Considering Intellectual Property Rights as a Collateral
In business parlance, assets can be divided into two major classes of tangible and intangible resources. Where tangible resources are constitutive of buildings, machines, and equipment, intangible resources are creations of the mind, which include inventions, literary, artistic, and musical works, labels, designs and symbols, and other goods or services of the like nature. In the present times, businesses significantly derive value from intangible resources since they are easy to transfer and hold substantial worth. Even though the ratio of intangible assets against tangible assets is witnessing a sharp rise, the idea of using Intellectual Property (IP) assets for debt funding is yet to take its best shape.
Understanding IP-Backed Financing
IP- backed financing is a term used in connection to the use of IP assets to enable access to credit. This subject has gained relevance amongst all sectors and all sizes of business operations alike since it allows leveraging the IP assets held by an entity in exchange for financing. Even banking and lending institutions have started to consider IP assets as collateral while extending any financial aid instead of conventional assets like land, jewelry, equipment, and machine.
The benefit of collateralizing IP is that it increases the amount of available credit. Since IP has the capability of multiplying the value held originally, it also raises the potential of a successful loan. Therefore, some banks utilize IP assets as a medium of credit enhancement. One sector where such financing is prudent is biotechnology since it strives on capital and largely depends on valuations. Such financing may come to one’s rescue in instances where a company’s assets are performing well, and such a financing strategy would attract funds easily. It may also be helpful in instances where the asset has failed to perform in its trials. Therefore, it is completely dependent on the strategy and goals of an entity upon which the route of such deployment is chosen.
Modes of Collateralization
There are different ways of pursuing collateralization of IP assets, some of which were highlighted in Enquiries into Intellectual Property’s Economic Impact published by the Organization for Economic Cooperation and Development (OECD) and are mentioned below:
- Securitization: The process of securitization can be followed up where the IP asset has substantial value and is capable of adequate returns. To initiate securitization, the originator (owner of the IP assets) has to place its assets or the rights to its future revenues (royalties) in a special purpose vehicle or a trust, which then issues securities in the capital market. It helps generate more value since there is no actual transfer of the IP. The investors buy these asset-backed securities, and there is a rate of interest that accrues to the investor, which is how it helps to raise funds.
- Direct Collateral: This is the easiest way of turning an IP asset into collateral. This mode enables an IP asset to be directly pledged in the form of collateral to secure a loan agreement. Therefore, where the asset holder fails to repay the loan within the stipulated time or turns insolvent, leading to defaults in payment, the lending authority can either seize the goods or utilize them in a manner to make good of such a loss. The IP asset can be licensed or utilized in any manner as may be provided for in the terms and conditions upon which a loan agreement was agreed to originally.
- Sale and Leaseback: Such a transaction enables the rights holder to sells its IP asset to a rather specialized investor or any other lender instead of immediate funding on a conditional basis. The condition allows the IP asset’s owner to be licensed, in return for which it pays some specific stipulated amount of royalty to the buyer for a fixed period. Once the stipulated term of royalty payments is completed without any default in payments, the original rights holder of the IP asset has the option to buy the asset back at an already decided price.
Initiatives Taken by Different Countries
|Singapore||The IP Financing Scheme (‘IPFS’) was a scheme launched by the IP Office of Singapore to increase the access to IP-backed financing to nurture IP-rich companies by enabling them to obtain loans from Participating Financing Institutions.|
|China||The China National Intellectual Property Administration is an organization responsible for the management and coordination of IP assets. This authority acts as the central registry of IP-backed financing pledges.|
|Korea||The Korean government supports many programs for the development of Intellectual Property Rights (IPRs), their protection, and financing. It also runs risk-sharing programs and IP commercial insurance programs.|
|Malaysia||The government has an IP Financing Scheme, which helps and encourages Small and Medium Enterprises (SMEs) in utilizing the IP assets as collateral.|
Hurdles in IP-Based Financing
As has been observed, the financing of IP assets is much in vogue in many countries like the United Kingdom and the United States. However, it is still underused in other countries. The barriers to such financing are mentioned below, which can be mitigated through new business practices or policies.
- IP Assets may be Difficult to Re-Deploy: Where an entity holds a set of complementary assets to a particular piece of IP, the value of its core IP is contingent on each other. Therefore, it may be financially distressing to dispose-off a single IP in isolation as it may imply the decline of its actual value.
- IP Exit Markets are Usually Immature: It has been observed that the secondary market for IP assets is underdeveloped to procure a quick and low-cost resale of such assets for the creditor who needs to realize a value from it. It is majorly due to the unawareness of lending institutions and banks in understanding the risks involved in securing an IP asset or how best its outcomes could be realized.
- The Transaction Cost for IP Assets as Collateral is High: Where an institution agrees to lend any credit instead of an IP asset, the transaction cost is high due to difficulty asserting the entity’s creditworthiness based on distinct asymmetric information. There is a cost of conducting a risk assessment as well.
- Unawareness of Lending Institutions in Contemplating IP Assets: This is especially true for banks as they do not have a well-developed plan or procedure to streamline the assessment of an IP asset. There has to be a proper framework to assess whether a particular asset can qualify as requisite security and whether or not it is capable of raising capital adequately in the event of failure of the lender to perform its part of the obligations.
The Merits and Demerits of IP-Backed Financing
|Merits of IP-Backed Financing||Demerits of IP-Backed Financing|
|It is an improved form of security if the potential is well realized. Therefore, in the event where a debtor fails to repay the loan, the bank is in a much stronger position to make good of the loss.||A major issue lies in the fact that IP generated by the company is very seldom represented on the balance sheet, as a result of which the directors may find it difficult to explain the actual potential of the IP assets.|
|IP assets have good value, and with time, their appreciation usually increases. Sometimes the value may increase more than a tangible asset.||Tangible assets have subsequent disposable value. However, the resale market for intangible assets is instead less formalized since they offer less certainty.|
|IP assets once pledged act as a powerful incentive for debtors to honor the repayment of their debts, especially in the case where IP assets are of core value to their business activity.||There is always a risk of valuation depending on market needs and the ratio of demand and supply. The same may be affected by the performance of one’s assets or the introduction of a competitor’s asset in the market.|
|Instead of undertaking Personal Guarantees (PGs), IP assets are more useful as they act as an additional source of security other than tangible assets.||Since IP assets carry some know-how or trade secret applicable or surrounding an IP asset that is not subject to disclosure, it may result in a substantial loss while calculating the actual value of the intangible asset.|
IP assets can be considered valuable tools for pursuing financing activities. Such financing is yet to gain full and functional momentum since there is a lack of infrastructure for financing activities and valuation techniques to facilitate such transactions, especially in the realm of IPRs. For proceeding further in such aspect, it is requisite to create transparency in the market to establish strong relationships between corporate entities with well-curated IP portfolios and other lending authorities to further the cause of IP-backed financing and utilize the same to the best possible extent. ✅ For more visit: https://www.kashishipr.com/