«Research commissioned by the Intellectual Property Office, and carried out by: Martin Brassell, Kelvin King This is an independent report ...»
It is not easy to dispose of IP in isolation, but it is always an important consideration in strategies to recover value. In a distress situation, it is very important to ensure that the management team is motivated and that the IP can be kept together with the know-how in the business. Often an acquirer will want to take on both the core IP and the people who know how to use it – we have had a number of cases where that is precisely what has happened.
Apart from insolvency practitioners, there are a small number of specialist companies serving the corporate recovery sector by supporting the identification of value-contributing IP and intangibles and supporting the process of selling them. One of these is Metis Partners84, established in 2003 and based in Glasgow, whose website claims that they have supported clients in raising over £15m in selling assets purely out of insolvency.
As well as working with insolvency practitioners, Metis are sometimes instructed by banks to assist in restructuring debt by creative use of the underlying IP, and provided two case studies to illustrate how the process operates.
84 See website at www.metispartners.co.uk 146 The role of intellectual property and intangible assets in facilitating business finance
Stuart Ager, referenced in Chapter 3, referenced his own experiences in this area during
It’s always difficult to value IP. If it has established revenue streams based on the IP, it is possible, but for an early stage business, it’s hard to do. An administrator won’t know whether there is a value to the IP, they will just sell it for whatever they can get.
But Andrew Mullinger of Funding Circle sees that the environment may be changing:
Even in a downside case, the IP will have an inherent value. Clearly, you want to understand the cash flows of an asset, which need to have been going for some time.
We would want to understand the investment that has gone into, for example, SaaS [Software as a Service] models. There, even if things go wrong, there are some customers that will need to be served. The question will be, how wedded are they to the supplier?
Obtaining value from licensing
Where value is realised for IP selectively for certain markets (whether based on geography or sector), it is generally desirable to use licensing rather than selling or assigning the IP outright.
IP licensing is an activity which continues to grow rapidly, and is now an important contributor to the global economy.
Licensing itself is by no means a new concept. Many innovators invent knowing that they will not have the resources to bring a product to market on their own, but that they can sell or
licence the rights to other people. As Daniel Papst pointed out in a recent article85:
Ever since the assembly line of the early 1900s ushered in an era of specialisation and turned businesses and workers into specialists, inventors no longer need to manufacture or sell something to make a significant contribution to economic growth.
Thomas Edison, for example, was primarily a licensor of patents… he filed and owned over 1,000 patents, and many of them were licensed to companies to manufacture goods or deliver services. In fact, Edison owned a patent for a time clock, and the firm that licensed this patent later on became what is today known as IBM.
85 NPEs and Patent Aggregators – New, Complementary Business Models for Modern IP Markets, Daniel Papst, Les Nouvelles, June 2013 148 The role of intellectual property and intangible assets in facilitating business finance
The scale of international licensing activity is also illustrated by data from the World Bank, which reports the level of payments and receipts between residents and non-residents for the authorised use of intangible assets and registered IP rights87. The figures also include licensing fees for ‘produced originals’ of prototypes, such as films and manuscripts. In summary, this data collection illustrates an increase from $150bn in 2005 to nearly $250bn at the end of 2011.
The table below is an extract featuring only those countries which have recorded revenues in excess of $1bn per annum over the past few years (all figures shown in $m’s – some figures are
not yet reported):
175,000 150,000 125,000 2005 2006 2007 2008 2009 2010 2011
Where IP consolidation in a holding company makes strategic sense, there may be inter-group issues. While it is obvious that owners need to protect their IP against external users, unregulated IP policies within a group of companies can lead to the creation of competing rights. Consolidating ownership and creating certainty of title within a single IP holding company or vehicle (off-shore or not) invariably adds value, which is why corporates view this kind of exercise as more than self-financing.
The figures above reflect the fact that Ireland has been a favoured location for IP holding companies for many years. Following the choice of location, each individual IP right held by each different group company is accorded an arm’s length valuation for assignment to the IP holding company. A licence is then granted back to participating group members on a similarly arm’s length ‘fair market value’ basis, at an appropriate commercial royalty rate. Group holding companies will nearly always also be licensed to use trademarks, the consideration being that they will use the mark wherever possible to promote goodwill and brand value, the ownership of which remains with the IP holding company.
If structures such as this are put in place, and the IP holding company licences operating companies and/or other entities, it will receive a steady income stream. This gives rise to a number of favourable further commercial opportunities, including the potential to securitise the income stream as a financing vehicle, or to sell the income streams and their capital value, which may be done using a special purpose vehicle.
As shown in the following section, rating agencies are becoming increasingly familiar with this type of transaction and may accord the bundle of IP rights, and the licences granted with them, a better credit rating than the underlying business, thereby improving the capital to interest ratio.
For financing purposes, the fact that the rights are all related to a single corporation provides a clearer ‘line of sight’ compared with other securitisation practices.
Companies will also ensure in this process that the structure provides the significant benefit of surviving an insolvency of the underlying business: another reason for using an IP holding company. This also applies to pension funds, as described elsewhere in this report.
Realising value through securitisation
The use of intangible assets as loan collateral has been studied by Maria Loumioti of the Harvard Business School Accounting and Management Unit in a 2011 paper89. This study sought to explore the role of intangible assets in reducing financing frictions in credit markets using a sample of secured syndicated loans.
