Boom or bust

A flight to quality

for IP’s status as a steady, conservatively The developed world is slipping into valued and uncorrelated asset class. recession and established investment vehicles are crashing A new focus on IP portfolios C-suite executives have tended to into disrepute. What will be the overlook the untapped financial value of knock-on effect for IP assets − and intangibles. But as market firestorms ebb those tasked with their management and smouldering recession takes hold, many and monetisation? industry professionals believe that this is set to change. John Squires, chief IP counsel at Goldman Sachs, explains: “Certainly, By Nigel Page where the financial crisis is concerned, we will see companies seeking to generate With the financial crisis continuing to wrap greater returns from their portfolios. If they its tentacles around the world, sparking a already have exclusivity, then it will be global liquidity crunch and massive risk incumbent on them to ensure that their aversion among , few patents can be relied upon to continue to commentators are prepared to make firm provide this.” Steve Lozan, VP of predictions about eventual outcomes. investments at Oppenheimer & Co, agrees: But there is no shortage of . “Without doubt, some companies’ Calls for a new Bretton Woods-style valuations have been killed over the past agreement to reform global economic weeks. And so, if they can sell their IP or governance are seldom out of the press and a license it, then they may now be much more prospective maelstrom of financial and happy to do so.” capital markets regulation haunts banks, Fire sales of patents are widely hedge funds and private equity firms anticipated in the term, as executives worldwide. Meanwhile, institutional in cash-strapped companies begin to view investors are taking of massive losses their IP as a source of operating capital − sustained from what were, until recently, capital that can usefully be deployed to considered to be safe havens for their capital. appease shareholders by compensating for Against this backdrop, the nascent IP dramatic drop-offs in revenues. Nir monetisation communities are seeking to Kossovsky, chief executive of Steel City Re establish themselves. Given what has LLC, believes that this could be the case: happened over the past few months, you “We should expect to see a lot more supply could be forgiven for thinking that than demand. The whole notion of selling IP intermediaries and financiers alike are is more widely accepted than it was, so feeling pretty depressed. But, in fact, that companies will seek to dispose of their IP does not seem to be the case. Although via the markets. But I can’t identify any real everyone acknowledges that these are driver of increased demand. At the same difficult and uncertain times, the general time, greater uncertainty over asset-based view is that IP and intangibles in general and cashflow-based valuations will likely may not only survive the storm, but may result in overall reductions in net present actually prosper. In fact, some predict this values of IP.” That said, Kossovsky could be the beginning of a brave new world continues: “The value of the intangible www.iam-magazine.com Intellectual Asset Management January/February 2009 41 Boom or bust

Challenging for new entrants substantial realisations. Historically, IP exploitation has been counter-cyclical as IP assertions have increased in recessionary environments. In addition, a variety of models have emerged for investment in IP. Their emergence shows an increased awareness in the market of the standalone value of IP. However, during times of great dislocation, investors often flock to liquidity and perceived safety. Given the opaque nature of the asset class, IP will be challenging for new investors. The overall deleveraging of the financial system will result in the elimination of many hedge funds and other financial institutions’ tolerance for risk will be curtailed for the foreseeable future. Rather than invest in a new and illiquid asset class, with the public equity markets down approximately 40% year to date, investors may find liquid investments more attractive relative to other investment opportunities. At Altitude, we have positioned ourselves Though investment in IP as an asset class as a well-capitalised liquidity provider that can has grown meaningfully over the last five serve the needs of many different stakeholders years, it is still nascent in its evolution. in the IP ecosystem. In these uncertain times, Analysis of historical returns remains difficult, we expect to be more productive than ever given limited data. Therefore, it is challenging before. Our crystal ball suggests that in the to predict how the current financial crisis will next six to 12 months, capital formation will be impact on attitudes of institutional investors considerably more challenging for new and the development of the asset class. entrants. If it flows at all, it will be directed to IP is viewed as uncorrelated to the rest of players which have demonstrated their the , making it an opportune capabilities and infrastructure to succeed in a area for investment by institutions that seek world that is changing daily. diversification and reduced . In fact, over the last nine months – during the eye of Amar K Mehta, partner, Altitude Capital the storm − our fund has had three Partners asset ‘integrity’ will become hugely inflated. result of the financial crisis: “Derivatives So IP that has integrity will maintain and investors thought that by continually increase its value, being seen as less risky transferring risk they would be spreading it. and more secure. In many ways, this will be Instead, they hid it. There is now a better analogous to the way Treasuries are viewed awareness in the asset-backed markets that as less risky and more secure credit scrutiny of ownership is a good thing. instruments in a financial crisis.” Patents subject to sale or investment are Ron Laurie, managing director of highly scrutinised and conservatively Inflexion Point Strategy LLC in Silicon valued. This will translate into a new-found Valley, believes that demand for high quality respect for the in-depth analysis and patents will help to safeguard their value, caution that IP investors bring to bear.” but he is less sure about those further down Berman says he believes that prospects for the scale: “In the new financial the IP industry generally are good. “There’s environment, high quality patent properties no sense of panic that I’m aware of and IP as will continue to command eight figure an asset class is still very much in growth prices, while patents in the mid-range mode. As markets continue to plummet, portion of the quality spectrum will be investors will be forced to focus on heavily discounted and demand at the maintaining their holdings, not flipping bottom end of the market will likely them,” he explains. It will, he continues, be disappear altogether.” much less about income statements for the For his part, Bruce Berman, CEO of foreseeable future, and more about asset Brody Berman Associates in New York, values. “Although IP is still being swept believes that there will be deeper into ‘goodwill’ in the US, we may well see understanding and respect for IP assets as a this re-focus on asset stewardship leading

