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Intangible Assets in Capital Markets

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Intangible Assets in Capital Markets Capital choices Intangible assets in capital markets IA for development and commercialisation As intangibles emerge as an asset purposes, even before start up. While funds class, financial firms are developing and firms often differ in structure, these a variety of mechanisms to utilise enterprises work with companies either to buy the IP/IA or invest in the company for them in the capital markets commercialisation of the IP/IA. Due to the private nature of private By Ian Ellis and Kenan Patrick Jarboe equity deals, many details about this group of firms and funds have not been disclosed. Over the past decade, intellectual capital has The large investment bank Deutsche Bank become foundational for many companies, (DB), however, announced publicly that it is while intangible assets – such as currently managing three IP funds totalling intellectual property (whether patents, more than €150 million invested in IP trademarks, copyrights or trade secrets), assets. Partnering with IP Bewertungs AG, brand value, corporate reputation, franchises DB has identified and purchased IP assets and human capital – have emerged as a for further legal and commercial refinement valuable asset class. The capital markets and to be sold and/or licensed. financial system have responded to this Another IA-focused firm, IgniteIP, calls shift. Financial firms have invented new itself a “full-service IP placement vehicles and updated existing models to enterprise” that works with inventors, IP provide capital to companies with owners and investors to commercialise significant value in intangible assets (IA). and/or license IP. IgniteIP’s model differs Based on published reports, we have from the traditional VC model in that it has been able to identify examples of the array paid attention to IP development nearly of models for equity and debt financing independent of the business itself. In one targeting intangible assets. It should be case, IgniteIP developed a new licensing noted that the details of the cases below are model for a new mining technology after occasionally limited by the private nature of the inventors failed to develop business the transactions. Many of the firms engaged around the technology. in IA finance are solely private companies and therefore do not publish much Blended equity–debt models transactional information. A number of financial firms, such as Silicon Valley Bank, Square 1 Bank and IA-focused equity investment Sand Hill Capital, blend the early stage Large investment banks and boutique focus of the VCs with the lending private equity firms alike have begun raising competence of banks. In most venture debt and investing funds targeted at intellectual cases, the investing firm establishes an property and other intangible assets. interest rate on the debt, taking into Broadly defined, these firms are targeting account the viability of the company and the traditional venture capital space, looking the current funding structure, as well as for promising early stage innovation and the reputation of the company’s current inventions. However, rather than looking for funders. On the equity side, the deal will entrepreneurs and start-up companies, also include warrants in the company to these firms are looking to invest in IP and buy shares at a fixed price. 56 Intellectual Asset Management May/June 2010 www.iam-magazine.com Capital choices It is becoming more commonplace for IP assets to be written into the contracts governing broad asset-backed loans, either as a separate asset or as an integral part of overall company value There is another set of private equity already well developed and take many forms. firms that target investments in companies Consumer loans, such as home mortgages with a critical focus on IP and intangible and auto loans for individuals, are the staple assets. These firms are not necessarily of the credit and banking system. Inventory targeting raw or undeveloped IP assets for and equipment loans for businesses are the purpose of monetising the IP itself available from either traditional banking through licensing. Rather, they look for sources or from specialised asset-based early stage or start-up companies with lenders. Specialised asset-based lending integral IP assets for the companies’ includes assets such as accounts receivable intended markets. In essence, these firms and extends from straightforward loans to screen their deals by looking for critical IP complex lease-back arrangements. and the overall cash flow the companies Similar to these transactions, intangible generate. These models also often utilise a asset–backed loans (IABL) use IP or other hybrid approach to equity investing, similar intangible assets to secure a loan. Such to the venture debt market. financing may be rare but has a long history. For example, Altitude Capital has The first trade secrets case in the United invested in 16 companies since the firm was States involved the debt on a bond secured created in July 2005. According to its in part by a secret chocolate-making