«Research commissioned by the Intellectual Property Office, and carried out by: Martin Brassell, Kelvin King This is an independent report ...»
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.
As well as central UK Government support interventions, a number of other equity, grant, loan and direct investment forms of assistance are available on a regional basis. Examples include a number of growth-related grant and debt funding initiatives supported by the Welsh Government (some via Finance Wales), and Highlands and Islands Enterprise, who provide services to sectors that are identified in the Scottish Government’s Economic Strategy.
International policy initiatives
There are a number of international initiatives, in various stages of development, which are seeking to address the issue of IP value and its use in accessing finance. These range from structured ten year strategies in Singapore through to primary IP exchange markets in Denmark and the provision of government insurance for IP-backed businesses in South Korea.
Each of these initiatives is quite distinct, and seeks to address the issue of financing from differing debt and equity perspectives. The starting points for the UK and the US, for instance, are very different. Whilst in the UK some 80% of investment finance is raised via debt, supplied in the main by the retail banking sector, and the remaining 20% is sourced through various equity-related mechanisms, in the US these proportions are reversed. Consequently, it can be argued that financial resources available to support IP-intensive businesses in the US have greater capacity, particularly in the current environment, and greater diversity. This latter feature is effectively demonstrated by the development of an insurance market in the US in support of commercial bank IP lending, referenced in Chapter 8.
Tax policy is also commonly in use as a means to encourage innovation, with a number of countries having already adopted incentives related to research and development activity along similar lines to the UK’s recently introduced ‘Patent Box’ (examined in Chapter 9). These schemes allow corporate income from the sale of patented products to be taxed at a lower rate than other income, reducing the financial risks of innovation and lowering the effective corporate tax rate for knowledge-based businesses. Ireland was the first nation to develop a patent box in 1973, followed by eight nations – Belgium, China, Denmark, France, Luxembourg, Netherlands, Spain and Switzerland – in the mid to late 2000s.
In France, revenue or gain deriving from the license, sublicense, sale or transfer of qualified IP is taxed at a reduced 15% corporate tax rate (the standard rate is 33.3%) under specified terms and conditions. In Hungary, companies owning qualified IP may deduct 50% of the royalties that related or unrelated parties pay for use of the IP. In Luxembourg, the patent box regime provides an 80% tax exemption for the net income derived from the use of (or right to use) qualified IP rights acquired or self-developed after December 31, 2007.
Spain’s patent box regime exempts 50% of the gross income derived from the cession of the use and the right to use qualified IP, with effect from January 1, 2008. Finally, and notably, Ireland, Luxembourg, Spain and Switzerland go further and also allow income from designs, copyrights, models and trademarks to be taxed at the lower Patent Box rate.
UK policy initiatives: debt finance The Funding for Lending Scheme As an addition to the quantitative easing programme (not discussed in this report), the Funding for Lending Scheme was announced in June 2012. It aims to boost the incentive for banks and building societies to lend more to non-financial companies and UK households by reducing funding costs. Its structure is designed to link access to funds available under the Scheme to the amount the financial institution lends to the ‘real’ economy, and to reward banks who lend more.
The Scheme is a ‘collateral swap’ designed to run over an 18-month period to the end of January 2014. It involves the Bank of England lending UK Treasury Bills to banks for up to four years, at a fee, with banks providing collateral (in the form of loans to businesses, households and other assets) to the Bank of England. Banks first have to be signed up to the ‘Discount Window Facility’.
The intention is that the collateral will be swapped back again when the loans mature (so there is no long-term transfer of risk from the originating bank), but the Bank of England does have the power to realise the value of the collateral if necessary, and can also require more than 100% collateral against the Treasury Bills it lends.
An individual bank can borrow up to 5% of its existing loan stock as determined at end June 2012 (worth about £80bn), plus any expansion of its lending to the end of 2013, with every £1 of extra net lending (i.e. after repayments) increasing the amount a bank can borrow by £1.
Whilst acknowledging that some banks have to reduce some parts of their lending activities, the intention of the Scheme is to reduce the impact of these reductions, and also to fend off increases in the cost of money that would otherwise further constrict lending.
The March 2013 report showed that whilst participating banks have drawn down £13.8bn, the collective lending book shrank over the initial period by £1.5bn. This was followed in September 2013 by a further report showing that while net lending grew by £1.6bn in the second quarter of the financial year, the fall in lending since June 2012 had grown to £2.3bn.
34 The role of intellectual property and intangible assets in facilitating business finance The performance of the two banks under partial public ownership received particular press scrutiny. In March 2013, it was announced that RBS had drawn down £750m but reduced its loan stock by £2.3bn, with Lloyds taking £3bn but reducing loan stock by £5.6bn26. There were, however, some brighter spots, with newest bank Aldermore increasing lending to £479m, representing growth of over 30% in less than one year, and Metro Bank increasing lending 119% since the Scheme’s introduction.
The Scheme was extended in April 2013, providing additional incentives for participants to increase SME lending. The September announcement showed continued improvements to the mortgage market but negative total net lending to businesses; however, perhaps as a result of modifications to the scheme, SMEs fared better than large companies.
The Business Bank and the Business Finance Partnership
The Business Secretary, Vince Cable, launched the first phase of the new Business Bank in March 201327. This allocated £300 million to be invested alongside private investors, as well as a further £50m for the Business Angel Co-Investment Fund (see Chapter 4) and £25m of extensions to the venture capital programme. It was the first deployment from the £1 billion of new capital allocated to the Business Bank in the 2012 Autumn Statement (alongside £2.9 billion of existing capital). This is a precursor to the Bank itself becoming a fully operational new institution by Autumn 2014.
