Ensuring you are match fit to securitise your IP assets

Asian jurisdictions have taken the lead in trying to encourage IP-backed lending. For would-be borrowers, presenting a credible IP-based business plan is crucial

Singapore and Malaysia have joined the growing ranks of countries with IP finance schemes, with the Singapore scheme issuing its first loan in 2016. Companies which hope to take advantage of such schemes need to adopt the right approach in order to win the confidence of both lenders and venture capitalists.

As part of the application process to secure finance using intellectual property as collateral, the scheme managers (the IP Office of Singapore (IPOS) and Malaysia Debt Ventures) require a recognised valuation of a company’s IP portfolio. In addition, a strong valuation requires a well-thought-out business plan. A poor business plan will hold up the entire process as the valuer will, of necessity, spend a considerable amount of time challenging its assumptions – some business plans are so poorly written as to undermine the whole process.

Companies looking to apply to IP finance schemes need to be aware of potential pitfalls in the application process – in particular, the importance of crafting a well-thought-out business plan and ensuring that IP assets are strong and well protected.

Whereas in the not-too-distant past, most business investment was in people or physical assets (eg, premises and machinery), today most business investment is in intangible goods: ideas, innovation and creativity. Ensuring that entrepreneurs, innovators and creators can translate their investment in the creation of IP assets into value is key to any country’s long-term growth prospects.

In 2013, the UK IP Office commissioned a report (of which Valuation Consulting LLP was a co-author) to investigate whether those who create or own IP assets can use them to secure the finance they need for business growth. The research drew on a broad range of data and feedback from the government, the financial services sector, business advisers and, of course, creative and innovative businesses. “Banking on IP? The role of intellectual property and intangible assets in facilitating business finance” found that knowledge assets were not appreciated in mainstream UK lending and that intellectual property was therefore a missed opportunity, with millions of pounds’ worth of business assets whose value was not being leveraged at all, or only inadvertently. My own experience attending meetings in Kuala Lumpur with Malaysian bankers is that the United Kingdom is not alone in being myopic in this regard. Persuading mainstream lenders to invest in intellectual property is one of the biggest problems facing business in the modern world.

IP finance schemes in Southeast Asia

This situation has, quite rightly, encouraged both the Malaysian and Singapore governments to launch initiatives in the field of IP funding.

Singapore announced the launch of its IP Financing Scheme in June 2014, run by IPOS. Under the scheme, S$100 million will be used to support local businesses to use their granted patents as collateral for bank loans – although trademarks and copyright are also included. It is targeted at IP-rich, asset-light companies, which are growing in the technology sector. The main driver behind the scheme is to open a new avenue for innovative companies to access capital so that they can grow and expand.

There are, of course, conditions – the most important of which is that eligible companies must be incorporated in Singapore and possess granted patents, trademarks or copyright to serve as collateral. Patents and trademarks must be registered, while copyright-related rights must be capable of being commercially exploited in their own right. Companies interested in participating in the scheme may apply through selected participating financial institutions (PFIs), which include DBS Bank, OCBC Bank and UOB. The banks will refer companies to seek the necessary valuation for the intellectual property – to facilitate this, IPOS has appointed a panel of valuers, which the applicant is required to use.

One of the scheme’s key elements is that the Singapore government will share the risk of the IP loan with the PFI to encourage financial institutions to accept IP assets as collateral for loans. However, the PFIs undertake the due diligence in assessing the applicants’ creditworthiness and business case.

Meanwhile, Malaysia has introduced its own initiative, the IP Financing Scheme, to promote innovation and increase productivity. The scheme is run by Malaysia Debt Ventures Berhad and is intended to enable companies with IP rights to use them as an additional source of collateral to obtain funding and spur more investments for companies with technology capabilities, in turn encouraging innovation. Malaysia Debt Ventures Berhad also maintains that the scheme will help to alleviate the difficulties which several technology-focused companies face when attempting to seek funding from financial institutions.

While a preliminary application form can be found on Malaysia Debt Ventures Berhad’s website, as in Singapore, one of the key components of obtaining finance is a properly conducted valuation. As it was launching its scheme, Malaysia recognised that, outside the major accountancy firms, it had no IP valuers, leading the Malaysian Intellectual Property Office to launch its own training scheme.

So, how best can a business support the valuation process?

Malaysia’s IP Financing Scheme

Malaysia Debt Ventures Berhad (MDV) sets out the key features of the country’s IP Financing Scheme as follows:

  • leveraging MDV’s strength as an innovative technology financier;
  • financing of up to RM10 million or 80% of valued intellectual property, whichever is lower;
  • five years’ financing tenure (including a grace period of up to 12 months);
  • 2% per annum interest/profit equalisation payment;
  • 50% guarantee provided by the Malyasian government and administered by Credit Guarantee Corporation Malaysia Berhad, applicable to all MDV financing products;
  • discounted guarantee fee of 0.5% per annum;
  • basic requirements of registered and valued intellectual property; and
  • meets MDV product criteria.

What do I own and is it protected?

While this may appear a simple question, it is surprising how much time is wasted in the valuation process because the business does not really know what it owns and how this is protected. For this reason, IP audits ascertaining what intellectual property is owned and whether this is adequately protected are key.

For accounting purposes, the US Financial Accounting Standards Board has created a list of what it considers to be an organisation’s intangibles (see Table 1).

