Royalty monetization and synthetic royalties

In a royalty monetization the company sells the right to some or all of a future royalty stream to an investor in exchange for an upfront payment. In a synthetic royalty the company grants a royalty on its own product sales. Either way, the company usually has continuing involvement, such as an obligation to maintain the product or a cap on the investor's return, and ASC 470-10 on sales of future revenues treats the proceeds as debt.

The liability is accreted using the effective interest method, with the interest rate derived from the expected royalty payments. Because those expectations change with sales forecasts, the rate and the non-cash interest expense are re-estimated periodically, producing income-statement volatility that has nothing to do with operations.

Companies favor these deals because they are non-dilutive and off the credit covenants of traditional debt. The finance team needs a model of expected royalties, a memo on the accounting conclusion, and a plan for explaining the interest expense to the board.