IP-Backed Asset Debt Financing
In this technological era, everything is changing drastically, as is the way to generate finance. Earlier only physical assets were used as a tool to generate finance, but now intangible assets are the new modern way through which finance can be generated. Intangible assets include Intellectual Property (“IP”) such as copyright, trademark, patents etc. With the growing digitisation in the economy, the concept of IP-backed debt finance is also evolving in how IP can be used as collateral to raise debt, instead of traditional borrowing and lending that was confined to physical assets. IP assets are brought into existence by the force of law and are playing a critical role as a source of financing.
Methods for IP Backed Debt Finance
Like other collaterals, IP can be used as collateral for the debt issued by the bank as per the debt agreement. IP will be pledged with the financial institutions and those institutions can sell them in case of insolvency or on non-repayment of the loan. Here, both the financial institution and the IP owners/Business Enterprises/Companies are in a win – win situation as the company obtains the desired financial liquidity, and the bank also saves its money in case of any default.
Debenture and other securities
IP-backed assets can be placed in markets. Raising money from the market is one of the easiest and most reliable ways to generate finance for any enterprise. IP owners are saved by the seizure of their IP assets and can raise funding under favourable conditions. Like debenture, bonds can also be issued and IP owners can directly work on maximizing their revenues, and paying interest to debenture holders and bondholders. Here, the IP owners are not forced to comply with the complex rules and procedures of collateral agreement, IP owners have greater autonomy in the securitization of assets.
IP can be leased to generate liquidity. This option is best for catering to short-term liquidity requirements. The IP owner leases the IP, and can regain the IP back on payment of the lease amount. Here, the owners of IP assets are sure that they will get their IP rights back as soon as the lease amount is returned. Another lucrative condition is Sale and Leaseback, where IPs are transferred for a fixed period of time, and the original IP owner may also be required to pay any royalties or future projected revenue to the transferor. After the expiry of the time period, IP owners have the option to buy back these securities.
Impact on SMEs
IP-backed debt finance is a boon for small and medium enterprises (“SMEs”). All enterprises need finance for the management of successful business operations. But for SMEs, it is very difficult to get a debt sanctioned from financial institutions if they do not have any physical assets or any other traditional securities for collateral. This is a serious issue because Micro Small and Medium Entreprises (MSMEs) account for 70% of employment in Organisation for Economic Co-operation and Development (OECD) countries. These SMEs rely heavily on banks because they can provide them with much-needed liquidity without diluting their equity. SMEs are often hijacked by venture capitalists and angel investors on the pretext of financing and forcing SMEs to dilute their equity. Once the equity is diluted SMEs often lose control over their enterprise as well. It’s high time that we start evaluating the IP right as commercial assets.[i]
The monetization of IP lies in exclusivity, the right to exclude others from its use except for the owners or the licensees thereby supporting its uniqueness. IP assets are safe because of the fixed time duration/term and sometimes in case of owners’ death beyond life especially in the case of copyright where the term is lifetime plus some more years. These IP assets can be used as collateral for the debt. These IP assets are more valuable than other physical assets which are often affected by other factors in the economy such as inflation, slow down or recession. IP rights are immune from adverse economic conditions and are far better than other physical securities which are directly impacted by adverse market conditions.
Valuations of IP Securities
Despite it being considered an asset, evaluating an IP is a critical task as it is on the basis of valuation the credit will be extended. For collateralization of IP-backed assets lender/financial institutions are required to be well aware of the exact value of IP assets. The value shall include the cost of research and development of the IP, the impact of particular IP in generating revenue for the business, and the factors which can affect the value of the IP. Their valuations should be precise and accurate to the particular point in time so that banks can extend credit and at the same time know the exact value of such IP. For any lender who is providing funds to IP-backed assets, the value lender can realize by the sale of such assets is of extreme importance. The major difference between tangible assets and IP assets is the complexity involved in valuation. If a tangible asset is given in collateral, the amount of the asset can at any time be easily calculated. Even in cases of default, tangible assets can be easily sold and the collateral amount can be easily realized. However, in the case of IP assets, it becomes a little complex to calculate the sale and resale value due to a lack of formal procedures and fewer buyers for the same. The IP is thriving in every continent, so a universal standard must be followed to value that particular IP so that there is no conflict in the valuation of IPs in other jurisdictions. Proper accounting systems need to be overhauled on how the IPs will be evaluated, and the effect of depreciation and appreciation on it. Unless and until the IP is not brought within the sphere of accounting and evaluation, it will be impossible for financial institutions to extend credit to IP-backed assets.
