IP-based financing, Singapore-style

In April 2014 the IP Office of Singapore (IPOS) announced a two-year US$80 million (S$100 million) IP financing scheme to help Singapore-based companies use their IP assets to collateralise loans. This article discusses the strategic rationale behind the move, the scheme’s key features and what it means for the financial marketplace in Asia, where intellectual property is fast emerging as the latest asset class. It also covers some practical aspects of IP-based financing, which will determine the new scheme’s commercial success.

Under this scheme, granted patents can be used by Singapore-incorporated companies as security to raise financing. The scheme does not specifically require the banks to take only intellectual property as collateral; banks are free to package the loan with other forms of collateral. Given that local banks and financial institutions have traditionally been reluctant to provide loans with intellectual property as the sole or primary security, the Singapore government will share the financial risks by partially underwriting the loan with three local banks – DBS, OCBC and UOB – known collectively as the participating financial institutions (PFIs).

Although banks and financial institutions in Singapore have long been able to take IP rights as collateral, they typically accept them only as part of the collateral. Unlike land or buildings – which can be easily disposed of in a foreclosure or as part of an enforcement of security upon non-payment – IP rights are typically embedded within technological innovations and are often seen as too niche, making them a less liquid asset.

Strategic thinking

For nearly two decades the Singapore government has been advocating the strategic role of intellectual property as a key economic value driver. As a tiny resourceless nation of about 5 million people, Singapore has long recognised that in order to join the league of advanced innovation-driven knowledge economies, it must focus on innovation and intellectual capital.

The government is thus actively seeking to position Singapore as an IP hub of Asia. Policy makers and industry players have long recognised the rise in patent and trademark filings worldwide, especially in Asia. Global royalty and licensing revenues have also risen significantly, according to IPOS officials.

In 2013 the government announced that it was looking at IP valuation and the use of intellectual property as collateral in loan transactions as part of Singapore’s strategy under the IP Hub Master Plan – which is designed to encourage the recognition of intellectual property as an asset class.

At the launch of the IP financing scheme in April 2014, Senior Minister of State for Law and Education Indranee Rajah said that there is a growing trend of businesses being valued based on intangible assets, and that Singapore-based businesses can grow by exploiting new ideas. Quoting a report by global intangible asset valuation consulting practice Brand Finance, she said that 42% of enterprise value in Singapore was down to intangible assets in 2012, up from 35% in 2011 (see Figure 1).

The minister added that the new IP financing scheme will allow businesses to monetise their IP assets, which in turn should encourage the recognition of intellectual property as an asset class. According to IPOS, companies that are IP rich but asset light – especially those in the R&D and technology sectors – often experience difficulties in obtaining loans from local banks or other financial institutions to finance growth and expansion. The scheme is designed to facilitate access to financing for growth and expansion.

Key features of the scheme

Under the scheme, US$80 million of funds will be made available for debt financing in the next few years with patents used as collateral. The risk will be shared between the PFIs and the Singapore government.

Companies can tap the scheme to access loan facilities by using their granted patents as collateral. The Singapore government will partially underwrite the loans granted by the PFIs. Interest rates, repayment structures and collateral requirements will be determined by the PFIs.

Targeted primarily at Singapore-based small and medium-sized enterprises (SMEs), the scheme should enable Singapore-based companies that are rich in intellectual property to reach the next stage of development and compete in international markets.

Singapore-incorporated companies which are wholly owned by international companies are also eligible to apply, which will widen the scope of involvement by international companies.

The scheme was launched in April 2014 and will run until April 2016. After this date, banks are free to continue to provide financing based on intellectual property as collateral.

The PFIs will undertake due diligence in assessing the creditworthiness of applicants and evaluating their business case. Firms keen to tap the scheme will have to get their patents valued by a member of the IPOS-appointed panel as part of the loan application submission.

Valuation companies American Appraisal Singapore, Consor Intellectual Asset Management and Deloitte & Touche Financial Advisory Services are all on the panel at the time of writing.

