«Research commissioned by the Intellectual Property Office, and carried out by: Martin Brassell, Kelvin King This is an independent report ...»
Strictly speaking, IP consists primarily of those rights which can be formally registered (patents, trade marks and registered designs), together with copyright (in its various forms), which can also prove to be extremely valuable, and automatic design protection (Design Right). However, in terms of value creation, IP is a significantly ‘broader church’ than these official definitions imply. For example, the International Financial Reporting Standard 3 (IFRS3) regulations provide a set of some 50 asset definitions which have been extensively scrutinised by the accounting industry.
Therefore, in addition to studying new data on business ownership of patents and trade marks supplied by the Intellectual Property Office, this report uses data drawn from sponsored IP audits and third party sources to examine ownership levels of further categories of asset which are capable of being properly validated, and therefore useful in the financing context. These include assets which are embedded within what a company sells, such as trade secrets and contractual agreements.
The value of IP and intangibles to companies A number of independent reports19 have concluded that company value is now largely dependent on intangible assets, with estimates ranging from 70% to 80%. There is an increasing recognition that company expenditure on intangibles ought to be recognised as a determinant of economic growth, rather than simply being expensed as intermediate inputs in national accounts20.
Research by Nesta and the Work Foundation highlighted that company investment in intangibles
now outstrips that in tangible assets, and made the following connection with finance:
The government should encourage the development of new financial institutions at both the national and local level to meet potential funding gaps for knowledge intensive, intangible rich but physical asset poor SMEs.21 Quoted companies have a ready market mechanism by which they can sometimes (though not always) determine and realise this intangible value, but unquoted businesses may not. Calculation of estimates for micro, small and medium enterprises is further complicated by the filing of abbreviated accounts. However, it is reasonable to surmise that the proportion of value in intangible assets will be even greater in many small unquoted companies than in quoted ones, with many high technology and creative businesses owning precious little apart from IP and intangibles.
Considerable progress has been made over a 40-year period in the valuation of IP, and certain methodologies are now accepted by accountants and regulators22. In the US, APB 16 (published in 1970) first required separate intangible assets to be identified for ‘fair value’ accounting and a purchase price. This was followed by IAS 22 in 1983 and ultimately by Standards 141 and 142 introduced by FASB in 2001. In the UK and internationally, within the last decade, changes in accounting regulations such as IFRS 3, the introduction of tax relief for R&D activity, and the introduction of a ‘Patent Box’ have created a set of tools and standards which can support value realisation from IP. These developments are set out in more detail in chapter 9 of this report.
The challenge this creates in the context of economic growth has been succinctly summed up
in the US context by think-tank the Athena Alliance, as follows:
As the U.S. moves away from a manufacturing-based economy and toward a technology-and-innovation driven one, intangible asset investments are becoming vital to economic growth and sustainability. Just as physical assets were used to finance the creation of more physical assets during the industrial age, intangible assets should be used to finance the creation of more intangible assets in the information age.23 19 Including the Gowers Review of Intellectual Property, HM Treasury, 2006, and Intangible assets versus tangible assets: the ‘great reversal’ of 20/80 to 80/20, Ocean Tomo, 2011 20 The Impact of Investment in Intangible Assets on Productivity Spillovers, BIS Research Paper no 74, May 2012 21 Accounting for intangibles: Financial reporting and value creation in the knowledge economy, The Work Foundation/Research Republic, August 2009 22 See Chapter 9 23 Intangible Asset Monetization: The Promise and the Reality, Jarboe & Furrow, Athena Alliance, April 2008 26 The role of intellectual property and intangible assets in facilitating business finance This investment in IP and intangibles does not appear to be translating into assets which can be leveraged effectively to fund growth. Whilst asset-based (or asset-backed) lending (‘ABL’) products leverage certain business intangibles, notably invoices, these do not explicitly recognise a business’s core value-producing IP. Yet at the same time, those who invest in businesses have a high regard for IP and its importance.
The question prompting this report is: what else could be done to bring this underlying asset value (and its relationship to cash flows) into play, for the purposes of financing growth? The
answers may provide insight into ways that broader access to finance issues can be tackled:
they may also provide a valuable platform for raising company awareness of the value and utility of IP more generally, with additional benefits for business competitiveness both nationally and internationally.
Given the large body of evidence (statistical and anecdotal) which is already in the public domain regarding the difficulties experienced by the demand side in obtaining finance, the report’s interviews have been intentionally weighted somewhat more towards understanding supply side opportunities and challenges, which are less well understood and documented.
For the primary research, questionnaires were supplied to participants in advance of each interview, in order to provide them with suitable stimulus material and give them an opportunity to prepare appropriately for the discussions. Wherever practicable, interviews were conducted face-to-face. There were also a few opportunities to participate and gather evidence in meetings being held by particular industry groups, which are acknowledged in the following chapters.
Permission was sought and obtained to record responses on the basis of the Chatham House Rule; as a consequence, this report contains verbatim records of what has been said, but does not attribute them to a specific participant unless that individual and/or organisation has provided their consent for publication with attribution, and confirmed the content of the matters attributed to them. Where there is no attribution for a viewpoint, it is only included if it has been corroborated using more than one source.