Most SMEs and young start-ups face a common problem, they have a lot of IP assets but lack tangible assets where IP could be leveraged to generate funding for their future growth and development. Such SMEs and start-ups are required to give formal training on how to commercialize their IP assets. Due to a lack of technical know-how in the commercialization of IP, SMEs are often left behind when compared with large companies in the usage of IP-backed assets as collateral. Large Multi-National Corporations (“MNCs”) always have the advantage of their goodwill, long-time presence, market confidence, success stories, and a huge IP collection which gave them an upper hand in commercializing their IP assets.[ii] This becomes a major barrier for SMEs and start-ups in generating funds from IP and often forced to use their tangible assets if any. This could be lethal to the existence of SMEs and start-ups as they are forced to provide their tangible assets to raise loans, and in case of default, they are left with nothing. This is because their tangible assets will be sold off to settle the debt and the IP assets will become obsolete as they lost the minimal required tangible assets to run the business smoothly. Therefore, especially for SMEs and start-ups, it is extremely necessary that they are provided with a platform where their demand for finance could be backed by an IP-backed assets system.
Role of International Institutions
Office for Economic Cooperation and Development (OECD)
OECD has underlined the importance of SMEs and start-ups and the role played by them in creating employment opportunities and supporting growth in the economy. OECD has specifically highlighted that a uniform finance ecosystem needs to be established for SMEs and start-ups so that their rising finance needs can be easily catered to. The major issue highlighted here is that lenders need to be made aware of IP assets as security and not look at IP assets with suspicion. A financial trust needs to be made with the financial lender where they understand how IP assets work and how they are at par with other financial securities like stocks which can be easily manipulated. Simultaneously SMEs and start-ups should focus on IPs that can have commercial viability so that the lack of trust and lender’s risk can be minimized.
World Intellectual Property Organization (WIPO) and United Nations Commission on International Trade Law (UNCITRAL)
WIPO is a specialised agency of the United Nations (UN) that deals with Intellectual Property matters. WIPO is partnering with the member states and raising awareness for IP – backed financing so that a global uniform system for IP-backed lending can be created. WIPO has found two major reasons which are causing hindrances in establishing an IP – backed debt finance system. First, there is hesitation in seeing IP as an asset and substituting it with other valuable securities. Secondly, there is no uniform and transparent system that can value IP assets precisely.
UNCITRAL adopted the Supplement on Security Rights in Intellectual Property to address this problem and to provide states with guidance on how to implement the secured financing system recommended in the UNCITRAL Legislative Guide on Secured Transactions to facilitate the financing of intellectual property.[iii] The purpose of the UNCITRAL Legislative Guide on Secured Transactions is to assist governments in developing effective secured transaction laws that promote low-cost credit by increasing the availability of secured credit, particularly for individuals and small and medium-sized firms (MSMEs).
IP is evolving in this globalised economy, there is no doubt that IP is playing a big role in generating revenues. IP-backed financing in general is often understood as complex and procedural but we shall keep in mind that fundamental lending principles always remain simple. The better the commercialisation avenue the more are lenders to bear the risk. States shall come forward and start drafting IP financing policies. At the global level, it often becomes difficult to bring all people to one table. Instead, the state shall start drafting policies on IP debt financing and shall create a dedicated IP Asset Backed fund to support their IP-based start-ups and SMEs. In this era of globalisation, a state shall partner with its friendly countries and establish bilateral agreements supporting IP debt financing, as business and commercialisation can’t be restricted to physical borders.
It is important to note here the fall of Silicon Valley Bank (SVB). SVB followed the traditional system of borrower and lending, and still collapsed. The two major reasons are first it lacked asset diversification and second, the depositors withdrew their money from the bank fearing the bank’s stability. IP-backed assets provide much-needed asset diversification, they are not easily affected by the market’s sentiments. The value of physical assets relies heavily on the policies and regulations of the government. Additionally, they are highly volatile if compared with IP-backed assets. IP is granted protection under the law for the hard work and intellect of the IP owner which provides it with the necessary stability. Neither hard work nor labour can be overpowered by market sentiments nor can it be affected by adverse economic conditions.
[i] Mark Bezant, “The Use of Intellectual Property as Security for Debt Finance”, 1 Journal of Knowledge Management 237–63 (1997).
[ii] Lisa Evers, Helen Miller and Christoph Spengel, “Intellectual property box regimes: effective tax rates and tax policy considerations,” 22 International Tax and Public Finance 502–30 (2015).
[iii] Helmut Volger (ed.), “UNCITRAL – United Nations Commission On International Trade Law” A Concise Encyclopedia of the United Nations 692–6 (Brill Nijhoff, 2010).
This article has been authored by Dr. Ashwini Siwal, Senior Assistant Professor, Faculty of Law, University of Delhi and Mr. Anupam Sharma, LL.M. & LL.B., Faculty of Law, University of Delhi. This blog is part of the RSRR’s Excerpts from Experts series.