IP financing, or the use of IP assets (trade marks, design rights, patents and copyright) to gain access to credit, is gaining increasing attention in IP circles. Multinational corporations as well as small and medium sized enterprise, are leveraging their IP assets in exchange for finance, and lending institutions around the world are increasingly extending their business to provide loans on the basis of IP. At the same time, a UN institution is currently working with its member states to modernize secured financing practices, and make it easier for IP owners to gain access to affordable credit. This article by an IP specialist at IP Consult 4U GmbH, Switzerland, introduces the topic of IP financing, which is further developed by Jeremy Phillips’ article “10 Commandments for IP Finance” and the articles by Lorin Brennan and Ben Goodger which look into current activities in international policy development relating to IP financing at the UN Commission on International Trade Law (UNCITRAL).
Why should corporate top management and policymakers care about IP assets?Or be interested in the latest trends in financing IP assets? Because they cannot afford to do otherwise. IP rights are not only valuable assets but can also be important sources of financing. The desire to enhance innovation is a very important issue for all nations, and access to financing is critical for start-up companies and innovative SMEs.1
Intangible assets, including IP rights, can increase a company’s asset value, and understanding and valuing these assets will help top management to make informed investment and marketing decisions. Higher asset values may also help in negotiations with a company’s bank and facilitate access to credit, or help to negotiate cheaper interest rates on credits.
Current IP valuation methodologies for securitization are more readily accepted by big banks when major patent or brands are involved. (Photos.com)
Financing practices
Most readers are familiar with traditional IP financing tools such as licensing (royalties) and direct sales of patents or trademarks. Recently, however, companies have found new ways to raise funds using intangible assets: one is by auctioning their IP. Auction houses specialized in this field hold live and online auction events several times a year. An auction enables owners to sell their intangible assets faster to gain access to rapid liquidity and also creates a market for potential buyers of intangible assets which might otherwise not exist. IP auctions are conducted by companies such as Ocean Tomo, IP Bewertungs AG and IP Auctions Inc. In addition, there are online exchanges for IP such as the technology marketplace run by Yet2.com and the technology trading exchange run by Tynax.
Another method for utilizing the value of IP is to use it as collateral. Normally, tangible assets such as real estate, equipment and inventory are used to secure asset-based loans, however, the collateralization of IP can also increase the amount of available credit. In cases where borrowers pledge their patents, trademarks or copyrighted works, the collateral pool increases in value and the potential for a successful loan is increased. Some banks also use IP assets as a credit enhancer. The number of such IP-backed transactions is growing, and the increased cash flow associated with the licensing of IP is attracting attention on Wall Street and financial markets around the world.
A legal mortgage is probably the safest form of security transaction, but it also requires that the IP be assigned to the lender with a license being granted back to the debtor. The problem that arises in this context is that the lender becomes the IP owner, and has control over the IP rights. This poses a potential risk for the ongoing business of the debtor, and also for the sub-licensees.
For some years, deals involving the securitization of intangible assets have enabled owners of IP rights to borrow money more easily and safely from adequately secured lenders. IP asset-backed securitizations are most common in the film and music industries, but the practice is increasing in the biotechnology and software industries. Some high profile examples of such transactions include the securitized royalty streams on the copyrights owned by famous musicians. For example:
- In 1997, David Bowie issued 10-year asset-backed bonds on the basis of future royalties on publishing rights and master recordings from 25 pre-recorded albums, and raised US$55 million. The purchaser of the bonds gained the right to receive future royalties from Bowie’s albums until the principal plus 8% annual interest was repaid.
- Nickolas Ashford and Valerie Simpson, songwriters and producers of hit songs including “Ain’t No Mountain High Enough” used the copyright on 247 of their songs as assets to back bonds, raising US$25 million.
These types of deals have been put together by David Pullman of the Pullman Group, a boutique investment firm, that created similar deals for James Brown, the Isley Brothers and the estate of Marvin Gaye. For his role in creating and selling the bonds, Pullman was rewarded with a fee of 10 percent of the deals’ value. The main purchasers of the bonds were institutional investors, such as pension funds and insurance companies as part of their diversified investment portfolios.
In 1997, David Bowie issued 10-year asset-backed bonds on the basis of future royalties on publishing rights and master recordings from 25 pre-recorded albums, and raised US$55 million. (Photo: Jorge Barrios)
While it is widely agreed that music asset-backed securitization has a great deal of potential, the volatility of the market and a lack of understanding of the music business by the investment community are still challenges to be overcome before the practice becomes widespread.
