IP led financing

Small and medium-sized enterprises (SMEs) account for a staggering 99.9% of all enterprises within the UK, providing for 59.1% of private sector jobs and employing upwards of 13.7 million people. But despite their obvious importance to both economic growth and stability, many SMEs are hindered by their inability to raise capital as a result of their disadvantaged position when it comes to attracting external financing. Consequently, only about 65% of small businesses are still operating after three years, and after five years, fewer than 45% of SMEs will have survived.

Innovative young SMEs often have one major asset which is both their boon and their hindrance: intellectual property (IP). It has been argued that certain IP, and the rights vested therein, are less valuable until they can be shown to underpin revenues. However, proper identification and valuation of the IP assets which underpins the actual commercial value and competitive advantage of an SME can be used to attract external finance and become an important business asset to raise money against. If an innovative new product or service is protected by a patent, trademark, copyright or formally-protected trade secrets, it may help to convince prospective lenders of the market opportunities for the commercialisation of those products and services. After all, intellectual property rights (IPRs) can create barriers to entry in the relevant market, guaranteeing a certain level of exclusivity and thereby a higher market share if the product proves to be successful.

The recent proliferation of Intellectual Property Exchanges, including IPXI – the world’s first financial exchange which facilitates the licensing and trading of IPRs – founded by Metis Partner’s JV partner Ocean Tomo, signals an increase in IP asset recognition. Essentially, it allows companies to buy, sell and hedge patent rights just like any other asset, and makes it easier for companies to make a profit off of the IP backing their novel ideas. Additionally, though IPR-backed finance was traditionally used by large corporates, the introduction of patent brokers such as ICAP – with whom Metis has recently worked – has opened up different funding mechanisms which can be used by SMEs.

Governments are also starting to take note of the increasing importance of IP rights, particularly in international governments such as those in China and Malaysia; Malaysia Debt Ventures (MDV), for example, was created as a response to companies which had difficulty in accessing financing from financial institutions or fulfilling their credit criteria. MDV targets companies which are still in their growth and expansion stage, specifically within the Information and Communications Technology (ICT) sectors, and helps them to procure the necessary financing for project inputs, capital expenditure and working capital. MDV differs from traditional banking institutions in that they assess companies based on their management and technical capabilities, key assets for technical companies, rather than on their current cash flow. The Malaysian government has gone even further, announcing that a deduction equal to the amount of investment made by an angel investor in a venture company can be offset against his income; this means that the Government is now the one taking the risk when individuals make angel investments, because if those investments fail, the individual will be able to offset the losses they made against future taxes. The greater incentivisation is, according to the CEO of Multimedia Development Corporation, the national ICT custodian and lead agency, “…a boon to innovators in the country.”

The UK is also starting to – slowly – follow suit. Clydesdale Bank is the latest player to enter the venture debt game, having recently backed a dozen or more IP-rich companies across the UK, including Aircraft Medical, a Scottish medical device maker, and Polatis, a Cambridge-based optical switching technology company, to the tune of £2.2 million and £2.5 million respectively. According to a managing partner at Clydesdale’s Financial Solutions Centre in Cambridge, “the Bank made a commitment to lend £10 billion of new lending to business customers… and this is just another example of how we’re working with local companies to help them invest in the future growth of their business.”

A newer, though lesser-known, option for IP-backed financing is also beginning to emerge. Pension-led funding works by utilising pensions held by business owners, directors and senior executives as a means of providing cash injection into a business, usually via the business’ own IP. This can happen either through the purchase of a business’s IP assets, and subsequent licencing-back from the pension fund to the company, or by way of securing a loan against the IP assets themselves. Anecdotally, after being turned down by a number of investors, including the popular BBC programme Dragon’s Den, Bristol-based heated glove manufacturer Tony Curtis released £27,000 of his total pension by way of a self-invested loan, secured through a general debenture, and facilitated by an independent valuation of the company’s pending UK patent to supplement the business’s balance sheet. The Company’s turnover is expected to hit £200,000 in its first year of trading, and it has already been awarded the 2012 Guardian “Startup Company of the Year” award. Apart from providing the funding a company needs, pension-led funding means that business charges and personal guarantees can be removed from the equation; that is, the security of a director’s non-pension personal assets will no longer rely on the success of the business.

Despite the increasing awareness of IP assets as a critical company asset, IP-backed funding still presents a challenge to SMEs looking for fresh capital. There remains a sense of unease over exit routes and the realisation of IP value for lenders, particularly in pre-revenue companies. However, there is a greater chance of IP assets being accepted as collateral if it can be shown that a company’s IP can be valued separately from the business in the event of default or insolvency. An SME must show the durability and marketability of their IP, as it provides a “competitive advantage” for that company, making it critical to identify all the IP assets within a company and to obtain an objective and independent valuation of the identified assets from a competent valuation firm. With our longstanding experience in the field of IP audits and valuations, Metis Partners have helped a number of IP-rich start-ups do just that, to their enduring success.

Image Credit: Olga Reznik

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