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No collapse in the market proving painful. And while this question There’s no sense remains, companies are asking how they can for ideas outperform competition, maintain value, of panic that I’m protect market share and generate a return on their investments. Unlike typical tangible aware of and IP as assets, patents, and know-how are the only form of true protection against a an asset class is drop in value. The collapse in tangible valuations leaves still very much in only one asset class available for a reliable collateral backstop – protectable intangible growth mode assets. Regardless of the path taken by the financial markets, there is no decline in the supply of, or demand for, ideas. Moreover, companies still need to borrow and investors still want to earn a return. Therefore, market demand will encourage monetisation strategies that include more IP-backed lending, licensing and auction and private sales than in the past. In addition to an increase and evolution in these strategies, there will also be revolutionary new strategies that investors What we are witnessing today is the popping will utilise. I believe we will see the rise of of an asset bubble and the associated such things as transparent trading platforms worldwide unwinding of highly levered for technology bundles and investment positions by entities across the vehicles focused on using intellectual spectrum. Banks, insurance companies and property as a signal of company value. investment funds built their businesses in Regardless of which strategies dominate part on the belief that many hard assets – in the future, it is clear that companies rich in most notably real estate, the ultimate intellectual property are best positioned to tangible asset – would never suffer a drop in take advantage of the changing financial pricing. Now that this faith has been broken landscape. the question on everyone’s mind is: what is the value of tangible assets? The market is Andy Carter, managing director, trying to find an answer, but doing so is Ocean Tomo

to IP being shifted onto the balance sheet – invent has not fundamentally changed.” where it belongs,” Berman concludes. Licensing activity is set to pick up too, If predictions of increased patent sales many believe. “Companies that rely more on as a result of the crisis are proved right, a licensing model will want to work their then Ocean Tomo’s auctions should benefit. portfolios to ensure that this can continue to In its most recent IP auction, held on 30th deliver value,” says Squires. “That said, there October in Chicago, Ocean Tomo generated could also be some more speculative IP a total US$12.84 million − slightly more assets out there that licensees will be than it raised in the equivalent sale in 2007. reluctant to take advantage of in the current Managing director Andy Carter is climate.” Typically, he explains, events in the optimistic for the future: “Given that we IP domain tend to lag those in the broader may be in a recession, managers will be , so these developments may take forced to focus on the core values of their some time to make themselves felt. companies − and, in many cases, this will be If companies are to get full value from their IP. Also, when times are bad, that can their patents at a time when they be the best time to buy assets to shore up desperately need to be able to do so, a the core of your IP portfolio.” Carter number of changes will have to be expresses no concerns about a possible drop forthcoming. In the US, practitioners agree in IP value as a result of supply outstripping that one priority must be for the USPTO to demand: “Will IP as an asset class be worth reduce the current pendency time. “This is less in the future as a result of what we’re divorcing these rights-gathering regimes experiencing now? No. Valuations of IP are from the actual marketplace and limiting built on future expectations and the future the ability of companies to deploy their IP need for and drive to create, innovate and assets,” claims Squires. If companies are to www.iam-magazine.com Intellectual Asset Management January/February 2009 43 Boom or bust

An onset of pessimism two possibilities. Either the IP sellers market Therefore, this kind of activity will most will almost completely break down for some probably be limited. The story is different time, in the absence of more strategic buyers where weapons of defence are concerned. (like Coller IP Capital); or there will be a major If the trolls force licensing too much, or if new focus by CFOs on their companies’ they become too many, the problem of trolls intangible assets (with the aim of monetising will find a solution in legislation (a process existing IP positions). that is already underway following last year’s We believe that the latter is more likely to US Supreme Court decisions). happen. For acquirers of IP, a potentially Independent of the financial crisis, more effective route, however, would be to it looks as if we could see an IP asset bubble consider all-out corporate acquisitions over the next five to 10 years, followed by a (especially if opportunities exist to acquire change in IP legislation. It is already smaller public companies whose share price impossible today to clean a complex is depressed). technology of external IP, or at least to If liquidity becomes short for a while − or assess and quantify the risk of stepping into if a long-lasting recession takes place − a trap. The number of worldwide patent companies will most likely react by toning applications is growing rapidly and with the down R&D activity. If this happens, they will coming more widespread use of IP rights (to generate less valuable patents and/or cash in make money) and a changed risk perception parts of their IP portfolio. That would result in among investors driven by the financial a buyer’s market for IP. crisis, a doom scenario can be imagined If more IP holders try to go for licences, where high-tech investment comes to a stop. In this environment, real estate asset evaluation then they will all eventually have to share in It’s autumn, it’s getting darker and these is considered to be an extremely risky process. whatever money is available. To argue by bear markets can lead to an onset of What effect will this have on market extreme extrapolation: we cannot imagine pessimism. perceptions (and valuations) of IP assets? licence payments going up by a factor of 20 Dependent on how strong the after- throughout industry. The resulting inflation Severin de Wit, IPEG Consultancy BV, effects of the financial crisis are, there are would force a change in legislation. The Hague (Netherlands) be able to extract maximum value from in acquiring high-value patent portfolios at their IP portfolios, he says, then a much fire-sale prices and then re-selling when the swifter examination process is necessary. market comes back. This is in part, he “The current lengthy pendency period is explains, driven by the need to deploy the also preventing licensees from getting full large sums of capital that they still have value from a licence − after all, as things under management. However, he continues: stand they are really just being given an “The central issue will be whether they can on a patent’s use, to put this in get comfortable with the level of risk derivatives-based language.” uncertainty that characterises the patent market, due to the limited price discovery Added investor interest mechanisms – for example, comparable A number of trends are driving hedge funds transaction data – and to the inherently and private equity funds towards a deeper unique nature of patents.” awareness of IP. Over in Silicon Valley, Ron Coller Capital is a leading investor in Epstein of IPotential reports seeing an private equity secondaries, with increased focus by banks and venture capital approximately US$8 billion under funds on investing in IP as a means of management. A private equity firm itself, recouping the bridging loans they made to Coller acquires positions in venture capital, tech companies. “As people withdraw their buyout and mezzanine funds, together with money from traditional investments, we’ve portfolios of companies or stakes in seen no slackening of interest in patent companies. Peter Holden is the partner who purchasing,” he explains. heads up the firm’s IP Investment Group. There is now every indication, Epstein He expects to see many more patents says, that having started to view patents as coming to market − a positive development capital assets, investors (including hedge for his business, which focuses on acquiring funds and private equity funds) are looking and leveraging large portfolios of IP from at how to channel money into IP. “The leading corporations: “We’ve had a market is liquefying now and, as this securities crisis and a credit crunch, and happens, investors are becoming we’re just now starting to see significant increasingly interested in it,” he concludes. pressure on corporate earnings with the Ron Laurie expects to see some of these effect that firms will look more to the near- investors looking at arbitrage opportunities term sale of non-core assets as a means to

