What is IP-Backed Finance?
IP financing, IP-backed finance, IP backed lending, IP funding, IP pension-led funding and the list goes on…. However, the subject matter is broadly the same and lenders and businesses alike want to understand the methods and best practices 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 IP assets such as patents, brands, software, trade secrets and copyrights, as the businesses seeking funding, typically are limited to offering their IP assets as the only or main form of collateral.
What Are the Attractions of IP-Backed Finance from lenders point of view?
- 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 usually 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.
Knowing the value of IP assets on a fair value (‘FV’) or going concern basis as well as knowing the value of IP assets on a liquidation basis in a downside or financial distress scenario, is extremely important. Furthermore understanding the factors that will impact on the recovery value when selling IP assets in a distress or bankruptcy scenario are also crucial and Metis Partners have been providing these services and collecting this data for more than ten years. Recent developments include insurance-backed IP loans, designed to reduce risk for the lender and borrower, which insure the recovery or sale value of the IP assets in a default scenario.
Despite the positives, IP-backed funding still presents a challenge to SMEs looking for fresh capital, as there remains a sense of unease from lenders over both the exit routes and ways to recover value from IP assets offered as collateral, particularly in pre-revenue companies.
What Are the Challenges of IP-Backed Finance?
- Visibility: despite the importance of IP assets and the often significant monies invested in IP 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 and reputation 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.
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 businesses 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 as the management of IP assets and their contribution to revenue growth and margin improvement, often demonstrates risk is being better managed in those businesses. However, demand for IP related lending is also growing from more mature and established businesses, therefore broadening demand beyond the typical venture-style risk, high-growth businesses.
Our observation is that the continued success and growth of this new pocket of finance for IP-rich companies, will be linked to the experience of the advisers to these transactions. Understanding the deal structures, IP valuation methodologies, terms and conditions of IP-backed finance and IP insurance will be important. Finally, experience of recovering value from the sale of IP assets in the open market is crucial, because whilst borrowers may focus on the upside, lenders will always focus on the downside. At Metis Partners we’ve got all of the aforementioned experience having worked on these transactions for more than ten years.