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«Research commissioned by the Intellectual Property Office, and carried out by: Martin Brassell, Kelvin King This is an independent report ...»

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As a minimum it is necessary to ensure that the borrower is the owner of the IP to be secured… In addition to an investigation of ownership it is necessary to establish that the IP to be secured in favour of a lender is not the subject of existing security in favour of another person… When drafting to take security over IP it is important to be sure that the description of the IP is precise and accurate… If the IP is insufficiently defined the security may fail for uncertainty on normal contractual principles or it may be found to suffer from a technical security defect such as that a charge purporting to be a fixed charge is in fact a floating charge130.

130 See Lexis/Olswang, 2012 184 The role of intellectual property and intangible assets in facilitating business finance

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These points also have implications for companies thinking of using their IP in this way,

particularly when negotiating contracts which could affect their ability to assign IP if needed:

Good record keeping is essential. A company which can produce on request a full list of its IP and the contracts, rights and liabilities which it is subject to will have a much easier ride than one which, when faced with a due diligence questionnaire, suddenly has to trawl through a chaotic filing system which may not paint the full picture or which, once brought under control, may expose worrying and possibly irremediable gaps.

Where rights exist internationally, or a borrower is generating income streams overseas which form part of the cash flows under consideration, the due diligence will also have to consider two aspects: whether the IP is effectively protected, and whether their interests will apply to it.

Since registered IP rights are territory-specific, an IP strategy needs to be in place for all the relevant jurisdictions where a borrower has commercial operations or needs to be able to enforce its rights.

Here, the process of scrutinising copyright may be more straightforward. If ownership questions have been satisfactorily answered, the lender can take some comfort from the fact that similar copyright rules to the UK automatically apply in other countries which are signatories to the Berne Convention. The question then will be whether systems are in place to detect and address infringement, and these can vary quite substantially by territory.

With multi-national businesses, while lenders may have a charge over a potentially substantial IP portfolio in English law, many jurisdictions may have entirely different processes, laws and applications of what charges are and what they mean. If the lender observes value in IP worldwide, their due diligence would need to include specific understanding of security rights by law in other jurisdictions.

Benefits of actual notice Notwithstanding the observations made regarding the implications of notice for a rights holder’s financial standing, providing visible registration of a lender’s financial interest in IP could serve another important function.

One of the key complaints frequently made by SMEs in the context of protecting their IP rights is that these are vulnerable to challenge by larger organisations with deeper pockets. Once a large and established lender has a visible involvement in an IP family, this dynamic could change considerably.

Gardiner is one of a number of interviewees who thinks this could be beneficial:

Visibility of a bank’s security position would help with enforcement and deter others from going down the same route. However, this would be a lot more effective if there were a worldwide register that could identify and collate all the charges in one place.

186 The role of intellectual property and intangible assets in facilitating business finance

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Interviews conducted for this study have confirmed that lenders operating in the venture debt space and insolvency practitioners do intervene in maintaining and safeguarding IP ownership where necessary in order to protect their position. The financial resources available to lenders would almost certainly give most infringers pause for thought were these interests to be made more visible.

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A lender could also consider using a retention mechanism to fund the IP strategy – to make sure an action plan is formulated and that money is set aside associated with the performance of those actions. It would be possible to create economies of scale by developing ‘best in class’ procedures which could be standardised.

Gardiner supports the principle of requiring companies to work on their IP, but cautions:

Working independently on the IP to build its value would be a change of approach and mentality. You would need to get into the corporate lawyers before the transaction happens to see how far this can be bolted in, and set the parameters.

Enforcement of security

As Kerrigan notes:

A lender to a business will also have a strategy which it would apply on an enforcement of security. This will be designed to balance considerations relating to the IP (such as whether it has value outside the business and the liquidity of the market for it), to the terms of any contracts relating to or constituting the IP (such as whether the contracts are terminable on insolvency or security enforcement) and to the rules which will apply in an insolvency… A key question will be how the lender might exploit the relevant IP on an enforcement of security. Answering this question in each case will require an understanding of how the borrower’s business operates and how IP contributes to this131.

One insolvency practitioner interviewed for this report explains that the trigger point for his involvement is generally when cash is running out, a further funding round is being proposed, or “people are starting to play strategic games over valuation.” Activities include business reviews, supporting second or third round fundraising, and in extreme cases restructuring the company or handling an administration process (but around 90% of companies are rescued provided action is taken at the profit warning stage).

All these processes involve thinking about where the business value is and how it might be

realised. He comments:

The problem for banks is that they try to think of IP as a physical asset. To get into this market, banks need to think more like investors and do a similar amount of due diligence. The process of deriving value takes time and is slightly higher risk, but the risks are quite similar to physical assets: Is it there? Who owns it?