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Patents and patent managers: shining stars in a dark economy? meet their quarterly targets.” In the first instance, he says, a lot of these sales will dispose of lower-quality patents – such as those marked for The financial world may finally be ready abandonment. But as they continue to look to recognise patents and patent managers as to plug deficits in earnings and discontinue tomorrow’s shining stars of asset non-core or underperforming business management. activity, a secondary cycle will develop Patent portfolio management software, where higher-quality patents, and in greater and objective patent quality rating systems, numbers, will start to come onto the introduced after the 2001 FASB Report, are market. Holden references several third- deployed today by the most forward-looking party efforts at sizing the IP trading corporations. By using computed quality marketplace that show a range of annual metrics (as a proxy for the economic value of global purchases of patents, either directly patents and portfolios), the quality of a or intermediated, ranging from US$1.5 patent portfolio can be measured and reliably billion to US$2 billion last year. He expects managed. to see these (probably conservative) In fact, computed data directly supports estimates rising by between 20% and 25% management decisions related to today’s over the next few years, with the slack from most urgent corporate objectives: slash corporations being taken up by a new costs and increase revenue. Day-to-day generation of financial, quasi-governmental tasks include patent acquisition, portfolio and private pool patent purchasing entities. In 2001, Baruch Lev, professor of accounting pruning, assertion and licensing campaigns, and finance, Stern School of Business, accelerating R&D and gathering competitive The need for a standard New York University, forewarned: “Investors business intelligence. Custodians of patent Underlying contributors to the financial crisis have something to lose … if investors don't assets are exclusively positioned to deploy have been shown to be certain types of know about intangibles, they are going to these tools, bringing effective intangible financial innovation and a lack of assume the worst. In capital markets, no asset management to the forefront of transparency. This, most commentators agree, news is bad news.” corporate asset management and reporting. could well spur an intensifying focus on IP Paradoxically, a 2001 FASB Report In a spirited debate at a recent valuation methods in the months to come. created an intangible asset reporting loophole, conference, a few senior IP counsel said they Whether or not a valuation standard is noting: “Companies’ inability to identify and would use “people, rather than tools” to feasible is another matter. Although most inventory intangible assets may be the most provide patent portfolio due diligence and agree that the existence of a standardised significant obstacle to any comprehensive evaluation. The notion that “people” could and agreed standard for patent valuations recognition of intangible assets.” provide objective and complete analysis of would go some way to building the level of Although PricewaterhouseCoopers portfolios containing thousands of patents investor confidence in this asset class that showed that 70% of the market value of the within a fiscal quarter, let alone annually, was could help it grow, the obstacles that stand S&P 500 companies was attributable to strongly challenged by those now using in its way are well recognised. intangible assets, Adams (Trevejo-Darko, software tools. Arguably, non-use of available There are a number of initiatives Adams and Bouchard, “Intangible patent measurement solutions could underway geared to creating some kind of Compliance: Capturing Overlooked Value”, constitute willful negligence. valuation standard for intangibles, but any Les Nouvelles, March 2008) concluded: The undeniable fiduciary responsibility of widely accepted system still remains some “The average ratio of reported intangibles all CXOs is to create, protect and grow way off. Andy Gibbs, the CEO of PatentCafe [reflected] a non-compliance level of 91 shareholder value. The failure of CXOs and chairman of the Intangible Assets percent! In any other category of financial effectively to manage tangible assets has Metrics Committee of the Intangible Asset compliance, such a level of non-compliance created an opportunity for the chief intellectual Finance Society, puts the efforts in would not be tolerated.” property officer to have a profoundly positive perspective: “I don’t think that we should I believe that a host of shareholder impact on shareholder value. expect to see any mechanism for calculating derivative suits will cite declining stock value As chief patent custodians are elevated the economic value of intangibles − for one reflecting C-level executives’ to key corporate asset management thing, I can’t see any hope of the underlying mismanagement of the tangible assets; and positions, their ability to create shareholder algorithms being agreed by the key players.” that will be despite their use of mature value is met with corresponding shareholder And even if they could agree on an accounting systems and legions of finance accountability. The new shining stars will be economic model, it would have to reflect the and accounting professionals. Alarmingly, noticed. wider global economy. That, says Gibbs, is these mismanaged assets represent only the just too volatile right now. However, there subordinate 30% of market cap value. are some changes afoot, he believes: “The How, then in these dark days of market is heading towards a system that will collapsing , can CXOs allow for a universally accepted method of demonstrate effective management of the Andy Gibbs, CEO of PatentCafe and establishing a qualitative value and other 70% of shareholder value; specifically, Chairman, Intangible Assets Metrics converting that to a quantitative measure.” intangibles? Committee, Intangible Asset Finance Society Epstein agrees that a valuation standard will be almost impossible to achieve: “I just www.iam-magazine.com Intellectual Asset Management January/February 2009 45 Boom or bust

