Bank lending to small and medium-sized businesses has virtually halved since the financial crisis.
New rules make it much tougher for banks to lend to most firms and many no longer even want to borrow from traditional lenders. The trust has gone, terms are often prohibitive and companies frequently prefer to stay away.
A number are turning to alternative sources of finance, such as peer-to-peer lending. Now a new option has emerged.
Bright future: Duke Royalty lends to a firm that makes paint for GT4 cars
Duke Royalty is an Aim-listed business specialising in providing royalty-style finance to companies in fields such as industry, leisure and technology. The shares are 39p and should increase substantially as the firm expands and develops. There is also a generous quarterly dividend policy and an annual yield of more than 5 per cent.
Royalty finance has existed for decades in the mining industry. Mining groups looking for cash borrow from royalty specialists and in return pay a proportion of their annual revenues to those financiers.
The approach has turned tiny minnows into mining giants over the years, it spread into the biotech industry and, over the past decade, royalty finance has sprung up as a source of cash for companies more broadly.
The idea was pioneered in the US and Canada but Duke Royalty has brought the concept to the UK and Europe.
The firm was founded in 2015 by Neil Johnson, who spent 19 years working for top Canadian investment bank Cannacord Genuity.
Johnson, a Canadian by birth, was a leading force at Cannacord’s London office, helping the European arm of the business to increase revenues from less than £5million to more than £50million, while completing more than 100 deals for companies.
Ambitious: Founder Neil Johnson
Johnson is equally, if not more ambitious, for Duke Royalty. Having listed on Aim in March 2017, the group has completed royalty deals with three businesses – Temarca, a 20-year-old Dutch river cruiser firm, Lynx Equity, a mini-conglomerate, and Trimite Global Coatings, an industrial paint specialist, founded in the 1940s. Trimite’s paint is used on a huge range of products, from German trains to GT4 racing cars to brightly coloured baking tins.
These businesses could have borrowed from traditional banks or other lenders but royalty finance offers particular benefits. The deals are extremely long term – generally 25 to 30 years – and repayments vary slightly from year to year, depending on the borrower’s performance.
When sales go up, repayments rise but when sales dip, repayments slacken. Crucially too, companies repay both interest and principal from the beginning so they do not have to find huge lump sums to repay their debt as it falls due. And Duke does not buy shares in any of the businesses it works with so managers retain full control.
Interest is similar to banks but, because royalty finance is structured in a more manageable way, demand is high. Duke is about to sign a fourth transaction, with a British glass manufacturer, and Johnson expects to complete around six deals a year.
Once the glass manufacturing agreement has been signed, Duke will have lent almost £30million. That is expected to rise to around £50million in 2019 and 2020, increasing to about £100million thereafter.
Nonetheless, the group is highly selective in the deals that it does. Johnson and his team have already seen around 150 prospective borrowers but just a handful have passed muster. That approach will persist over the coming years.
As the company grows, it will ask shareholders for more money but Johnson will make sure there is a pipeline of deals before turning to investors for cash.
New shares will invariably be offered at a slight discount to the prevailing price and new royalty agreements will always be signed on terms that increase Duke’s profitability and its potential to pay dividends.
In December, for example, Duke raised £20million at 40p a share, when the market price was 42p and it subsequently announced the Trimite deal and an increase in the dividend.
The group’s chief investment officer, Jim Webster, pioneered the world’s first publicly listed drug royalty company in 1993, and he has worked in the industry ever since, raising £4 billion for companies across the world.
Duke’s shareholder register is reassuring too, including blue-chip names such as Hargreave Hale, Axa Framlington and Janus Henderson. Johnson and fellow directors own 12 per cent of the shares so they are incentivised to run the business well.
Duke’s financial year ended on March 31 and results will be out in a couple of months. Brokers expect profits of around £500,000 with a dividend of 2p. Next year, profits are expected to surge to £3.6million with the dividend rising to 3.2p.
Midas verdict: Royalty finance is a new concept in the UK for companies outside mining and biotech but it can certainly help businesses to grow without borrowing from banks. Duke Royalty is a relatively new business too but the management team know what they are doing, demand is there and the shares should rise, while offering healthy dividends too. Buy.