Let’s start with the familiar case first. With equity funding, the investor is buying shares of stock, options, warrants or something equivalent. They have ownership in the company or the ability to gain ownership of the company in the future. The amount of ownership is based on the company valuation and amount of money being invested.

The investor can make money in two ways: loan repayment or selling stock. It might be another investor, an acquisition or an IPO. The difficult part – especially for new companies or startups – is determining a fair valuation and how much equity the investment is worth.

In royalty financing, the investor is buying a percentage of future sales. It’s basically an advance or loan to the company. Traditionally this type of finance has been common to investors in the mining and energy sectors, but it’s becoming more common for technology companies as well.

According to financial writer David Evanson, this type of financing works particularly well for established companies that have an existing product or service and emerging companies about to launch a product with high gross and net margins. He also believes it’s ideal for financing intensive sales and marketing activities.

Additional Resources

Small Business Encyclopedia
Article by David R. Evanson, Financial Writer (.pdf)

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