Implications of the coming downturn for the IP services industry

cash, they will take a hard look at all areas, even in the best of circumstances, is uncertain including their IP and legal departments, in and risky; and technology licensing, while not an effort to reduce or eliminate some or most adversarial, is a time-consuming process that discretionary spending and defer yields little short-term benefit. One potentially investments in areas that do not a quick overlooked area is licensing. payback in terms of revenue or profit upside. Deals can be concluded relatively quickly and The pressure on IP departments to cut costs can be structured in a mutually beneficial will be exacerbated by the fact that, in most manner. They can bring incremental, high- companies, there is limited understanding on cashflow to the licensor and an the part of business executives about the opportunity to gain share in turbulent markets role and value contribution of IP in helping a for the licensee. company meet its financial and strategic We in the IP services industry have a great objectives; that is, most of what is done in opportunity to help our clients navigate the IP department probably appears to be through these treacherous times. With our discretionary, non-value adding activities. IP expertise and advice, we can help IP service providers can expect to face departments make the best possible trade- significantly reduced demand and downward offs between short-term cost reduction and price pressure for the portfolio assessment, monetisation pressures, and the need to Times of economic uncertainty present valuation and strategy services that they maintain, develop and exploit an IP portfolio significant risks to all participants in an have traditionally provided. that meets the longer-term strategic and industry. Less well understood, perhaps, is The upside, of course, is that many operational needs of the business. Those IP that market turmoil presents the opportunity companies that have historically avoided groups that get it right will clearly be seen as for stronger, more aggressive players to gain selling and/or licensing IP will be more open- major contributors to their company’s near- share and restructure the rules of minded about these cash-generating activities term profitability and cashflow, and to the competition. The IP services industry, looking as a way both to reduce some of the creation of sustainable market value. Those IP into 2009 and beyond, will be no different. budgetary pressure that IP departments will service providers that prove to be most adept The pressures that our clients (in face and to justify the department’s role as a and cost effective in helping their clients ThinkFire’s case, primarily technology critical, value-adding part of a company. It will accomplish this will be the winners as well. companies) are facing will clearly have an not be easy. For patent sales, there will be impact on our industry’s growth and fewer buyers and they will have a focus on Steven J Hoffman, president and CEO, profitability. As companies seek to conserve quality and lower prices. Patent licensing, ThinkFire don’t believe that IP is an asset class that the Bilski case to have a significant impact lends itself to any standardised valuation on valuations. Goldman Sachs’ Squires is methodology. I am not aware of any asset one of these: “The decision in Bilski could class that has an objective valuation method mean that from now on there will be a − all are dependent on markets where premium placed upon innovations that are subjective variables play a critical role. Even built out, versus paper patents. This could in the currency markets, valuations depend favour more of an incubator model for on a number of subjective measures, such as companies. In other words, we will see the potential effect of debt and inflation, valuations becoming more closely correlated and patents are so much more subjective.” to underlying products and services.” But other practitioners are more optimistic. Professor Alexander Wurzer, Driving to transparency and real IP Director of the Institute for Intellectual The crisis has prompted widespread Property Management, Steinbeis- discussion of the merits, or otherwise, of University, Berlin, is one: “I am working fair value (mark-to-market) accounting as with the DIN (German Institute for the means by which the value of complex Standardisation) for the German Ministry financial assets held by banks, insurers and of Economy on a research and development other companies should be reported. What project about patent valuation standards. A differentiates fair value accounting is that it year ago, we offered our first proposal for requires companies to mark-to-market such a standard to the US and were told that financial assets such as securities and nobody needed it. Now the financial crisis derivatives, and to value them at the price at is changing all that.” which they could be sold, rather than at the Some expect the US Court of Appeals cost for which they were acquired. In the for the Federal Circuit’s recent decision in recent credit market conditions, the market

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for many of these assets shrank or virtually application of these rules were to [embrace Greater disappeared, forcing many banks and intangible assets], I believe that greater companies to make massive write-offs. transparency around IP would certainly transparency Although critics of fair value claim that generate more value as there would be less its measurement requirements can produce perceived risk attaching to IP assets.” around IP would inaccurate or arbitrary results under The expected upsurge in patent sales unusual market conditions, investors are can, most agree, only be a positive certainly generate generally in favour. This is largely because development, helping to create a much more of the added insight fair value accounting liquid IP market. This will, in turn, enable more value as there provides into a company’s current financial much clearer and potentially higher situation. The wider argument now, in light valuations. “During this financial crisis,” would be less of global calls for transparency, is whether says Oppenheimer’s Lozan, “the price of fair value could or should be extended to mortgage bonds decreased in part due to the perceived risk other non-financial assets, including lack of liquidity. Liquid markets in IP are intangibles. Ocean Tomo’s Andy Carter only now starting to take off and these can attaching to IP observes: “It may be true that these only lead to increased visibility and accounting rules caused some companies potentially higher values.” assets and banks to fail. But I personally don’t It looks likely that we will see a think that this was the case. And if wider derivative model of IP emerging, where the

A wonderful buying opportunity immediate impact on their businesses, rather than the larger, longer-term and more strategic plays. As with R&D expenditures, though, Japan and Korea (and more recently Taiwan and China) will continue to acquire IP actively with a longer-term perspective in mind; while US and European firms − that are more quarterly earnings-driven − will have reduced IP acquisition budgets. Price inflation on patent purchases, fuelled by the increased intermediation of IP transactions (though high-end transactions will continued to be managed directly by corporate sellers) and increased demand, will level off considerably in 2009. The financial crisis is forcing fringe buyers, such as hedge funds, banks and PE firms, to retrench from speculative IP investing to focus on asset triage and core activities instead – we have started to see a flush of sales from these entities recently. This is somewhat offset by increased activity by global sovereign funds IP as an investment-grade asset class is, of and government initiatives in the Middle East course, not immune from the financial crisis and Asia, particularly those that may have a and the impending corporate earnings regional economic development rather than a erosion. But at the same time, there are pure market-driven focus. some counter-cyclical aspects to IP investing In short, we see this as a wonderful buying that are very compelling. opportunity, while recognising that the gains On the supply side, I see leading global one may make on cheaper, better-quality corporations increasing the quality and assets will be metered by the longer runway quantity of their sales offerings for two and increased management costs required to reasons: in order to create liquidity to meet leverage these assets − at acceptable levels of business unit or corporate-wide earnings ROI − subsequently in the marketplace. targets; and to de-risk their IP monetisation programmes with outside capital partners Peter D Holden, partner, IP Investment and management teams. Group, Coller Capital On the buy side, corporations will engage in smaller, more tactical acquisitions to fill in The above are personal opinions which do shorter-term holes in their portfolio or for not necessarily reflect those of Coller Capital counter-assertion purposes with an and its investors.

