Sales Certificates - Background
What Are Sales Certificates?
Sales Certificates provide a return that is a function of a firm's future sales over a specified period of time, say, 10 years. Sales Certificates represent property interest in a firm's sales and can be bought and sold in a secondary market. The security's return is transparent; there are no costs or other deductions made from the firm's reported sales figures before the payments to be made to the investor are calculated. There are no assets segregated as collateral for this security, and the security expires worthless at maturity.
Sales Certificates will be created in such denominations and quantity as to facilitate trading.
The Need for Sales Certificates
From an Information Point of View
There is a need for financial products that provide an investor with easily obtainable, understandable and verifiable knowledge of what the investor is buying, selling or holding.
Many securities do not allow investors to be easily or fully informed as to the value of those securities. With respect to bonds, only the prices of on-the-run Treasury bonds* are readily available because there are so many individual bond issues traded and corporate debt issues have prepayment, conversion, rollover and other features that are difficult to evaluate. With respect to equities, it is a demanding task to understand both the accounting practices that generate the earnings per share figures and the linkage used to value equity securities on the basis of reported earnings or sales.
From a Capital Markets Point of View
Currently issuers offer, and investors purchase, stocks and bonds (and their derivatives). The consequences for issuers are that they accept the burden of debt's fixed cost, subject the firm to interest rate volatility, or give up some ownership. For investors, they buy stocks when they are young to have their wealth grow with the economy, but this subjects their wealth to a volatility roughly 10 times that of sales. Investors then shift to bonds as they approach retirement to avoid the market's volatility, but this subjects them to the ravages of inflation.
In Summary
Sales Certificates are a complementary security and do not supplant equity. However, the existence of Sales Certificates may change the value of equities. Once Sales Certificates issue, the incentives of the equity holder are better aligned with the Sales Certificate holder than with those of the debt holder. The latter impose covenants in the debt indenture (trust deed) that, in the interest of maintaining debt coverage, limit the equity holders' ability to increase sales. Sales Certificates are a hybrid security that provide debt markets with competition and can be viewed as self-liquidating equity. Within limits, the incentives of the holders of a firm's equity and Sales Certificates are aligned.
The securitization of Sales Certificates is covered by US Patent 7,149,719 issued 12 December 2006. An article covering this concept was published in the July/August 2006 issue of the Financial Analysts Journal entitled Revenue Recognition Certificates.
* on-the-run Treasury bonds are recently issued Treasury Bonds
