Using Intellectual Property to secure finance

Wherever a business uses specialist knowledge to serve its customers, its activities will have intellectual property (IP) at their core. This IP might lie in “formal” rights like patents, designs or trademarks; increasingly, in a service-driven economy, it is likely to involve proprietary processes, trade secrets and copyright material.

But IP poses companies with a common problem, wherever it may lie. While a business’s bundle of IP assets often underpins all its income streams, its worth is seldom expressed on a balance sheet. Since the underlying IP is hardly ever identified or valued, it cannot be exploited in the same way as tangible assets like property, plant and machinery – assets whose importance is reducing in an increasingly knowledge-based age.

Understating a business’s value in this way inevitably curtails its ability to borrow and to fund growth, a problem that is widely recognised in industry and Government circles. For example, at its February 2007 seminar on SMEs and their intangible assets, the ACCA summarised the position as follows: “Impetus must be given to developing an accepted valuation methodology and to stimulating intangible asset markets… It is imperative that a methodology is developed that values intangible assets so as to promote innovation within firms and the economy as a whole1” In February 2008, the DCMS paper Creative Britain concluded that: “Since most of the value of the creative sector derives from intangible assets, creative businesses must be able to value them accurately and have confidence that they will be vigorously defended under the law2.”

The way forward

There is no legal impediment to deriving greater shareholder value from IP. As its name suggests, IP is essentially a type of property, which means it can be licensed, bought and sold (or, technically, assigned) in much the same way as any tangible asset. However, to enable this potential value to be realised, two key preconditions need to be met.

Firstly, the IP’s scope and nature need to be clearly understood. This requires there to be an accepted means of describing and “commodifying” it – in other words, to transform the IP into a business asset with a separate identity, capable of being transferred to other parties. Secondly, the IP needs to have a financial value attributed to it.

Inngot’s system has been designed to overcome these two barriers. It provides new processes to explain what a company’s IP is, where its value lies, and how much it might be worth. In doing so Inngot also enables companies to make their IP known to a wide range of prospective customers, partners and investors.

With the help of Inngot’s registration and valuation regime, IP can be sold to a finance house, which then leases or licences the exclusive usage rights back to the originating business, in return for a monthly payment stream.

Inngot registration

Inngot’s systems exploit the potential of existing copyright law to create a secure environment where businesses can register and publish their IP. A unique new classification system is used to describe both the business and its IP, making it easy for potential customers, collaborators, acquirers and financiers to search for it. This is the opposite of existing copyright registration schemes, which effectively “lock away” published material.

As well as registering the IP, Inngot records the existence of any finance associated with it, creating a “notice mechanism” needed for a market in IP to prosper.

Inngot valuation

While IP valuation is conducted regularly, it is usually a “one-off” exercise in the context of a business sale or licensing agreement. Comparatives are rarely available and seldom published.

Inngot’s valuation mechanism has been created with a standardised transaction form in mind – an “arm’s length” sale to a finance house. In this context, the importance of the valuation is that the amount involved must be realistic; the asset must be worth at least the amount being lent (having factored in an appropriate contingency); and the lessee must have the ability to repay on the agreed terms.


For companies, using IP as security provides a means to maximise the value of existing core assets without having to sell shares. All of the exclusive rights of usage remain with the originator, who can continue to develop its IP just as it would previously have done, but with the benefit of significantly more capital.

Asset finance always involves a fixed stream of payments over a given period of time, likely to compare favourably with variable bank charges. At the end of the term, a lease can revert to a “peppercorn” rental, while a licence can provide for full ownership to be returned at the end of the term. In the meantime, the fact that the legal ownership of the IP rests with a major financial institution significantly reduces the risks of deliberate infringement by a competitor.

Entering into a lease agreement does not “fix” the value of the IP, any more than the size of a mortgage determines the value of a property. If the business does well, the value of the IP will increase, opening up opportunities to realise further funding streams. This also suits the lender, as it prevents them from becoming technically “over-collateralised”.

The way forward

There are a growing number of commercial finance precedents where IP has been used to provide security for lending, and the mechanisms involved are familiar and well understood. As the marketplace develops, many of the techniques already developed in a competitive leasing market will start to be introduced, such as extended primary periods, payment holidays, peppercorns for secondary periods, and even (potentially) “balloons”. There are already signs that finance houses and brokers will develop specialisms in one or more sectors or IP types, as they have done for many years with tangible assets.