Asset-backed securitization is also well recognized in the field of patents, where the patent can be treated as a commercial asset on the basis of the exclusive legal rights it represents. There are numerous players in this marketplace, ranging from licensing entities composed of single inventors (such as Fergason Patent Properties LLC, an IP licensing and development company founded by Dr. James Fergason, an inventor in the field of liquid crystal displays) to patent brokers such as Pluritas, iPotential and IP Value and institutional patent aggregators such as the US-based company Intellectual Ventures2. In addition, IP is increasingly implicated in investment fund activities.
For example, Altitude Capital Partners is a US$250 million private investment fund which invests in IP assets and IP-focused companies, covering patents, trademarks, copyright and royalty streams. The company works with individual IP owners, as well as small and large IP-holding companies. In February 2007, Altitude invested in DeepNines, a network security solutions provider with returns linked to repayment from DeepNines’ IP proceeds and secured by the company assets. In April 2008, Altitude paired with Goldman Sachs & Co. to invest US$11 million in Intrinsity, Inc., a Texas-based IP technology company designing processor cores.
| Intangible asset classes |
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Management interested in using their IP as a source of collateral should gain familiarity with the following intangible asset classes before discussions with the credit grantor: Cash flow assets:
Assets with implicit value:
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Can a sound valuation be achieved?
Valuation is a key tool in the process of financing based on IP assets. Technical valuations are required of intangible assets to give a point in time value of the IP for the purpose of securitization. The available methodologies for IP valuation work best with individual major patents3and brands4. So far, no standard methodologies have been developed that are generally applicable to all IP big or small, however company reporting requirements and assessments for taxation may require valuations.
Recent efforts to develop general market-based approaches to valuation include the American Stock Exchange Equity Index based on the value of corporate IP rights, and plans for an IP exchange in Chicago to enable investor and company participation in a broad spectrum of IP-related financial products such as qualified equity listing/co-listing, IP-related indexes, futures and options, IP-backed debt instruments, patent rich company initial public offerings (IPOs) and new IP-based exchange-traded products.
In 2007, the German Institute for Standardization (DIN) published its “General Principles of Proper Patent Valuation” (PAS 1070 (SAB)) to assess the quality of valuation reports and expert appraisals. DIN then formed a working committee and initiated an international standardization project on patent valuation at the International Organization for Standardization (ISO), which will appoint a committee to develop an ISO-standard for patent valuation if all relevant and concerned groups express interest to ISO through their national standardization bodies.
Legal framework
From a legal perspective, it is interesting to note that most jurisdictions still do not offer adequate legal means for financing intangible assets, including IP. While some sectors of academia are aware of these shortcomings, it appears that there is not yet sufficient political pressure to modernize these legal systems. That said, the issue of IP financing is currently the subject of policy development at the international level. An overview of business and government action has been published by the International Chamber of Commerce in Section B-V of the IPRoadmap (English, Chinese, Arabic, Spanish and Portuguese).
In 2000, the United Nations Commission on International Trade Law (UNCITRAL) established a Working Group to address security rights in personal property, including intangible assets. The Working Group was given the mandate to develop recommendations for an efficient legal regime for security rights in goods involved in commercial activity, including intangible assets, and to identify the issues to be addressed, including the form of the instrument and the exact scope of assets that could serve as security5.
The decision to undertake work in the area of secured credit law was taken in response to the need for an efficient legal regime that would remove legal obstacles to secured credit and could thus have a beneficial impact on the availability and the cost of credit. In 2007, UNCITRAL concluded a Legislative Guide that contains recommendations for a uniform legal regime for secured financing, which also covers IP financing. This Legislative Guide must be regarded in the context of earlier policies by UNICTRAL, including the UN Convention on the Assignment of Receivables in International Trade and the Model Law on Cross-Border Insolvency.
The Vision for IP Financing
A successful future for IP financing is a significant step in further development of the IP-based economy:
Enhancement of a company’s credit basis:
- As inventories, receivables and, increasingly, IP will become more marketable, and more useful to increase access to credit, and to lower the cost of accessing credit.
Transparency in the credit system, and trust in capital markets:
- If implemented, a general credit registration system (such as that envisaged by the UNCITRAL Legislative Guide on Secured Transactions) will provide legal certainty for lenders, by giving transparency as regards the debtor’s credit structure, and giving visibility to secured transactions.
For market participants, IP financing will be of key importance to achieve their economical goals.
Acknowledgement Lucinda Longcroft, Senior Legal Officer, Copyright and Related Rights Sector.
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