The focus of this initiative is on promoting greater diversity of debt finance available to SMEs by encouraging the growth of smaller lenders and new entrants in the market. Investments will be made via new and existing lending channels on a commercial basis. The Business Bank initiatives are intended to complement the activities of the Business Finance Partnership (BFP) in that they aim to leverage at least the same amount in private sector investment.
BFP has an overall value of £1.2bn. The first round of the BFP saw private sector investment into non-bank lending match the government’s £55 million investment, taking the total investment to £110 million. The second round of the BFP saw private sector investment exceed the government investment of £30 million, resulting in a total investment of over £70 million.
Successful BFP bidders in round one were peer-to-peer lenders Funding Circle and Zopa, fund management company Boost & Co and specialist asset finance provider Credit Asset Management Ltd. Successful BFP bidders in round two were the online platform Market Invoice, supply chain finance platform URICA and mezzanine fund manager Beechbrook Capital.
• Direct Capital Investments: funding, either by way of equity or debt injection, alongside private sector investors into lending businesses able to use these commitments to increase their lending activity BFP appears to be the single most relevant source of additional Government funding which could be brought to bear on IP-rich companies. It is open to bids from specialist funders for additional capital to improve their reach and scale and could be relevant for lenders seeking to leverage company IP more effectively.
Export Trade Finance IP-rich businesses and high growth companies often have international markets for their products and services, but face a number of barriers to successfully transacting business overseas.
UK Export Finance (UKEF) is run by the Export Credits Guarantee Department (ECGD). It is a UK export credit agency which works with exporters and investors by providing credit insurance policies, political risk insurance on overseas investments, and guarantees on bank loans. Export Insurance policies can also be provided to support exports to most overseas markets outside the EU and certain OECD countries, for organisations unable to obtain cover from the private sector. UKEF also operates a network of export finance advisors.
UKEF operates a number of initiatives through and in conjunction with banks. These include the Letter of Credit Guarantee Scheme (between 50% and 90% guarantee), the Export Working Capital Scheme (normally providing up to 50% cover), and the Bond Support Scheme. The last of these provides a partial guarantee (typically up to 80%) which enables participating banks to issue bonds even if they do not have the risk appetite for the full amount.
Addressing the absence of collateral: the Enterprise Finance Guarantee scheme About the scheme The Enterprise Finance Guarantee scheme (EFG) is particularly relevant to considerations about IP, being aimed at businesses lacking tangible collateral or a sufficient track record (but which would otherwise be considered fundable by a bank according to their normal credit policies).
EFG is available in support of loans, overdrafts and invoice finance facilities of between £1,000 and £1m. This is an increase from £250,000 under its predecessor, the Small Firms Loan Guarantee Scheme (SFLG), which also restricted use of the scheme to businesses less than five years old. It is being moved under the auspices of the Business Bank and is currently due to continue to the 2014-15 financial year.
Data last collated in December 2012 indicates the following trends for the four largest UK banks (as now constituted) and all other lenders29:
29 Source: www.gov.uk. Data for 2012/2013 financial year relates to April-November period only.
36 The role of intellectual property and intangible assets in facilitating business finance
At present, 45 lenders are approved to access EFG. Proposals have been announced30 to expand EFG to support businesses seeking loans of under £25k, and also to help bridge the ‘affordability gap’ by providing a guarantee of up to 25% of the overall cost of repaying a loan (at present the guarantee only applies under circumstances of default).
The overall average size of loan under EFG has been relatively stable since its inception, fluctuating between £103,000 and £98,000 over the 2009-2012 period, before rising to £110k in the first eight months of 2012/13. This latter increase in value is possibly due to the fact that the turnover threshold for eligible businesses was extended in 2011 from £25m to £41m.
However, the levels of usage have varied considerably over time.
2013 EFG review: outcomes A comprehensive independent review has recently been conducted for BIS of the effectiveness of EFG31. This considers the cohort of businesses funded in 2009, the first full year of operation for EFG, and the value the scheme has delivered to them and to the economy more
generally. The report summarises the rationale and objectives of EFG as follows:
The purpose of such an instrument is to address the long established market failure in the provision of debt finance to SMEs which requires SMEs to provide evidence of track record or collateral to address asymmetric information between the lender and the business.... Economic uncertainty can increase lenders’ aversion to risk, making the availability of collateral and evidence of a track record more important factors in the decision to lend.32
The most relevant conclusions for considering the role of IP and finance include the following:
• The lack of security is confirmed as being a genuine problem for EFG users, with 82% of users indicating that they would not have been able to obtain a loan without the scheme
• Only 49% of EFG businesses had any collateral to offer (compared with 78% of other borrowers), and where it was available they had less to offer (a median of £50-100k compared with £250-500k). It was also much more likely that any collateral would be personal rather than business-related, compared with other borrowers. There appear to be a very small proportion (6% of cases) where the business may have actively chosen to withhold collateral they had
• EFG represents a far greater proportion of a business’s total funding requirement than its SFLG predecessor – over 90% compared with under 50%
• Businesses that borrow under EFG grow at a similar rate to those which borrow from other sources, and a significantly higher rate than non-borrowers (33% sales growth for EFG, 35% for other borrowers, 25% for non-borrowers)