IPOS will provide a valuation subsidy to successful applicants. To be eligible, companies must have drawn down 100% of the approved loan. The valuation subsidy will be capped at the lowest of 50% of the IP valuation cost, 2% of the value of the intellectual property or US$20,000 (S$25,000).

The valuers will determine the worth of the intellectual property, which will enable the banks to decide how much to lend. The government will share the default risk with the banks. The author understands that the risk-sharing ratio is not cast in stone and the partners will look at each deal on a case-by-case basis.

There is no restriction on the way that loan facilities may be used. Companies can use loans as working capital, R&D or investment. The PFIs may require applicants to identify the use when they apply for the loan and this may subsequently be imposed as part of the loan approval.

Why only patents, not copyright or trademarks?

The scheme is limited to granted patents at this time, which could prove a wise move. Like companies in many newly industrialising economies – especially those that focus on innovation and IP creation to bring their economies to the next level – most Singapore companies have IT assets in the form of source codes, which are protectable by copyright.

While the IP financing scheme could have opened up collateralisation opportunities to these copyrighted software assets, there is a danger that they would have proven too soft an asset class at the qualitative level when compared to patents, which must meet multiple requirements of novelty, possess an inventive step and have some form of practical application in order to qualify for registration. This is not to say that patents are necessarily more valuable than copyrighted software assets. Value depends on the IP asset’s quality and whether it can generate sustainable revenue and ultimately push the IP-owning enterprises to higher profitability.

Likewise, trademarks are not covered under the scheme, despite their contribution to brand value. This makes sense, given that the scheme is directed at young, innovative enterprises based in Singapore. Most young companies have few, if any, brand assets. Only marks owned by giants such as Coca-Cola, IBM and McDonald’s have the compelling global brand value against which lenders are prepared to take financial risks.

Feedback from the banking community

According to Lim Chu Chong, head of SME banking at DBS Bank: “A growing number of companies, especially SMEs, are paying greater emphasis to intellectual property. In the long run, IP assets will increasingly become a significant part of companies’ balance sheets compared to conventional tangible assets. Consequently, lending against such intangible assets, such as intellectual property, will become a more common practice for asset-based lenders and commercial banks in Singapore. DBS Bank see this as an exciting new phase in commercial lending and hope we can help many more SMEs grow together with us.”

Lim was reported in the Singapore media as saying that the bank will charge interest of between 3.5% and 7.5% for loans of between one and six years. This is significantly lower than the 8% to 10% normally charged to smaller firms seeking unsecured loans.

Image courtesy of Merlion44. Source: Wikimedia Commons

Linus Goh, head of global commercial banking at OCBC Bank, said: “Singapore businesses are increasingly leveraging intellectual property to differentiate their businesses and fuel their growth. The IP Financing Scheme recognises the value of IP deployed in businesses today and offers a new source of financing for businesses. This will ultimately encourage a stronger focus on innovation and IP development in businesses.”

Image courtesy of William Cho. Source: Wikimedia Commons

Eric Tham, managing director and head of group commercial banking at UOB, commented that: “The entrepreneurial spirit runs deep in Singapore and the IP financing scheme will help more companies springboard to their next stage of growth.” UOB sees this scheme as an opportunity to partner with forward-looking home-grown businesses that are looking to use their IP assets to grow and explore new business opportunities locally and overseas.

Singapore-based SMEs should evaluate this new financing opportunity to see whether it could lower the cost of raising capital. As the IP financing scheme is a type of debt-based financing, it should help to minimise the challenge of equity dilution.

Opportunities

Given the scheme’s sole focus on patents, international companies with strong patent portfolios should consider how to take advantage of this new additional form of financing as part of their overall Asian or Southeast Asian strategy.

As the scheme is targeted at SMEs, international companies could structure their business to involve small businesses in Singapore. For instance, multinational companies can collaborate with young, small but innovative Singapore-based companies by licensing or assigning their non-core patents for joint strategic collaborations.