promotional materials, it specifically invests process in 1837. In 1884, Ara Shipman in “portfolio companies that have valuable loaned Lewis Waterman US$5,000 to start a patents, trademarks/brands, copyrights, pen-manufacturing business, which was royalty streams, trade secrets, and other secured by Waterman’s patent. intangible assets, which will create a Much of intangible asset-backed lending competitive advantage in creating value”. may be invisible. Intangibles have always Altitude has structured a variety of been included in a blanket lien on all assets. transactions, providing common equity, In these cases, the IA is not explicitly preferred stock and subordinated or secured identified or incorporated into the terms of debt. For example, its investment in the loan. Thus, the collateral value of the Intrinsity Inc. used an equity–debt assets is not recognised and the borrower combination of Class E preferred stock and may not receive all of the capital they could senior secured notes with warrants. qualify for. Newlight Capital is another firm However, it is becoming more focused on IP venture debt investments. commonplace for IP assets to be written Newlight’s model focuses on intellectual into the contracts governing broad asset- property because, the firm’s materials backed loans, either as a separate asset or suggest, it is traditionally undervalued as an integral part of overall company value. compared with accounts receivable, durable For example, Smithfield Foods company goods, inventory and so on. After Newlight received a US$1 billion revolving credit values the IP, it issues a broad security facility from JP Morgan that was secured by package for a term loan with interest and first-priority liens in the company’s and its warrants in the company. US subsidiaries’ cash, intellectual property, equity interests in the subsidiary Intangible asset–backed lending guarantors, inventory, accounts receivable Pure debt financing deals are secured by the and other personal property. In other assets of the company; for our purposes, its words, intangibles were treated like any intangible assets. Asset-backed loans are the other asset. most straight forward debt instruments. Companies can also arrange funding Financial markets for asset-backed loans are through a dedicated amount of IA-secured www.iam-magazine.com Intellectual Asset Management May/June 2010 57 Capital choices Figures 1. The intangible asset financing matrix Equity Debt Models Intangible asset equity Debt-equity blended Intangible asset-based investments models lending Description Equity investments Flexible model that Traditional bank lending focused nearly utilises both debt and utilising intangible assets as intangible exclusively equity structures to collateral for loans on asset value provide proper balance of security and liquidity Example Deutsche Bank/IP Altitude Capital portfolio Cambridge Display Bewertungs Patent of investments include Technology financed Value Funds combinations of common commercialisation through a and preferred stock loan secured by CDT’s along with secured patent portfolio and subordinated debt Variations Commercialisation funds Venture-Debt model Securitisation or collateralising that purchase intangibles where debt can be a securitisation of an to commercialise IA transferred to equity intangible asset upon meeting certain milestones debt within a broader lien structure, often a combined with the value of its real estate. syndicated loan with multiple financial Ultimately, KBC loaned Burn £31 million. institutions. For example, Toys ‘R’ Us has a But IA is not just an add-on financing complex debt arrangement that includes tool. Companies can secure loans based loans secured by its real estate subsidiary, a primarily on their IA as well. For example, secured-term loan based on the company’s Paradox Capital in August 2008 provided an intellectual property and a second lien on IABL to Snapware Corporation, which accounts receivable and inventory. specialises in storage and organisation The Toys ‘R’ Us example is a window solutions for the home and kitchen with into the barriers to IP-backed lending. A brands that include Snap ‘N Stack, Smart recent Fitch ratings report articulates the Store, mods, GlassLock, Airtight Canisters recovery prospects for its various tranches and Snap ‘N Serve. The financing of debt. The IP-secured term loan is listed relationship between Paradox and Snapware as less than 10% recoverable compared grew out of an initial IP-based loan with real estate debt, which is seen as 71% provided more than a year before the to 90% recoverable. The unsecured debt August deal. After the relationship proved was also listed at less than 10%. Clearly IP successful, Paradox Capital partnered with is still not seen as a highly recoverable New Stream Capital to close the IABL for asset; IP-secured loans are on par with Snapware, supported by the storage unsecured debt. On the other hand, using company’s strong and ongoing investments IP to secure part of its debt may have given in brand and product design. Toys ‘R’ Us access to otherwise Taking an example from the creative arts unavailable capital.
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