Inngot registration and valuation address the structural issues which have constrained the use of IP as security for finance to date – chiefly the lack of clear description, valuation and notice mechanisms. With these points addressed, IP-based financing becomes a very attractive option both for innovative companies and for finance companies.

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Categories: All, Inngot, IP General, Lending, Value | Tags: , , , , , , , , , , | 3 Comments

Is your Intellectual Property utilised?

Intellectual Property has too long been seen as a guard against imitators and should be better used forging partnerships and raising valuations, Sean Hargrave Discovers.

There are two major problems with the way the business world considers intellectual property (IP). Many companies see a patent, trademark or registered design mainly as a defensive measure and so will not look beyond these protective rights and consider what other IP the business might own.

Read the full article Here

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Categories: All, IP General, Lending, Protecting, Utilising, Value | Tags: , , , , , , , , , , | Leave a comment

Attitudes to secured lending: Are we living in the past?

How can identifying your companies intangible assets benefit your organisation?

It’s no use trying to address 21st Century funding needs by focusing on 19th Century assets for secured lending. We need to learn lessons from the past, and apply them to the challenge of growing the knowledge economy

Given the current turmoil in the Eurozone, there’s no shortage of commentary on structural issues facing markets. The finger is being firmly pointed at the connection between low-cost debt and burst property bubbles. Meaning banks are sitting on portfolios that no-one can shift.

We’ve blogged before on the fixation that financiers seem to have on what they see as solid assets. But in fairness, we should explain that secured lending has a long and honourable tradition. In fact, there is a lot it can still teach us.

Back in the industrial age, in the 19th century (and much of the 20th), the most important assets in a business were indeed tangible ones. Companies created value by mechanising processes which had hitherto taken large numbers of people to accomplish, and allowed goods to be produced on a scale and to a quality never before seen. This required big ‘things’ like factory buildings and equipment, and companies often lacked the cash reserves to acquire use of the assets they needed in order to expand.

Secured lending emerged as an imaginative and highly effective solution to this problem. It enabled businesses to leverage both the assets they wanted to acquire, and the assets they already had, thereby providing the security banks needed to lend money for growth. A real win-win.

These assets were crucial when the key determinant of a company’s success was its ability to multiply manpower. Businesses were well motivated to repay their loans, and from a bank’s viewpoint, if things got sticky and company A got into difficulties, there was a good chance company B could use the same tools or machinery productively.

So how does this translate into the knowledge economy, where competitive advantage is about offering something unique and distinctive – about multiplying brains, not brawn?

In theory, rather well. While the key value-producing assets are now intangible not tangible, they are assets nevertheless. All the most important ones (patents, brands, distinctive designs, software copyright and so on) all have property rights associated with them which means they can be bought and sold (or charged, or leveraged) just like anything made of metal. Supply problems with any of these assets will interrupt value production just as surely as a hardware failure – the difference being that you can’t simply bring in a new machine to solve it. So that’s good news for secured lenders, as it means these assets are more business-critical.

So why, on the rare occasions that lenders do acknowledge intangibles within a deal, do they take such ineffective security over them, like a floating charge? The truth is that they find intangible assets difficult to understand. The detailed appraisal process that will go into assessing a tangible ‘thing’ is not entered into with intangibles, meaning there is no ‘clear line of sight’ – and we all now know how dangerous that can be.

In a nutshell: as the seat of value has shifted – decisively so, in the last 40 years – companies have moved with it, but lending habits generally have not. There is only one thing wrong with 21st century asset-backed lending: it is still focused on 19th century assets.

As the US-based Athena Alliance has put it: “Just as physical assets were used to finance creation of more physical assets during the industrial age, intangible assets should be used to finance creation of more intangible assets in the information age.”  We couldn’t agree more.

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The real security question – banks evaluating a loan application

For any bank evaluating a loan application, the first consideration is whether the business in question can afford to repay the amount being sought. This is sometimes called serviceability. Without evidence that sufficient cash should be available to meet the resultant debt and interest, the verdict will always be ‘no’. Most business owners would probably agree that this approach is perfectly fair and reasonable.

Hot on the heels of serviceability comes another factor: security. This is about the collateral which a company can provide as a safeguard. And to be honest, if you ask a business to describe their discussions with banks about security, their first words are pretty unlikely to include ‘fair’ or ‘reasonable’. So what’s the problem?

Security is partly a question of identifying secondary exit routes – lender-speak for assets that can be sold off if needed to repay debt. Banks have become accustomed to using tangible assets that have resale potential, like commercial property, for this purpose.

