Intellectual property is among the most valuable business assets. In some sectors, it’s far and away the biggest part of a company’s assets, and in start-ups, it might be all they have. If all a lender can rely on from a pre-revenue business is personal guarantees from the founders, it’s going to be hard to cover the business’s financial needs. So, when raising finance, and considering what can be offered as collateral, intellectual property is bound to be important.
In this article, our intellectual property solicitors explain what intellectual property finance is, the benefits of intellectual property finance and how intellectual property finance can be used as collateral.
Contents:
- What is intellectual property finance?
- How can intellectual property be used as collateral for financing?
- What types of intellectual property can be used for IP backed finance?
- What are the benefits of intellectual property finance?
- Who can apply for intellectual property finance?
- What do lenders or investors consider when evaluating IP backed financing opportunities?
- How does intellectual property finance work?
- Summary
What is intellectual property finance?
Intellectual property finance involves the use of intellectual property assets, such as patents, trade marks, and copyrights, as collateral for financing. This allows companies or individuals to leverage their intellectual property to secure loans or investments.
How can intellectual property be used as collateral for financing?
The most common techniques for raising finance on the security of intellectual property are mortgages and charges. A third and rather different possibility is a pledge over a physical object that embodies intellectual property – a master recording, perhaps, or a work of art or a copy of a valuable piece of computer code.
Although frequently mentioned in the same breath, having similar effects, and involving similar formal requirements, mortgages and charges have significant differences.
A legal mortgage is the strongest type of security interest. The mortgagor (borrower) transfers the title to the asset to the mortgagee (lender), by way of security for certain obligations, on the condition (express or implied) that it will be transferred back when those obligations have been discharged. This makes the security interest easier to realise and prevents the borrower from selling the asset from under the lender. In the meantime, the borrower will need a licence (usually an exclusive one) to carry on using the intellectual property in their business. The lender will have to make sure renewal fees are paid and other steps taken to preserve the intellectual property, including suing for infringement.
A charge, on the other hand, leaves the IP asset in the hands of the borrower, so there is no need for a licence, and the borrower remains responsible for renewals and for stopping infringements. A fixed charge will be more appropriate where the IP assets can be clearly identified (e.g. by patent number), whereas a floating charge will be appropriate if the IP can only be identified as a class of assets (especially unregistered rights such as business or trading names, or copyright). A floating charge over all the business’s assets will cover IP, with any assets subject to fixed charges being carved out.
Floating charges have the advantage that the IP can be sold and licensed in the ordinary course of the borrower’s business, but by the same token, they give less control to the lender. Floating charges also give less security, because the holders of fixed charges will be paid out first if the borrower becomes insolvent. A combination of fixed and floating charges is likely to give the lender the greatest security.
What types of intellectual property can be used for IP backed finance?
In principle, all types of IP can be used as backing for a company’s borrowing. Registered IP rights are easier to deal with because their existence and status is clearer, but unregistered rights like copyright and design rights can also be used. Know-how and trade secrets are more complicated – they can still be used if a lender will accept them, and even unregistered trade marks may be acceptable because they form part of the goodwill of the business.
What are the benefits of intellectual property finance?
The benefits of being able to raise finance on the back of intellectual property assets are easy to see. If this important class of assets can be brought into play, huge opportunities to raise secured debt finance open up – often for exactly the sort of IP-rich start-up business that needs the cash but otherwise would be hard-pressed to find it.
Who can apply for intellectual property finance?
To borrow on the back of intellectual property assets, you obviously need to have some valuable IP. This can take many forms: pharmaceutical companies usually have extensive portfolios of patents and trade marks, manufacturers of consumer goods will probably have registered and unregistered designs and trade marks, tech companies will own copyright in computer code – and trade marks. Artists and musicians will have copyright or rights in their performances.
In other sectors, IP assets are more likely to be used along with the other assets of the business rather than in their own right, to secure a floating charge. Just because you’re not in one of those IP-rich areas doesn’t mean that your IP assets are not going to be useful in securing your borrowing.