www.iam-magazine.com Intellectual Asset Management January/February 2009 47 Boom or bust

The vital role of insurance paying attention will appreciate that this has mortgage instruments underlying the now been done and we have the answer. derivatives. First, the markets will struggle to establish In keeping with its mission of education, value. This will manifest as unprecedented advocacy and the promulgation of asset price movement and record-breaking management best practices, the Intangible volatility. Second, market authorities will Asset Finance Society audaciously proposes seek to communicate value through non- a theory. Here it is: to create or protect – that conventional channels and proxies. This will is, insure – value in the intangible assets, manifest as political and economic summits such as safety, security, quality, integrity, and policy pronouncements. The markets sustainability and innovation, which underlie will respond with hope followed by a period , intangible asset financial of reflection. The effects of reflection depend stewards must: (i) manage the business on the strength of the markets’ belief processes underlying these assets; (ii) use an systems. These, it appears, have been independent financial metric (index) or other battered by political dithering. Irrespective, proxy to provide measurements for that the fluff best be followed quickly by which is being managed; (iii) signal the substance because markets respond poorly reasonable value of these assets; and (iv) to missed expectations. deploy insurances to increase stakeholders’ This brings us to the third piece, which is confidence in the signalled value. action by the authorities to establish value by And a final thought. In 1970, Joni proxy. So far, this action is taking form in Mitchell’s Big Yellow Taxi advised: “Don’t it guarantees and capital infusions. The always seem to go, that you don’t know what Experiments of nature are epistemological guarantees, such as raising the insurable you’ve got till it’s gone.” We now know the gifts that test our models of the world limits for deposits or underwriting inter-bank collective value of the intangible assets that without the nasty morality bits. We could loans, seem to be doing their part in drive the reputation of the global banking never have purposefully tested, for example, restoring confidence, another key intangible. system: US$30 trillion. the market consequences of suddenly This affirms a central role for insurances in transforming conventional balance-sheet intangible asset finance. Fourth and last, the Nir Kossovsky, chief executive, assets, tangible assets, into intangible authorities will develop business processes Steel City Re LLC and executive secretary, assets. Anyone owning equity securities and to manage and create value better in the Intangible Asset Finance Society most valuable IP will be recognised as that Instead, a lot of collaboration is needed to which derives its value from commercialised make them deliver value. “If licences are to products or services. This, in turn, will be transferred in the ,” he mean that companies will have to be able to continues, “then there needs to be some show that their IP is properly aligned to know-how involved as well − all of us would their overall business strategy. Many agree prefer to see patents come in a package that that, as a result, this could be a defining offers a value proposition to licensees.” period. Companies will have to be smarter about IP management and boards will have Using the capital markets to get more involved in IP. And With the shattering of confidence in many conversations between both camps will have financing structures built upon tangible to get much more sophisticated. assets, most commentators expect to see This focus on real-world IP will be companies putting their IP assets more to intensified by the financial crisis. Investors the fore to prove that they have valuable will attach greater value to rights that work collateral backing them up. Harder IP assets, and have not been removed from their such as patents, are likely to be favoured creators. Michael Martin is a private and, with a lot of capital rumoured to be investor in IP, based in Palo Alto. Since the waiting on the sidelines for a good home, Bayh-Dole Act, he explains, there has been there seems little doubt that companies an increasing trend in the US towards the with well-defined IP portfolios will be best separation of patent ownership from the placed to take advantage. “From now on, teams that actually did the work in creating investors are going to be a lot more the IP: “We have a lot of universities demanding,” says Squires. “Companies will working with corporations, with companies have to be able to show that they have investing in commercialisation in exchange robust IP portfolios and this, in turn, will for patent rights. But that dynamic − where call for more and better due diligence by IP rights are removed from the original professionals.” inventors − is responsible for a lot of the Andy Gibbs also expects there to be no dysfunction that we’re seeing.” Patents, says shortage of capital − and no drying up of IP Martin, can’t just be taken and used. financing mechanisms. “Notwithstanding

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the meltdown we’ve been seeing, the the importance of intangible assets to financial mechanisms that have evolved in companies will help to ensure their value is the IP industry will continue to operate,” he maintained and leveragable: “Until recently, says. He explains that this is because all of we saw people putting blind faith in the the markets that are collapsing now are rising value of property. But logically, why based on tangible assets, such as should houses have been selling for so much commodities and real estate. With money more than the value of their component being withdrawn from those markets, an parts? With companies, the principal source inordinately large pool of capital is being of value has been proven to be intangible freed up for investment elsewhere. “Put assets and these are still seen as solid and simply, with tangibles temporarily off the conservatively valued.” While a collapse in map, intangibles are set to become very hot the tangible value of homes was probably property,” Gibbs sums up. long overdue, says Carter, it is unlikely the For a while now, the asset-backed same thing will happen with regard to IP- securities (ABS) market has been moribund. backed lending. “I would expect that to Jay Eisbruck of Serengeti Asset increase − ideas are what matters and, from Management – and formerly managing now on, innovation is the one area where director in Moody’s Investor Services’ the US must really look to compete on the Asset-Backed Finance Group – expects that global stage,” he states. while some of the deals that got done Carter goes on to point out how previously will come onto the secondary innovation, measured in terms of patenting market, the new issue market will be quiet activity, is generally not affected by for some time yet. “It’s hard to say what the economic downturns. He observes that longer-term effect will be on structured IP patent filings per capita in the US were financings. Without doubt, it will take some stable from the late 1800s until World War time for the market to come back − the Two and then again from after the war until same as it will for other types of 1990. “During those periods America saw securitisation deals. The capital markets booms, busts, bubbles, panics and need to calm down before we can see a way numerous technology and market shifts,” ahead,” Eisbruck says. Carter says. “Yet patenting activity was For his part, Andy Carter believes that fairly stable. Why? Because there is a