131 See Lexis/Olswang, 2012 188 The role of intellectual property and intangible assets in facilitating business finance

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Chapter 9 Valuing, and accounting for, IP and intangibles Key points Balance sheets are not a reliable indicator of the real asset value of businesses Established valuation methods exist for IP and are acknowledged by HMRC, court processes, accounting and in the RICS Red Book Valuations have proven sufficiently robust to pass the scrutiny of large pension funds New tax incentives are prompting more businesses to take IP seriously and understand its value

Accounting rules for IP

In general accounting practice, the value of intellectual property is still only recognised when it changes hands and even then this is only in part. This heading provides a brief history of how the accounting position has developed, with particular reference to IFRS3 and IAS36.


The concept of a ‘fair’ valuation of acquired assets and liabilities has been accepted for some time. However, the degree to which the goodwill (a word applied in this context to all the nonfixed assets of a business which are typically intangible) element of the purchase price is required to be broken down into its constituent parts has a chequered history.

In the US APB 16 was published in 1970 and required separable intangible assets to be identified and valued. However, the continued use of merger accounting negated its purpose.

International Accounting Standards (IAS) 22 followed in 1983, a standard similar to the US rules which was applicable to all listed companies in the EU from 2005.

The UK Accounting Standards Board issued FRS 7 in 1994 which required all acquired assets to be fair valued but excluded intangible assets, notwithstanding the fact that they did not appear on the balance sheet of the acquired entity. This proved unpopular and was supplemented three years later by FRS 10 which specifically dealt with the issue of acquired goodwill and other intangible assets. Under this standard acquired intangible assets could be separately identified 190 The role of intellectual property and intangible assets in facilitating business finance

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In 2001, the US Financial Accounting Standards Board issued new standards 141 and 142 dealing with the recording of assets acquired in a ‘business combination’ and their treatment thereafter. These standards were different from APB 16 and 17, which they replaced, attempting to make the accounting for intangible assets both more uniform and more comprehensive.

FAS 141 requires all business combinations to be accounted for at acquisition and abolishes merger accounting. This of itself is a major step in furthering the recognition of intangible assets used in business, as acquisition accounting requires the acquiring company to identify and fair value all the assets acquired irrespective of whether they are shown in the target’s financial statements, whereas merger accounting simply requires that the balance sheets of the combining companies are added together. It requires that the purchase price be allocated across the fair value of all the acquired assets and liabilities including all the intangible assets that meet the specified recognition criteria.

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The sister standard to FAS 141 is FAS 142, which introduced further change. Under these rules goodwill is no longer deemed to have a finite life and is therefore not amortised. Instead it is treated as having an indefinite life and is reviewed for impairment at least once a year (or more often if there is reason to believe that impairment has occurred). Other intangible assets may also be deemed to have indefinite lives but this was expected to be rare and to be limited to certain trademarks and other generally long lived assets. PwC identified that most intangible assets other than goodwill would be amortised over their expected useful lives.

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The latest significant step is International Reporting Standard 3 (IFRS3) on business combinations, requiring intangible assets obtained through such combinations to be separately recognised and valued in the accounts.

This purchase accounting must be applied to all acquisitions (business combinations are also treated as acquisitions, and there is no more merger accounting).  Many intangible assets that would previously have been subsumed within the goodwill definition must now be separately identified and valued.  Explicit guidance is provided for the recognition of such intangible assets and IFRS3 includes a list of assets that are expected to be recognised separately from goodwill.

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Examples of intangible assets to be separately recognised and categorised within the purchase cost are set out in the regulations and include marketing related items (trademarks, brands,

domain names, newspaper mastheads): customer related items (customer lists and contracts):

artistic related items (television programmes, photographs, films, publications): contract based items (e.g. licensing and royalty agreements, contracts for numerous situations such as advertising, construction and supply); and technology based items (patents, computer software, databases, trade secrets and so on).

Additionally under IAS 36, valuations need to be independently tested for impairment by an IP valuation expert on a regular basis.  One of the IP valuer’s first questions in that process will be whether there has been any diminution of the legal, technological or economic nature of the IP that was originally categorised.

IFRS3 is mandatory for all new transactions from 31 March 2004 and applicable to fully listed and AIM companies, though not SMEs because, typically, they do not report under IFRS.  R&D reporting: putting IP & intangibles on the balance sheet Whilst the value associated with IP and intangibles is, for the reasons stated above, not generally shown on a company balance sheet, there are certain circumstances under which activity leading to the creation of IP and intangibles might be capitalised and therefore become a balance sheet item, under the heading of research and development reporting. However, it should be emphasised that such activity will only reflect the cost associated with the development activity.

IAS 38 This standard states that the intangible asset/completed product arising from development (or from the development phase of an internal project) shall be recognised if (and only if) an entity

can demonstrate all of the following:

• The technical feasibility of completing the intangible asset so that it will be available for use or sale

• The intention to complete the intangible asset and use or sell it

• The ability to use or sell the intangible asset

• How the intangible asset will generate probable future economic benefits

• The existence of a market for the output of the intangible asset itself (or if it is to be used internally, the usefulness of the intangible asset)

• The availability of adequate technical, financial and other resources to complete the development and to use or sell the development/asset

• The ability to measure reliably the expenditure attributable to the intangible asset during its development.

192 The role of intellectual property and intangible assets in facilitating business finance

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