Securing sustainable finance is critical to the development and growth of any business. Intangible assets are now estimated to represent 70-80% of the value of UK companies (as recognised in the UK Intellectual Property Office's "Banking on IP" Report). However, commercial lending practices are still more favourable to those businesses rich in tangible assets (such as property) to use as security. Establishing a framework in which the value of intangible assets is more readily recognised by lenders will help IP-rich SMEs to overcome barriers in the early stages of financing, helping businesses to succeed and grow. This article considers why IP is so difficult to use as security and the developments required for lenders to finance IP rich businesses more readily.
The status quo
Intellectual property rights are already used as secured assets; it's just that they are usually not given a high value when lenders are assessing the profile of a company. A lender's objective is to obtain sufficient security for a loan in the event that the company defaults on its loan obligations. If the lender has taken security over the IP assets of a company, it is able to either (i) step in and either operate or sell the business (including the IP assets needed to run it) or (ii) monetise the IP assets by selling them outright to a third party.
When you compare IP assets to conventional tangible assets such as property, you can understand why lenders are reluctant to use IP assets more widely:
- There are long established and accepted practices for property valuation. On the other hand, valuing IP assets can be a complex, uncertain and time consuming task. Most lenders will not be equipped to undertake an in-house review of an IP portfolio and the cost of an external valuation may not be feasible in the case of an SME loan.
- While the value of a property can change over time, the value of IP assets can be subject to more dramatic changes. A patent that is subsequently held to be invalid loses all of its value (or could be attributed with a negative value if the expenses of court proceedings are taken into account). Or a patent which protected a significant product becomes less valuable if the consumer behaviour shifts and adopts a different product produced by a competitor.
- There is a fluid market for the disposal of property. The market for IP assets is more limited. The size of the market will vary depending on the type of IP assets and the market to which they relate. In a default situation, the value from the IP assets that can be realised by a lender on a sale depends on how much a third party is prepared to pay for them. In narrow fields, there may be a limited number of businesses interested in acquiring the assets, which could result in a shortfall to the lender.
It's clear from the interviews referred to in the "Banking on IP" report that commercial lenders still regularly consider a borrower's IP assets. However, it is apparent that this is a more qualitative assessment than a valuation. A company's IP portfolio can be used as an indicator of its competitive advantage in the market or a litmus test of management's skills and diligence. But if lenders are going to offer more financing opportunities to the IP rich (but tangible asset poor), IP assets will need to be more closely examined.
What needs to improve?
The UK IPO's response to the "Banking on IP" report identified the need to educate businesses, lenders and financial professionals to increase awareness of the value of IP assets. The UK IPO committed to the development of online tools and guides in its response and other measures to support a constructive dialogue between businesses and financial professionals.
The other goal set out in the UK IPO's response is to grow financial confidence in IP as collateral. This will require improving some of the issues identified above in respect of IP as security, such as ensuring more accurate valuations and addressing the risk of a potential drop in the value of the assets.
Obtaining more accurate valuations may be helped by improving the quality of data available on IP rights. For example, the rate that patents are successfully revoked in a particular industry or market may affect the value of a patent portfolio. Integrating information from national patent offices and courts could lead to more sophisticated data analysis, supporting more cost-efficient valuation methods. However, such analytics will need to be used with caution. For example, differences in national systems and practices will mean that extrapolating beyond one country may not be appropriate. The validity of a patent depends on the words in the specification and there will be a limit to what can be predicted about the patent's enforceability without undertaking a detailed analysis of the individual right.
As noted above, it's difficult to value an IP asset portfolio unless you know there is a viable market place in which it can be sold. An online market place is an efficient way to access a potential licensee or purchaser, such as the ICAP Patent Brokerage. There will be greater demand and interest in some areas, such as in electronics and telecommunications for the moment. A marketplace can help facilitate transactions, but will still struggle to achieve sales if the IP assets are in a narrow field. Transparent patent sales data would help in more accurately valuing portfolios of similar assets. This is not currently possible under ICAP's sealed bid auctions and such a proposal would meet with commercial resistance from the parties to an otherwise confidential transaction.
One strategy to "de-risk" IP assets as collateral is to develop a market for insurance products to effectively underwrite the IP valuation. If the patents are held to be invalid or fail to reach a minimum valuation on a sale, the insurer pays out on a proportion of the valuation. At the moment with limited demand and an immature market, the cost of such insurance will be high. Greater take up would improve insurer's abilities to quantify the risks, potentially leading to lower costs. If a racehorse can be insured at a price, taking into account the risks of the equine business, it's feasible that a market can develop that shares the risks associated with IP rights. According to Tony Clayton, Chief Economist of the UK IPO, this also represents an opportunity for insurers. If businesses are investing more in their intangible than physical assets, insuring only a company's fixed assets will result in a shrinking market over time.
Another way to improve lenders' confidence in IP as collateral is for governments to share the financial risk. The "Banking on IP" Report refers to the progress already made in other jurisdictions, particularly in Asia. For example, Singapore and Malaysia have set up government funds to assist with businesses using their IP as collateral for loans. The Singapore Intellectual Property Financing Scheme only applies to granted patents. The Singapore government will partially underwrite the loans granted by financial institutions participating in the scheme and offer financial assistance with the cost of valuations. The scheme is in its infancy but its results will be of great interest. The UK is not the only country to recognise the need to enable IP rich businesses to grow and in doing so contribute to national economies.