Effect of the financial meltdown on the patent trading market be counter-cyclical, more high-value patents will be acquired by operating companies to settle litigation or deter attacks by commercial rivals. Second, institutional the likely effects of the pain in the debt and investors that have substantial sums under equity markets on the patent trading market? management but have soured on the credit On the supply side, larger corporate and equity markets may turn to patents as a patent owners unable to finance operations new alternative investment asset class. Even via commercial paper and other short-term before the financial meltdown, a number of debt, or mindful of the effect of an anaemic patent funds were financed, in whole or in income statement on their stock price, will part, by institutional investors, including turn to their patent portfolios as a source of Intellectual Ventures, Altitude Capital, operating capital. This will increase the Rembrandt IP Management, NW Patent number of patents available for acquisition Funding, RPX and IPCom. The question is and will drive prices down as patents change whether institutional investors will accept the hands under fire-sale conditions. Obviously, limited liquidity in the patent market and the the first to go will be patents that are not lack of reliable valuation methodologies for core to the owner’s business or which do not assessing the various types of risk discount provide defensive protection against applicable to patent value such as invalidity competitors with aggressive licensing risk, design-around risk and narrow claims programmes. In addition, smaller venture- construction risk. To the extent that these backed companies may sell their patents in sources of risk uncertainty can be reduced, Since the credit freeze and resulting equity exchange for a defensive grant-back licence or at least managed, more institutional collapse began in early October, there and cash in order to get them to the next will flow to the patent trading market and to has been a lot of speculation in intellectual financing round. companies that are players in that market. property circles about possible implications On the demand side, there are two for the nascent but rapidly expanding market potential drivers. First, because patent Ron Laurie, managing director, Inflexion for buying and selling patents. So what will be litigation between commercial rivals tends to Point Strategy, LLC

www.iam-magazine.com Intellectual Asset Management January/February 2009 49 Boom or bust

New IP business models IP in the form of patents has already ex ante rather than building their business been established as a viable source of and defending against patent infringement could struggle revenue in the biotech and pharmaceutical litigation ex post. industries in which the present value of Unfortunately, the current financial exclusive rights (eg, to sell a particular crisis will be a headwind against any medical device or drug) can be valued in the IP-based business models that are new to hundreds of millions of dollars. The success a particular industry. Given the current of private equity firms in these markets, such litigation-driven dynamics, any new player as Paul Capital and Royalty Pharma, may in these markets will have to operate at even accelerate through the current financial considerable scale and the backing of crisis as some institutional investors may institutional investors necessary to achieve begin looking for sources of cash flow such a scale is going to be difficult as many outside of traditional fixed-income securities. of these institutional investors are suffering In other industries, transaction costs from major losses. On an optimistic outlook, associated with the financing, development the current players such as Intellectual and transfer of IP have traditionally Ventures and Paul Capital will generate amounted to a more substantial proportion of high enough returns to generate excitement the expected value of the IP. In these about new entrants. On a pessimistic industries, investors and company managers outlook, IP-based business models will have typically ignored IP until much later in suffer terrible returns as royalty streams dry the cycle of development of new products or up along with the revenue of entire markets services, or at least until a point in time at as the financial crisis spreads to the rest of which the present value of exclusive rights the economy, including the technology First, it is important to distinguish between could better be estimated. Over the past 10 markets. I tend to be optimistic because investments made in IP for the purpose of years and continuing on today, however, the I believe that market crashes tend to create increasing the equity value of a company transaction costs of IP procurement have opportunities for good companies at the versus investments made in IP for the been declining. This is largely due to the same time they bankrupt bad companies. purposes of generating revenue from other dramatically reduced costs of But the dynamics are far too complex, and companies using the technology. The former communication and search made possible changes too fast-moving, for any predictions will decline at many companies because of by the internet. We are now arriving at what to be reliable. the weakness in credit markets, which makes is perhaps the first moment in history in R&D more expensive for most companies. which it will be cheaper for companies in any Michael Martin, founder, Venetian Capital The latter presents a more complicated story. industry to identify and acquire or license IP Management constant demand for innovation, regardless investment and risk transfer involving of the short-term fluctuations of the intellectual property and other intangible business cycle. So, barring a world war or assets. He also reports that activity in the other calamity, the supply of intangible ABS markets has slowed to a crawl, but assets to the markets is not set to contract.” points to other initiatives where his team is Alexander Wurzer agrees that it would currently involved: “We’re working on a be wrong to write off IP financings via the number of different opportunities, some of capital markets: “In the wider market, them involving the capital markets for IP- people invested in assets which they didn’t related risk transfer, supplementing what understand. Mortgages are obviously has already been done in the insurance something solid from the physical economy, markets. And overall, and notwithstanding but the investment products themselves all the turmoil out there, we’re optimistic were strangely configured. What I think will about the products we’re developing.” happen, and what we’re already seeing Lucier explains that risk is a major among banks in the US and in continental underlying theme in much of his work, Europe, is people being increasingly keen to mainly advising Fortune 100-type understand what IP assets have to offer. companies. He continues: “These clients are They want to understand the risk structures not looking at funky IP-based financings to of these assets and I’m convinced that this raise capital. But they are very aware of and greater interest will stay.” concerned by risk exposures. The fact that even Berkshire Hathaway has seen its credit Innovation doesn’t stop default swap spread increase by nearly 100 Innovation is a constant. Patenting activity basis points since the beginning of October is not impaired by economic downturns − underlines just how risk-averse the and neither is financial ingenuity. Marc marketplace has suddenly become.” Lucier is a director at Deutsche Bank in In the capital markets, one way of New York focused on asset finance achieving risk transfer for property and

