The Reality of Royalties An expert explains why investors ask for them and what that means for you and your company.

Why would an investor want royalties? Doesn't he believe in my business?

The straight answer is no, he doesn't believe in your business. Investors are all about risk and return. The more risk they see in a situation, the more return they must have. By asking for royalties in lieu of equity, the investor is telling you that your company involves more risk than he's willing to take. Here are four reasons an investor may choose to suggest this route.

• The size of the investment is not in line with what the investor usually doles out. A royalty offer could be indicative of an outsize funding request (or the opposite).
• The stage of your startup doesn't sync with the investment strategy. The investor may concentrate on angel and seed rounds, whereas your business has moved beyond that stage to selling product.
• The investor loves the product but doesn't necessarily believe in the team behind it. Many investors will tell you they invest in people, not products or companies.
• The investor sees potential for a profitable business, but not the kind of explosive, hockey-stick growth needed to justify taking an equity stake in your company.