IP Financing: the Ten Commandments

By Jeremy Phillips

This is Professor Jeremy Phillips’ second article for the WIPO Magazine (see A Day in the Life of an IP Blog-Meister). In this article he lends a biblical cast to the “dos and don’ts” of IP Financing.

Read the small print. Banks and commercial lenders include terms in contracts for their own protection. Make sure these are terms you can live with. (Photo: istock.com)

What does finance have to do with IP?

In a word, everything. It costs money to develop new products, to prototype new gadgets, to get professional help and to pay official fees. Depressingly, while the IP owner only gets his reward if his creation results in a profitable venture, everyone else – banks, accountants, lawyers, market consultants, advertising agencies, patent and trademark registries – gets paid regardless of whether an IP-backed project hits the jackpot or sinks without a trace.

Innovation and creativity are bugs that afflict almost everyone, but most of us are born without money. So for those of us who are in the majority, we have to raise the money we need if we are to promote our creative talents to the full. This might mean a bank loan or mortgage (often in return for a share of any IP profits, or with the lender holding the IP right as security for repayment), a grant from public funds or even earning extra money by taking on a night job.

In each case, where an IP creator needs to raise that money, he also needs some guidance. Below are listed the ‘Ten Commandments’ that are applicable in almost every case. The advice they offer is only the beginning, though:  they are no substitute for careful thought, strategic financial planning or professional advice.

Incidentally, where a creative individual is employed by someone else, the same Commandments still apply, but it is the employer who has to bear them in mind rather than the creative employee.

Thou shalt …

1. Identify your IP clearly. Inventors make inventions. Designers create designs. But it’s the lawyers who create IP rights when they examine a newly-created concept and proclaim it to be comprised of various different intellectual properties. Thus an inventor may come up with a new torch, but to a legal specialist there’s a patent for the functionality, a design for the shape, a possible trademark again for the shape, and so on. If you are pledging IP to a lender or licensing it to a manufacturer, be sure to know what exactly it is that you are dealing with.

2. Read the small print in finance documents. Not just banks but all commercial lenders are sensitive about their money. They are as excited about their money, which is their principal asset, as the IP innovator is excited by his new creation. This is why they include terms in a contract for the financing of IP development that are for their own protection. So read the details of the contract and, if need be, have them explained to you. If consumers refuse to buy the exciting new widget for which a bank has advanced cash on the security of some patents, and the borrower defaults, does the bank just get to keep the patents, or can it collect on your work-tools, your car or anything else?

3. Keep proper records. Particularly if you have received public funding – or if you are called to account for not having used investment cash for the purposes for which it was lent. Proper records may be a pain to prepare but they can protect you from untold annoyance and embarrassment later.

4. Recognize your limitations. The modern creator rarely has all the plant, equipment, know-how and management skills to take a project from drawing board (or computer screen) to marketplace. Don’t spend time and money learning what you can buy from or outsource to others, unless it makes business sense to do so.

5. Make contingency plans. Even the best plans can go wrong; this is certainly the case with business plans for innovative products and services. By definition, no one has ever done what the IP owner hopes to do, so the past gives few clues as to how the future will turn out. That’s why it’s wise to have a Plan B. Keep asking “what if …?” questions and see what answers emerge. If there is no realistic Plan B, ask if it’s worth taking the financial risk of developing the IP in the first place.

Thou shalt not …

6. Don't be greedy. Most IP rights generate little or no profit on their own, but they can prove valuable when combined with the products or services of others. A chef’s new pizza recipe will earn him more if he licenses its use to a chain of franchised outlets –even if the chain makes more from each pizza than he does – than if he opens his own pizzeria and spends his days policing competitors in case they copy his delicious product.

7. Don’t overlook other people’s IP rights. The value of an IP right might be entirely contingent on receiving permission from other IP owners to use their IP. For example, a patented lubricant that cannot be made without infringing a patent for the original version of it. Payments to other IP owners can be substantial – and their existence must always be disclosed to potential lenders on security, since they will sue the borrower if a secured IP turns out to be unusable in this way.

8. Don’t forget the dynamics of the marketplace. It is easy to view the commercialization of an innovation as being literally the ‘last word’, the dawn of a halcyon era in which a new product is manufactured, distributed, purchased and profitably marketed until the end of time. This rarely happens. Competitors rise to the challenge of innovating around any successful new product in order to share, or improve upon, its money-earning ability (who still uses portable cassette players?);  fashions and tastes change (how much revenue would a new Bing Crosby song generate in 2008?);  even the environment takes its toll, as dazzling new contrivances are rejected for their carbon footprint. The moral is clear:  when computing how many years of income you may enjoy, during which you hope to pay off a loan or redeem a mortgaged IP right, be realistic:  you may have far less time than you think.

9. Don’t overlook the effect of ‘leakage’. Copyright in works such as sound recordings can be difficult to police and enforce in a world inhabited by private copying devices, even though those works are hugely profitable at launch. If IP rights cannot plug infringement leakage, works may remain hugely popular, but the stream of income from them may diminish to a trickle.

10. Don't borrow more than you need. Public funding usually doesn’t have to be paid back, but the private sector does – and the lender gets his profit by charging interest or its equivalent. This means that, over the period of the loan, you may have to repay far more than you borrowed. To reduce the risk of doing this, (i) only borrow as much as your budget suggests you need, and (ii) don’t borrow it until you really need it, or you’ll be paying interest on the loan before you’ve been able to put it to use.

Epilogue

Innovation is a brain disease for which there is no effective cure. Money may alleviate the symptoms, but only when it’s properly administered and the patient follows the instructions for its use. But for first aid, just remember the Ten Commandments and you won’t go far wrong.