At first glance, this policy seems perfectly sensible. The ability to realise value in extremis seems particularly important in a period of economic uncertainty and low growth.

However, to rely on tangible asset security solely for this purpose would be to have an extremely short memory. Over-exposure to tangible assets that people thought were valuable is not only one of the practices that got half the world into its current mess, but also continues to be one of the reasons we can’t get out of it.

No, the real reason for taking security is because lenders know the importance of their customer having ‘skin in the game’ – showing their intention to repay by putting something of value at stake.

Banks want, and need, the businesses in question to make a real commitment of their own; but as is widely reported, security is the place where many conversations between banker and business currently fall down. In the absence of available, tangible, company-owned assets, directors generally get asked to put up their personal assets to fill the gap.

This seems to be borne out by ONS data (see blogs passim). Not only is the lack of collateral the biggest single reason for declinations being given; but also, where loans are provided and guarantees are obtained, they come from owners and directors in 94% of cases.

The data also points to one (although only one) of the reasons why the Enterprise Finance Guarantee scheme falls short of the mark. EFG is great in theory as it recognises that many companies don’t have enough of the kind of security a bank traditionally likes to see. However, the scheme can’t be used unless all other avenues – including personal assets – have been exhausted, which is why it hardly features in ONS data.

What’s needed to create good quality security is an asset class that is truly core to the business and as closely associated as possible with the way it generates value, rather than a commodity that the company can do without or easily replace.

Anything come to mind…?

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Merlin’s spells need more work – sector specfic bank lending

Project Merlin has hit the headlines again in the past few days. Despite news that all the large players (bar one) reached or exceeded their SME lending commitments under this Government deal, there still seems to be ample anecdotal evidence of unmet company need.

What’s really going on…?

One set of data that was released by the Office of National Statistics in October 2011, and referenced in the Chancellor’s Autumn Statement, is quite enlightening. It contains evidence from a Europe-wide survey comparing the financing experiences of a large sample of businesses, across a range of sectors, in 2007 and in 2010.

The headline is that demand is up and approvals are down. This is no particular surprise (though the increased demand shown in the ONS data seems a little at odds with bank surveys, which consistently suggest that companies overall are choosing to repay existing debt rather than request more). However, the scale of the change in loan approval rates for certain sectors is quite striking.

Reflecting the shape of the UK economy, the majority of the companies in the sample were service businesses. 32% of these sought finance in 2007, which grew to 37% in 2010. Of those seeking finance, the main source was bank lending. Again, so far, so unsurprising. But approval rates for bank loans to these businesses were running at 84% in 2007: in 2010 the approval rate fell to 61%.

The position for ICT businesses is worse, where demand for finance has grown more strongly (28% to 36%), and bank loan approval rates have fallen more sharply, from 85% to just 45%. And this is puzzling, when 70% of construction industry applications were still approved in 2010.

The same picture emerges on less formal lending via overdraft. 2010 approval rate for construction companies, 73%: for ICT firms, 63%. And if you are unlucky enough to be a service business looking for an overdraft, the ONS data shows that your chances of getting one in 2010 fell to a barely credible 26%.

So your prospects of bank funding seem to vary markedly by sector. Which suggests that the underlying issue may be a process problem as much as any overall lack of appetite.

After all, at the same time as banks are being told to take more risk by increasing their lending, they are also being required to strengthen their capital adequacy ratios, a message strongly backed by the Bank of England. The Basel III regulations undoubtedly encourage, and arguably compel, banks to do more of their lending to lower risk, better secured customers.

The largest single reason obtained by ONS for loan declinations in 2007, and in 2010, is lack of collateral. And what is the key difference that separates the manufacturing and construction sectors from the service and ICT sectors…?

Virtually all businesses, including manufacturing ones, have valuable intangibles which generally do not feature on the balance sheet. There are solid accounting reasons why they don’t, but the omission has the effect of making these assets not only intangible, but invisible. Trouble is, wherever these intangibles do appear in a company’s accounts, credit teams tend to attribute a nil value to them. This is a bit of a problem, considering that intangibles are the main source of corporate value and the main focus for company investment.

The ONS data seems to point to a pretty fundamental disconnect between the access to funding needed to build a successful, competitive, knowledge-based economy and the steps that have to be taken to reduce the risk of further financial shocks. It’s a dilemma that must be resolved, because as nearly all commentators agree, growth is essential if structural debt is to be reduced.

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