IP Backed Lending

There is a lot of talk about these different types of funding, however the subject matter is broadly the same, and lenders and businesses alike want to understand the methods and best practises in providing funding to IP-rich companies.

The primary goal in this field of finance is to unlock the hidden value of intangible assets or intellectual property (IP) assets such as patents, brands, software, trade secrets, and copyrights. The businesses seeking funding typically rely on their IP assets as the main form of collateral.

Despite being an area lacking in relevant data sets, successful IP-backed lending models do exist. In the last decade, businesses of all sizes have been investing more in intangible assets than in fixed or physical assets. For many years, these business have often secured venture debt style funding solutions from various venture debt and growth finance providers.  These days, non-dilutive funding secured against the IP assets of high-growth companies is better understood.

The risk profile of businesses is also changing. Effective management of IP assets and their contribution to revenue growth often demonstrate that risk is being better managed. Demand for IP-related lending is also growing among more established companies, extending beyond traditional venture-backed businesses.

Knowing the value of IP assets on a fair value or going-concern basis, as well as on a liquidation basis in financial distress, is crucial. Understanding the factors that affect recovery value when selling IP assets in distress or bankruptcy scenarios is equally important.

Understanding the value of IP assets on a fair value or going-concern basis, as well as their value in a liquidation or financial distress scenario, is essential. It is equally important to understand the factors that influence recovery value when selling IP assets in distress or bankruptcy situations.

Recent developments in this area include insurance-backed IP loans designed to reduce risk for both lenders and borrowers by insuring the recovery or sale value of IP assets in the event of default.

Despite these advances, IP-backed funding still presents challenges for SMEs seeking new capital. Many lenders remain cautious about exit routes and the recovery of value from IP assets offered as collateral, particularly for pre-revenue companies.

The continued success and growth of this form of finance will depend on the experience of advisers involved in these transactions. A thorough understanding of deal structures, IP assessment methodologies, terms and conditions of IP-backed finance, and IP insurance will be critical. Experience in recovering value from different types of IP assets in open markets is also vital, as borrowers tend to focus on upside potential while lenders must evaluate downside risk.

What Are the Attractions of IP-Backed Finance? 

• Improved security: at present, any charge placed over a business’s IP and intangibles tends to be floating rather than fixed, weakening a lenders position if the business gets into difficulties. Defining IP assets as part of a lending agreement puts a bank in a much stronger position with a bankruptcy trustee, administrator or insolvency practitioner. 
• Potential for value appreciation: the IP assets of a well-run business will increase in value over time, whereas most of their tangible assets will reduce in value.
• A wider pool of assets: lenders often face situations where existing good customers want to borrow more than established asset-lending financial ratios will allow. The value of certain IP assets such as brands provide a means to lend more (stretch lending), with increased security over those brands and other IP assets. 
• Stronger repayment incentives: where intangibles are core to business activity and offered as collateral that can be enforced or controlled by the lender, they provide a powerful incentive for borrowers to honor their repayment commitments. 
• Alternative to personal guarantees (PGs): lenders recognize the complications which arise from requesting PGs for business transactions. IP and intangibles provide an additional source of security and/or “comfort” which is directly related to the company, not an individual. 

What Are the Challenges of IP-Backed Finance?

• Visibility: despite its importance, and the amount invested in it by large and small businesses, internally generated IP is seldom represented on business balance sheets. It is, therefore, incumbent on the C Suite and business owners to understand and explain their IP and intangibles in language a lender will understand. If awareness is lacking in either or both parties, this acts as a hurdle. 
• Better informed lending decisions: obtaining expert insights into IP assets, sometimes called off-balance sheet assets, provides lenders with a more representative picture of a company’s resources and value. 
• Value attribution: unquoted companies do not have access to a market mechanism to measure and demonstrate the intangible (off-balance sheet) value attributable to their businesses.
• Value realization: many tangible assets have a realizable disposal value, even if it is a fraction of the new (originally funded) cost. Markets for resale of IP and intangible assets exist, but are presently less formalized and offer less certainty on realizable values. 
• Value risk: some intangible assets, such as brands, can be subject to rapid value changes depending on the fortunes of the companies that own them. 
• Value recognition: lenders need to gain confidence in understanding the particular risk profiles associated with IP assets. This involves familiarization, training, and the adoption of recognized standards for IP value recognition and management.