The launch of the scheme also presents IP professionals with new business opportunities. IP valuers and IP investment specialists should consider this opportunity to provide professional services in Singapore, to service not only the small but high-value market in Singapore, but – more importantly – the larger Association of Southeast Asian Nations (ASEAN) market, which has a population of over 600 million.

Over the longer term, banks and other financial institutions should start exploring this new opportunity to grow their businesses, perhaps starting in Singapore but eventually targeting the larger ASEAN or Asian market.

Over the last few decades, IP rights have emerged as the next financial asset class to join existing asset classes such as land, stocks, cash equivalents, fixed income and private equity. Within the last 25 years the market value of S&P 500 companies has deviated greatly from their book value. This value gap indicates that the physical and financial accountable assets reflected on a company’s balance sheet now represent a much smaller percentage of the average firm’s true value.

Today, the most valuable assets of many innovative enterprises are intangible. Research from Ocean Tomo, a leading US IP rights investment banking firm, shows that in 1975 intangible assets represented 17% of the market value of S&P 500 companies. In 2010 that figure was a staggering 80%. A significant portion of this intangible value is represented by patented technology.

While intangible assets, especially patented technology, are fundamentally reconstituting the composition of the market value of the S&P 500, recent trends show that more and more patents are being registered out of Asia.

According to the World Intellectual Property Organisation (WIPO), the geography of innovation has shifted to Asia. China’s State Intellectual Property Office became the largest patent office in the world when it overtook the US Patent and Trademark Office in 2011 and the Japan Patent Office in 2010. According to WIPO, only Germany, Japan and the United States held the top spot in the 100 years before 2011: China accounted for 72% of the almost 294,000 increase in patent filings worldwide between 2009 and 2011.

So it is of some strategic significance that while new IP-driven market value is still being created out of the United States, the quantitative numbers are fast being driven by Asian economies, led by China, Japan and South Korea.

Singapore leads Southeast Asia in terms of payments and receipts for the use of intellectual property ($1.65 trillion), followed by Thailand ($250 million) and Malaysia ($135 million), according to World Bank data for 2012.

So although Singapore is a small economy, its capacity to leverage intellectual property for economic value creation appears to be disproportionate to its size. This may suggest a trend whereby potentially small but emerging high-value IP-driven economies can help to shape the future of intellectual property in the financial marketplace.

Against this context, there is also some movement in Singapore towards the creation of an IP exchange, to be called the Global IP Exchange (GLIPX). Unlike the scores of so-called ‘IP exchanges’ that already exist to match services between owners and interested acquirers, GLIPX has been conceived and designed as a new financial and stock exchange-like marketplace for IP-based securities. If it succeeds, it will add further depth to Singapore as an IP-based financial marketplace.

IP-based financing: the practical context

While the macro trends and policy announcements described above indicate some interesting shifts in global and regional developments in IP-based financing, it is value creation and deal making at the transactional levels that will ultimately make the difference.

It has now become something of a cliché that in today’s innovation-driven economy, intellectual property has emerged as a new value driver and a new source of competitiveness. As proven time and time again, it is ultimately enterprises that create revenue-generating IP assets which truly make a nation or a region competitive – not governments. However, governments and policy makers can still make a critical difference in creating a commercial environment conducive to IP value creation and exploitation.

The success of IP financing schemes depends on the availability and quality of patents and how the participating financial institutions evaluate the lending risks against such IP assets. The banks will be secure in their lending deals only if the borrower performs well in the marketplace.

The IP financial or investment marketplace is divided into the surplus and deficit sides of the equation. Enterprises with IP assets seeking funding (whether debt or equity based) are on the deficit side, while investors keen to invest in IP-rich enterprises and lenders wanting to extend financial facilities to borrowers are the surplus side. In between are the financial intermediaries and the investment advisers, including the newly emerging class of IP investment bankers.