The authors acknowledge that any qualitative research process has risk, in that however good the preparation for a set of interviews may be, the use of a pre-planned and structured approach (essential for comparability) may fail to ask the questions that are most pertinent in each context.
Reliance on interviews also means that it takes time to arrange access, develop trust and rapport, and find out what interviewees think, particularly when placed outside a box which may have become their everyday sphere of operation.
In the process of interviews, the authors have endeavoured to address this risk through continuous examination of transcripts to identify common themes, references, comparisons and contrasts with other subject candidates, and refine and update question and interview content accordingly.
The authors are particularly indebted to the Government departments, non-Governmental agencies and trade bodies who have assisted this work by contributing information from their existing research and survey activity which has been used to inform this project and benchmark its findings. Amongst the Government departments, we would particularly like to thank BIS and IPO for making available information from their economic and survey activities.
28 The role of intellectual property and intangible assets in facilitating business finance
In order to identify, understand and explore the barriers to broader use of IP in financing, and
the areas in which solutions may be found, this project focuses on six key areas of investigation:
By approaching the subject matter in a structured qualitative way, this research project aims to
provide evidence-based conclusions on the following aspects:
Interviewee selection In order to gain detailed insights into the opportunities and challenges presented by IP in the financing context, the authors have spoken to a wide variety of individuals with first-hand experience of funding and fundraising, in a variety of different capacities.
When looking at equity finance, interview subjects have included business angel networks; high net worth individuals; crowdfunders; providers of venture capital and private equity funding to SMEs; trade bodies representing organisations offering business angel and venture capital finance; knowledge-based SMEs seeking and obtaining finance; intermediaries working with SMEs to raise finance and service providers (such as lawyers) involved in the deal-making process; and government and industry-backed organisations such as the Business Growth Fund and Angel Co-Investment Fund.
For debt finance, our subjects have included past and current heads of policy, relationship management, credit strategy and appetite, credit sanctioning and/or business recovery within high street commercial lenders and ‘challenger’ banks; senior management within asset and asset-based lenders; alternative business finance providers; debt fund managers; and trade bodies representing lenders.
In seeking to understand methods of value realisation, important contributions have also been made by corporate financiers; legal professionals; individuals involved with licensing;
organisations providing IP brokerage and auction services; acquirers of patents and other IP and intangibles; and insolvency practitioners. Policy and thought leaders have included the Prudential Regulation Authority, Intellectual Property Office, Nesta, and other industry and accounting organisations.
Every person interviewed has provided valuable insights into the debate on IP and finance. In order to ensure that their views have been accurately represented, all those who have been attributed have had an opportunity to confirm their views in writing prior to publication.
30 The role of intellectual property and intangible assets in facilitating business finance
This chapter places the following research findings in the national and international context as it concerns IP and intangibles and their relationship to finance.
Within the UK, current relevant policy initiatives are largely directed towards improving the safety of the banking system and improving access to debt finance. Internationally, however, a growing number of initiatives are dealing directly with the question of IP and finance. This tends to reinforce the view that harnessing IP value is becoming increasingly important for competitiveness generally, as well as for individual firms.
As many commentators have observed, there are challenges inherent in requiring banks to strengthen their balance sheets and to increase lending at the same time.
Assets such as cash and currency normally have zero risk weight associated with them, whilst certain types of loans have a risk weighting of 100% of their face value, meaning that financial institutions are obliged to provision fully against them. Emmanouil Schizas, Senior Economic Analyst at the Association of Chartered Certified Accountants (ACCA), sees this as a potentially
As things currently stand, these liquidity regulations are unhelpful to IP-based lending because such activity would attract a high risk rate due to the absence of ready markets. More transparent and better understood marketplaces for registered IP (though possibly not for other types of intangibles) could assist considerably with the capital relief aspect, and could (over time) establish a basis for a more favourable risk rate that a bank could generate internally.
The authors have been able to explore some of these issues directly with the Prudential Regulatory Authority (PRA), which since 1 April 2013 has been the body responsible for the regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. The findings of these discussions are included in the discussion in Chapter 8 on security interests in IP and intangibles.
In addition, the Banking Reform Bill was introduced to the House of Commons on 4 February
2013. Among other measures, the proposals require UK banks to separate ‘everyday’ banking activities from more volatile investment bank activities by creating a ring-fence around the deposits of individuals and businesses. Whilst this is not a policy intervention directed at SMEs, concerns have been expressed that separating deposits from the business of arranging loans will have adverse knock-on effects. However, as these do not have a specific impact on IP and intangibles, such concerns are not discussed here.
assist companies to access capital. These were represented in chart form25 as follows:
24 The following UK sections of this chapter look BIS, March 2013 Building the Business Bank: Strategy Update, at each of the initiatives providing support of more than 25 £25,000, separating debt and equity for ease of reference.
Ibid The Enterprise Finance Guarantee scheme is examined in detail, since it directly addresses issues relating to the absence of ‘conventional’ collateral. The equity section also includes a brief summary of relevant tax incentives: the Enterprise Investment Scheme and Entrepreneurs’ Relief.
32 The role of intellectual property and intangible assets in facilitating business finance The following UK sections of this chapter look at each of the initiatives providing support of more than £25,000, separating debt and equity for ease of reference.