50 Intellectual Asset Management January/February 2009 www.iam-magazine.com Boom or bust

casualty losses caused by natural disasters don’t know how to model it and they need has been via catastrophe bonds (or cat to find a way of mitigating the high degree bonds). With these instruments, the of moral hazard.” insured retains some risk, insurers take the As a result, Lucier continues, it has been next level and the cat bonds cover the rest. impossible to carry out pure IP risk transfer Although this is still not a huge market, it is − so his team has been focusing on growing. But, Lucier points out, this growth developing products that go as far as did not start until a methodology was possible towards this objective: “There is developed for predicting damages. “That’s definitely interest in uncorrelated and something we still don’t have for patent innovative investment opportunities where infringement-type liability − and there will investors can identify some long-term be problems involved in arriving at this sort potential. In the long term, because of the of methodology,” he says. “Another obstacle fundamentals of IP as an asset class, I’m is the fact that moral hazard with patent optimistic it won’t be affected by the crisis. infringement risk exists to a far greater Indeed, IP will attract greater interest extent than it does with hurricanes. So this precisely because of its fundamental role in is limiting the capital markets’ interest in IP driving value in our economy.” risk right now. In other words, they still The attraction of royalty As companies seek out alternative routes to Problems for non-practising • With diminished sales of products and capital raising, certain players in the IP services, the amount of royalty due under finance community appear well placed to entities existing or new licences will diminish. The take advantage. “The financial crisis will result will be that non-practising entities slow down some areas of IP monetisation a (NPEs), relying primarily on contingent lot,” claims Michael Martin. “But there will law firms, will experience greater difficulty be exceptions – for example, the biotech arranging for contingent representation. market where the royalty streams are • Whether patent assertions are by operating relatively easy to quantify. To the extent companies or NPEs, they will face a more that the funds already operating in this hostile and less receptive audience, secondary market can point to consistent significantly extending all but small (sub- royalties, they should find it easier to million US dollar) settlements, even for attract investment.” robust assertions, as companies seek to Royalty Pharma is one such player, preserve their cash and profitability. investing in royalty streams in the • Those companies with technology biopharmaceutical industries. Its senior VP, leadership and differentiating, proven Mike Herman, sums up the business know-how may find a more welcoming climate: “Sales of royalty streams are licensing environment for technology increasingly being looked at as a real transfer as companies seek to reduce their alternative to raising equity capital. Because own R&D expenditures, while the method of financing that we provide is simultaneously gaining access to features product driven, not market driven, it and functions that may improve their remains very consistent. This means that ability to win more business in a shrinking companies can use it to access capital, The financial crisis itself would have had market. But the licensor must be patient to whether or not their stock price is a negligible effect on intellectual property participate in the upside (rule: patient, win- depressed and irrespective of market matters. However, the broad-based global win deals will gain from the downturn). fluctuations.” recession that is underway, and likely to • Companies with excess patents will seek Focusing on human healthcare, Royalty deepen, will significantly impact on to divest portions of their portfolio, as will Pharma currently holds around US$5 billion intellectual property practices over the next failed and failing companies. Allied in assets. Its business model centres on several years: Security Trust will benefit from this buying up royalty streams flowing from • Operating companies will seek to enforce occurrence given its ability to combine products in the pharmaceutical and biotech patent rights as a means to bolster funds to purchase patents, or licences to industries, providing liquidity to their sagging profits (notwithstanding the fact patents, that may otherwise fall into owners and assuming the ongoing risks and that, given the three to five-year period adversarial hands. Sellers will benefit rewards. Herman maintains that the required to resolve patent disputes from a robust market that will remain for business has experienced a significant involving sufficient royalties to have a patents of interest to companies most uptick in activity since the onset of the material impact on large company P&Ls, targeted by NPEs (high-tech, financial financial crisis: “With cash levels so low such efforts may in fact diminish near- services, medical devices and retail). and the need for funding so robust, we’ve term profitability as enforcement costs noted that people are getting much more are incurred – a reality too often Daniel P McCurdy, CEO, Allied Security interested in what we have to offer.” overlooked). Trust and chairman, PatentFreedom Structured as an evergreen fund rather than as a series of closed-end funds, www.iam-magazine.com Intellectual Asset Management January/February 2009 51 Boom or bust

Royalty Pharma has been attracting storm clouds: “No one will escape from increasing levels of institutional this crisis. And there’s no reason why investment, as Herman goes on to explain: intellectual assets should escape either. “People invest in us at a It’s not so much the financial crisis, but which includes all the royalty streams we’ve the fall-out from it that will be serious. invested in so far and there’s no question The global recession will be profound and that institutional investors have become demand for products and capital-spending much more interested in us as an alternative projects will decline. So money for asset class.” While declining to disclose the enforcement, innovation and licensing will level of return that investors in Royalty all be in shorter supply.” Pharma’s fund can expect to receive, he And McCurdy is not the only one. “The says: “We’re investing in intangible assets danger facing all of us in this industry is that are single product-based. This makes that the regulators will now try to enforce these assets riskier than debt instruments, too much rigidity onto the marketplace. It’s so the returns are correspondingly higher.” conceivable that they will attempt to nail Currently invested in around 24 royalty down asset classes more tightly − rather streams, Royalty Pharma has built up a than focus as they should on the broad-based network spanning researchers, transparency and complexity of the asset,” academic institutions and biopharmaceutical says Ken Jarboe of the Athena Alliance, a companies. This means that it offers non-profit organisation dedicated to public investors a diversified portfolio. And, education and research on the emerging relatively long-established, it is able to tap global information economy. “If that into low-cost capital − a real barrier to entry, happens, pension funds and other major Herman believes, for other companies that institutional investors could be prevented may be enviously eyeing his business model. from investing in anything other than tightly defined ‘dirt’ assets. If there’s a Looking ahead flight to that level of safety, then we’re all in But while the general mood may be upbeat, trouble.” This means, he continues, that the not everyone is optimistic about the arrival IP industry needs to be on its guard. “Right of a brave new world for IP. Dan McCurdy, now, everyone is in fire-drill and blaming chairman of PatentFreedom LLC, cautions mode. And when you’re putting out the fire, that there is no immediate prospect of a you’re not talking about where to install silver lining to the financial and economic new sprinklers and smoke detectors,” Jarboe