Lending banks make their money primarily from interest, while investors expect to profit from equity-based capital gains or through revenue-sharing arrangements. IP advisers and IP investment bankers in turn rely on professional fees and/or success fees. Whatever their expected source of returns, IP-rich borrowers or investee companies must monetise their IP assets and generate revenue in order for lenders or investors to secure their returns.

At the grass-roots transactional level, banks and investment houses will decide whether to lend or invest based not only on whether a high-quality patent has been granted or how hot the technology is, but – more importantly – on the revenue-generating capacity of the IP assets. Ultimately, it is all about whether the intellectual property can generate sustainable returns, especially in the form of licensing revenues, for the applicant companies seeking to raise financing.

When it comes to managing and structuring IP-based financing or investment or debt-based transactions, it is useful to bear in mind the following ways in which intellectual property can be leveraged in financial transactions:

• as the subject or target of a financial transaction, such as a merger or acquisition;
• as collateral to raise financing;
• to generate revenue (eg, through licensing and securitisation of future income streams); and
• capitalised as part of a company’s paid-up capital (eg, land and cash).

So IP-based collateralisation in financing is only part of the bigger picture. IP strategists and IP-based investment specialists should therefore look at the entire value chain in order to figure out the best space to create and drive commercial value.

Whatever the strategy, ultimately it boils down to revenue-generating capabilities and sustainable profitability levels. Lenders and investors will assume financial or investment risks only when they can safely conclude that the likelihood of commercial success is sufficiently high.

The success of the Singapore IP financing scheme will ultimately rest on the quality of borrowing entities’ management and their ability to generate market value through sustainable revenue and eventual profitability levels.

However, another layer of protection which has emerged is that the Singapore government has stepped in as part of this financial risk equation.

The involvement of government agencies (and, by default, taxpayers) in the IP financing scheme is a welcome move and appears to be just the kind of strategic support that small innovative enterprises in Singapore need in order to foster the growth of an entrepreneurial ecosystem.

If the start-up community were to rely solely on banks and financial institutions to lend based purely on the commercial strength of their business model and IP assets, it would take a much longer time for IP-based financing to take off. Singapore is not Silicon Valley and the Singapore government behaves and thinks differently from the US government. Silicon Valley does not need the help of the US government to create a global technological and commercial impact. Instead, it thrives on innovation and financial risk taken substantially on its own. However, for tiny, resourceless Singapore, the role of the government is strategically necessary – at least at this point in its young economy, which turns 50 in August 2015.

Asia’s IP hub?

The trend in IP-based financing and IP-driven investment deals in Asia is likely to be led by Singapore as a leading financial centre and a city state increasingly recognised by the global community as a centre of innovation in Asia. The Singapore IP Hub Master Plan has laid the foundation for the country’s emergence as an IP hub.

So while the sheer number of patents being filed out of China, Japan and South Korea means that Singapore will never lead the patent pack, there is a place for small but high-value players in the Asian IP ecosystem, with Singapore uniquely placed to create and deliver value.

Even with a small population of just over 5 million against ASEAN’s total of over 600 million, Singapore is already the fourth largest economy in ASEAN, which comprises 10 countries. With the manufacturing and financial services sectors contributing 25% and 11% respectively to the Singapore economy and a sharp focus on higher-value and IP-driven innovation in manufacturing and services, the role of IP-based financing is expected to rise even further in the coming decades.

The launch of the IP financing scheme heralds a new phase as intellectual property emerges as an asset class in the financial marketplace in Asia. While there have been efforts in other emerging Asian markets, such as Malaysia and China, to promote the use of intellectual property as collateral, Singapore’s unique position as a trusted financial hub with one of the best IP protection regimes in the region makes it a unique place to promote IP-based financing or investment.

As Singapore attempts to push the envelope in IP-based financing while deepening its national innovation drive, this tiny but high-value economy may even become the harbinger of the next financial wave in the emerging intellectual capital economy.