While the predominant managerial (and scholarly) perspective suggests that intangible assets are not sufficient collateral, it was found that 11% of US originated secured loans included intangible assets as loan collateral, and that the practice of collateralisation of intangibles had significantly increased. Loumioti’s research concluded that the redeployability of intangibles and borrower reputation are positively related to the probability of using intangibles as loan collateral, and that collateralising intangibles has significantly increased the supply of credit to firms. Moreover, loans secured by intangibles emerge as being of similar quality as loans secured by tangibles. Overall, the results suggest that intangible assets can and do increase firm value not only in equity markets, but also in credit markets.
152 The role of intellectual property and intangible assets in facilitating business finance There are a number of factors concerning IP (including copyright) that make it potentially attractive as a secured asset class. The very fact that the assets are seldom used to maximum effect, or properly represented on balance sheets, may in itself be beneficial as it represents an opportunity to generate new and additional value from assets that a business may have held and used for some time. IP is also mobile, desirable, capable of attracting favourable tax treatment, and is well aligned with the underlying business because these rights convey a competitive advantage to the user and barriers to entry to a competitor.
These attractive characteristics need to be contextualised by the potential difficulties in guaranteeing the validity of IP rights, and the fact that they may in some cases have a finite and/ or limited life. However, IP does benefit from the fact that royalties are often traditionally used to exploit it, and being generally based on turnover, these provide a broad sense for computation based on identifiable cashflows.
The importance of different IP rights, and their availability for securitisation, varies by sector. In manufacturing and industrial design, as the statistics in Chapter 5 indicate, patenting is important (as are confidential information and trade secrets). In consumer group companies, branding involving trade marks and design rights are important, as are know-how and formulations. Databased businesses tend to rely on copyright and database rights, whilst telecommunications companies may use all of the above. In the TMT sector more generally, there are ‘layered’ rights involving performance, recorded material and broadcasting.
There is no doubt that the value attributed to IP can be very substantial. Global brands are an obvious example, but patent and technology portfolios in areas such as medicine and communications also underpin multinational corporations (hence the reason why they attract strong competitive bidding, as illustrated elsewhere in this chapter).
Examples of these IP financings, which have unlocked value previously largely overlooked by markets and providers of capital, are not hard to find. There have a number of very public milestones, starting in 1997 with the securitisation of music copyright and publishing rights by David Bowie ($55 million). These were followed in 1999 by Ashford and Simpson ($25 million) and James Brown ($30 million), and then by further deals for the Isley Brothers, Marvin Gaye, Iron Maiden and Rod Stewart. The film receivables of DreamWorks Pictures started in 1995 with mostly slate financing collateralised via a portfolio of films to be released; this amounted to approximately $8 billion over time, mostly rated AAA.
Other sectors have subsequently followed the example of the entertainment industry. Royalties from retail franchises provide further examples of approximate size and ratings; in 2000 Arby’s ($290 million AAA), 2003 Athlete’s Foot (undisclosed, and BAA 3), 2005 QFA Royalties LLC ($250 million, BAA 2) and 2006 DB Master Finance (rated AAA), backed by Dunkin’ Donuts and Baskin Robbins to finance the Private Equity LBO from Allied Domecq.
Patents and pharmaceuticals followed with deals including Biopharma Royalty Trust (issuer Royalty Pharma, approximately $80 million in December 2000, not rated), Royalty Pharma Finance Trust (issuer Royalty Pharma, approximately $225m, closed July 2003, AAA), Royalty Securitisation Trust 1 (issuer Paul Capital, $228m, closed December 2004, rated AAA) and Drug Royalty Trust 2005 – 1 (issuer Drug Royalty, $68m closed March 2005, not rated).
There are also examples of trade mark licensing securitisations. These have included Universal Credit Trust 1999-B (issuer Bill Blass, $25 rated BAA 3), Candies (issuer Candies, $75m, BAA 3), Guess ($75m rated BAA2), MLA Multibrand (issuer BCBG, $53m rated BAA3/AAA and KCD IP LLC (private, $1,800m, rated BAA 2).
At the mature end of the scale, Sears Holdings Corporation in 2006 illustrated the largest securitisation of IP rights in history, according to analysts at Standard & Poor’s, in creating a separate, wholly owned, bankruptcy-remote subsidiary for its three biggest brands, Kenmore, Craftsman and DieHard. This was done by transferring ownership to an IP holding company that charges Sears royalty fees to license these brands, and uses royalties to pay the interest on bonds sold to the insurance subsidiary. In total, this involved approximately $1.8 billion worth of securitisation and transferred ownership.
In this period Moody’s Investor Services stated that IP based securitisations accounted for as little as 1% of all public asset backed securities, but patent and trademark transactions were thought to have good growth prospects. The main issues for consideration were considered to be legal ones (cleared definition and identification of IP, who owns it, how the IP is being used, how it is being licensed and ensuring that the IP is properly protected).
Accounting was needed to clear up records of royalty streams in a better way that had traditionally been reported. Legal risks were being identified as product liability, patent challenge or infringement, expiration (technology and economic life and such like) and bankruptcy. Risks could be seen as minimised by the provision of backup for others to service the business, for example, licensing out the current patent or trademark position to third parties. The picture was
summarised in 2007 as follows:
The technical nature of intellectual property and its ambiguities make investment a complicated proposition. It requires a firm to have many different skill sets as well as a willingness to incur high due diligence costs while monetisation strategies are fussy and timetables to exit are unclear. For those who understand all this, however, there are substantial opportunities90.
90 Source: Introduction: Welcome To The IP Century – Joff Wild 2007 154 The role of intellectual property and intangible assets in facilitating business finance