The patent market in a troubled increase their purchasing, and the risk of the tech crash in 2000, patent litigation NPE assertions to increase. Product against large technology businesses time companies will need to seek new defensive increased dramatically. We expect a similar patent strategies to augment their traditional trend to develop in 2009, with more quality strategies to restrain NPE assertion costs. portfolios in the market, new NPEs being Three factors will drive increased patent formed and offensive patent assertions supply (sellers): first, increased issuance of increasing. patents; second, increased sales of patents Additionally, NPE litigation statistics for from companies seeking to reduce their 2006 through September 2008 show an overhead or increase their cash, or from increase in NPE-based litigation in the US distressed company sales; and third, the from 10% in 2006 to 16% in 2008. This trend growing appeal of improved liquidity for should accelerate in 2009. inventors from public auctions such as Product companies can expect increased Ocean Tomo. NPE risk and costs in the 2009 recession. IP demand (buyers) will shift as the 2009 Current defensive strategies will not keep up recession affects corporate budgets. Product with the increased supply and demand shift companies will decrease their budgets for IP in the IP market. They should invest in new purchase or extend their review processes, defensive strategies. Joining a defensive thus reducing purchases. NPEs will increase patent aggregator allows IP management to their buying in the market. Overall demand reduce their NPE risks and costs, at lower may remain constant, but NPE purchasing net cash outlay and with less staff time. In a will increase in 2009. recession it will be a key new tactic for cost We expect the supply of patents for sale to Litigation history indicates clear reduction and risk management. increase during the recession, the demand to increases of patent litigation against shift as product companies constrain their technology companies in and following David Ruder, VP business development, budgets and non-practising entities (NPEs) recessions, especially for non-US firms. After RPX Corporation

52 Intellectual Asset Management January/February 2009 www.iam-magazine.com Boom or bust

Moves to put patents on the pretty dead at the moment, as is the market expected that in the future there will be a for IP-based papers. But there is also a good requirement to include patents in the balance balance sheet side to this. Financial institutions are now sheet. This requirement to capitalise will trying to gain a comprehensive provide a more transparent picture of a understanding of the risks involved. Instead company’s situation for investors and capital of ignoring risks, they have started an providers. This is a positive signal for capital intensive analysis of the asset IP. This will market communication in times where there is prevent careless or useless investments in IP a demand for capital, but a high risk aversion and should help to avoid an IP investment on behalf of investors. At the same time, the bubble. The requirements for evaluation and new requirements will increase the pressure risk analysis have increased considerably. on companies to capitalise those assets. This is a good opportunity for high-quality Improved evaluation principles, transparent services and badly needed standards for risk analysis and funding requirements will transparent evaluation. increase utilisation of IP-based financing. In the months to come even companies We will very likely see a growing number with good ratings will have difficulties in of companies failing and falling into obtaining outside capital financing, above all insolvency despite having good technologies medium-sized companies. Even companies and good IP. Therefore, more IP will be big enough to turn directly to the capital available following insolvencies. Due to the market for funding will have difficulties in pressure for capitalisation, the market for IP satisfying their funding requirements. This is will increase as companies have to use all a good opportunity for IP-based financing their assets to generate liquidity. This will solutions, which had previously been more eventually intensify the activities of patent The current financial market crisis affects expensive as a rule when compared to trolls, offering investment opportunities for four different fields of the IP community and similar concepts for tangible assets due to those with capital who are currently avoiding the evolving IP business: the financial market the extensive analysis necessary. Debt- the equity markets. for IP; financial service providers; companies; based solutions and sale and lease (license)- and the market for IP. back concepts will gain . Professor Alexander J Wurzer, director of The market for securitisation such as In Germany, a far-reaching revision of the the Institute for Intellectual Property CDS, ABS or other commercial papers is Commercial Code is under consideration. It is Management, Steinbeis-University, Berlin

says. “Starting soon and continuing over the opportunities. If the downturn does next six to 12 months, however, the translate into an upsurge in patent sales, regulators are going to be looking at long- this could spin out a number of benefits: term prevention measures for the years market liquidity would increase, valuation ahead. This will be a key time for methodologies would come under the professionals in this industry to start spotlight and a standardised valuation getting actively involved in the policy process might emerge. For their part, debate that is set to develop.” institutional investors – disenchanted with Although unwilling to speculate too pre-crisis investment vehicles – may begin much in the midst of such volatile times, to target very significant allocations to most of the IP professionals interviewed for intangible assets, provided they can be this article believe that the long-awaited IP shown to be based on high-quality IP. And boom will have been given a helping hand financial institutions might reassess IP as a by this financial crisis. But don’t expect any valuable financing tool. hugely dramatic developments − the brave Summing up, it looks like there could be new era will take time to arrive. “I believe plenty of opportunities over the next couple that it will take another five years for us to of years. Then it will come down to people have a market for the effective transfer of IP having the courage of their convictions and value in Europe,” says Wurzer. “We need to being prepared to invest when times are see value coming from the expectations of tough. Those that do make the right IP buyers − that’s what’s really needed to decisions will emerge very strong when the drive the market. Until now, IP markets green shoots of recovery start to appear. We have been very idiosyncratic. From now on, could be about to enter a defining period in we need to see plenty of standardisation the development of the IP marketplace. and liquidity. We still need more time and more confidence.” There is no doubt that times are tough and all types of IP professional have to work Nigel Page is the finance editor of a lot smarter. But despite the warnings from IAM magazine McCurdy and Jarboe, there do appear to be [email protected] www.iam-magazine.com Intellectual Asset Management January/February 2009 53