may vary depending on the profit of the company

Advantages and disadvantages of royalty

Here are some of the main advantages of royalties:

• Payments are made regularly despite the financial performance of the company
• If the company goes bankrupt it does not affect royalty holders
• Royalty tends to be fixed depending on the contractual agreement

Some of the main disadvantages of royalties include:

• Difficult to value and transact
• Lower possible returns
• No influence on how the company is managed
• No ownership of the company

Equity vs royalty: FAQ

What is the difference between royalty and profit?

One difference between royalties and profits is that royalties are typically a fixed percentage of sales, while profits can vary depending on a company's expenses and revenue. For example, if a company pays its workers a salary, their wages would be deducted from profits, but not from royalties. 

Royalties are also typically paid on an annual or quarterly basis, while profits may be distributed less frequently. Finally, profits are taxable income, while royalties are not.

Royalty payments are typically made to the copyright holder (or patent holder) of a work, whereas profit is the amount of money that remains after all expenses have been paid. 

The main difference between the two is that royalty payments are fixed, while profit can vary greatly depending on a company's success. For example, a company might make $10 million in profit one year and only $1 million the next year.

What is the difference between a dividend and a royalty?

A dividend is a payment, usually in cash, that a company pays to its shareholders out of its profits. 

A royalty is a payment that a company pays to an owner of a patent or other intellectual property for the right to use that property.

Conclusion

While there may be some similarities between royalties and equity, the differences are clear. One is part ownership in a company which benefits investors depending on the financial performance of the business. 

While royalties are a fixed payment for the ability to use intellectual property.