Not all patents, or trade marks, or designs, are equal, though. Just as if you were mortgaging your house, the lender will be concerned to know that it’s worth enough to cover the loan, plus a bit. in the world of IP finance, things are a little less formalised than with domestic property. An IP valuation is a less established technique than real estate valuation. However, it remains of central importance to IP finance.
What do lenders or investors consider when evaluating IP backed financing opportunities?
Just as you would if you were selling your house, you need to make sure that the assets you’re offering as security to a lender look attractive. Although the idea is not to transfer the IP outright to the lender, they still need to be sure that it’s good enough for their purposes. If they have to realise their security, will they be able to get their money back?
Before you start to set out your stall, make sure you know what assets you have in the business. Demonstrating that you are on top of IP management will reassure your lender, who will recognise that the risks inherent in IP financing are under control. You should have an asset register that lists all the IP owned by and used in the business, but even if you do, the chances are that assets have been overlooked – in particular, internally-generated IP seldom appears on the balance sheet. Because copyright comes into existence automatically, there could be a lot in your business that no-one has really thought about.
Carrying out an IP audit, identifying what assets clients have and what they should be doing to protect them, is a large part of our work, whether preparing a business for sale or (which is not very different, in this situation) identifying collateral to offer lenders, or just to help ensure its smooth running.
An audit might, for example, identify an invention that the business hadn’t recognised as important, or a trade mark that has developed to form part of the business’s corporate identity but had been overlooked for registration. While an invention or an unregistered trade mark would count as IP assets, they will be much more valuable to a lender if registered.
An audit might also find that there is valuable copyright that hasn’t been dealt with optimally. It’s common to find that important elements of a business’s marketing activities – photographs, logos, copy – have been created not by employees (so that copyright almost always belongs to the employer) but by outside contractors (so assignments of the rights might be needed).
Not applying for a patent, or registering a trade mark or design, leaves the business exposed and misses an opportunity to acquire a valuable IP asset. If your IP is vulnerable to infringing activities by third parties, or activities that are not infringements because you didn’t register earlier, lenders are going to be less likely to consider your request for finance.
If someone is already infringing your rights, you would usually be best-advised to resolve that dispute before you talk to lenders about lending against your IP assets. That might not mean going to court – resolving a dispute that way will probably involve a longer timescale than the one your lender is working to – but there are other ways in which to make disputes go away. We help clients settle disputes without the cost and aggravation of litigation, including using alternative dispute resolution techniques like mediation.
How does intellectual property finance work?
Intellectual property finance is no different from any other form of secured borrowing, in many ways. Before a lender will lend your company money, it will investigate its financial standing, including its accounts and overall lending commitments. In particular, your lender will want to make sure that by entering into a loan, your company won’t be in breach of existing loans or other commitments. Does it have enough assets – intellectual property and other assets – to secure the loan? Has it already used those assets as security for other borrowings? A lender will also wish to make sure that you have the resources to repay the loan plus interest.
Working out the value of your IP assets is not a precise science, though there are well-established techniques. It will be important to the lender to have an idea of their value both on a fair value or going concern basis, and (for the worst case) on a liquidation basis. The risk to both parties may be mitigated by ensuring the recovery or sale value of the IP assets in the event of a default.
After a loan has been cleared by its credit committee, the lender will draw up a term sheet indicating the major terms on which the loan is to be offered. The term sheet sets out the key clauses to be included in the facility agreement, including provisions about security, and you can negotiate these terms with the lender at this stage.
A commitment letter is then sent to the borrower, together with the term sheet. If the borrower agrees to the terms, then a loan agreement will be drafted. There will also be security documents – mortgages or debentures – and guarantees, and often insurance policies too. Once they have all been signed, the borrower is able to draw down on the finance.
Summary
IP-backed finance is not a new idea, but it’s definitely one for the modern age. While there are many established businesses that depend very much on their IP, and many younger businesses that have few if any other assets, it’s trite to say that every business has some IP even if it’s only going to interest a lender if wrapped up with all the business’s other assets and subjected to a floating charge. Wherever your business finds itself on this spectrum, keeping tabs on your IP assets and their value is an essential part of the management role, whether you currently plan to use those assets as collateral or not.
