Royalty Income Trust

A type of special-purpose financing created to hold investments or their cash flows in operating companies. These trusts are neither stocks nor bonds but investment trusts (a legal entity). Royalty trusts buy the right to royalties on the production and sale of a natural resource company and pass on the profits to trust unit holders.

Royalty trusts are attractive to investors because they promise high yields compared to stocks and bonds. They are attractive to companies wishing to sell cash-flow producing assets because they provide a much higher sale price than what is possible with conventional financings.

For example, suppose that ABC oil company has maturing oil wells with well-known rates of production and reserves. The company estimates that it will produce and sell one million barrels per year for the next 20 years at a price of $20 per barrel (thus $20 million per year). ABC wants to sell the wells, but an investment bank suggests that ABC use a royalty trust, so ABC sells all the oil wells to a trust, the XYZ Royalty Fund. ABC receives a payout from the investment bank and will still manage the company for a fee.