This is a useful checklist and should form the basis of any IP audit, as many companies may think of their registered rights (eg, patents and trademarks), but do not appreciate the importance of any other intellectual property that they own. For example, trade secrets, knowledge and know-how and the workforce itself (often overlooked) are vital for the proper functioning of patents. An eminent medical professor once told me that his patents were all well and good, but at that stage of product development and without the knowledge and know-how of his staff, they would be no real use to anyone until a new workforce had been brought up to speed, which would take at least a couple of years.

In the same way, a good brand name is often the result of dedicated and knowledgeable staff, who are the face of the business to its customers. In many technology-driven companies, software is of vital importance, especially in areas such as financial technology and gaming.

Obviously, lenders would not be interested in lending against some of these types of intellectual property – eyebrows would certainly be raised if a workforce were put up as collateral. However, in a valuer’s eyes, the strength or otherwise of the supporting intellectual property can do much to enhance or diminish value.

Having identified your intellectual property, the next obvious step is to check that, where possible, it is adequately protected and registered – if it is to be used as collateral, there must be something that the lender can take security over or ownership of. It is strongly recommended that before any finance application, a business should approach a reputable patent and trademark firm to ensure that its intellectual property is match fit. There is no doubt that properly protected intellectual property is worth more than intellectual property which is not properly protected; lack of proper protection may well negate the chances of obtaining finance at all.

Table 1Categories of IP asset

Category

Examples

Market related

Trademarks, trade names, service marks, trade dress, newspaper mastheads, domain names

Customer related

Customer lists, customer contracts, customer relationships, customer agreements

Artistic related

Ballets, books, plays, articles, other literary works, musical works, opera, pictures, photographs, video and audiovisual material

Contact based

Licensing agreements, advertising or service contracts, lease agreements, construction permits, operating and broadcast rights, employment contracts

Technology based

Patent technology, computer software, unpatented technology, databases, trade secrets, secret formulae

Business planning

Having ascertained what intellectual property you own and made sure it is protected so that it is eligible to be securitised, the next step is to produce a credible business plan to support a financing application. As a valuer, I see many business plans every year and the projections in several of them appear laughable, on face value. Table 2 provides a hypothetical example. Such poor plans lead to what is known as the ‘hockey-stick effect’, as illustrated in Figure 1.

As can be seen, the hypothetical business plan projects a loss of $3.6 million becoming a net profit of $360 million in less than five years. While not impossible, to a potential lender this simply would not seem credible unless there were a very persuasive business plan to support these projections.

Many basics should be included for a business plan to be credible. While some of the information mentioned may, to many people, seem excessive and not everything will necessarily be available, it will help the valuation process and will almost certainly be needed to support an application for finance under either the Malaysian or Singapore scheme.

Table 2Hypothetical financial projection

 

Year 1 $

Year 2 $

Year 3 $

Year 4 $

Year 5 $

Revenue

790,156

66,087,822

164,384,964

366,777,699

813,684,208

Expenses

(4,773,417)

(18,825,202)

(67,436,460)

(147,895,117)

(447,577,275)

Net income

(3,983,261)

47,262,620

96,948,504

218,882,582

366,106,933

Income taxes

360,364

(23,655,628)

(48,507,425)

(109,476,794)

(183,086,903)

Net income

(3,622,897)

23,606,992

48,441,079

109,405,788

183,020,030

Retained earnings at start of year

N/A

(3,622,897)

19,984,095

68,425,174

177,830,962

Retained earnings at end of year

(3,622,897)

19,984,095

68,425,174

177,830,962

360,850,992

IP protection checklist

Protect the intellectual property:

  • Having ascertained what you own, make sure as far as possible that it is protected.
  • Do not forget to renew – if your registered rights lapse, they lose their value.
  • Lenders will securitise only if there is an asset which they can take ownership of, so there must be legal ownership in place.

However, unless the intellectual property is already revenue generating, it is unlikely that it would qualify for the Malaysian and Singapore schemes. This makes life difficult for start-ups, which tend to be most in need of the type of finance offered by both the Malaysian and Singapore schemes. As a result, start-ups are often driven to find private investors to finance the business until they become revenue generating. However, just because a business does not qualify for these schemes does not mean that a credible business plan should not still be sought. Any type of investor will require a well-thought-out business plan and is unlikely to invest or lend without one.

Business and intellectual property

After a general introduction and executive summary, a good business plan should have a section on the business as a whole and the intellectual property in particular, including as much of the following as possible:

  • an overview of the nature of the business (ie, key trading activity, recent key developments, key personnel, background history);
  • an outline of the business’s latest strategic plans;
  • a listing and description of the patents, trademarks, copyright, design rights and non-legally protected intangibles such as know-how, trade secrets and formulae;
  • the status of all patent or trademark registrations and applications (ie, dates, classes and territories covered), together with full descriptions of other assets, such as software and databases;
  • a description of product(s) and services using the intellectual property;
  • information concerning the markets within which the intellectual property is (or is intended to be) exploited and whether these are local, national or global;
  • details of how the intellectual property fits into the market:
    • its unique selling points;
    • the advantages it brings to the business; and
    • how it compares relative to similar assets held by competitors;
  • strategies to enhance the intellectual property;
  • information on the remaining useful life (ie, technological, physical, economic and legal) of the intellectual property – this can be particularly important as a right’s legal life is not necessarily the same as its economic life. You need only consider the short lifespan of mobile phone technology to realise that much of it is superseded in a short space of time;
  • a description of the competitive advantages provided by the intellectual property;
  • a description of competing technologies and companies in the marketplace, available sector and technology reports and general market data – including sector forces which might affect the value of the intellectual property;
  • a section on the key personnel in the business, setting out their strengths and experience; and
  • an analysis of the strengths, weaknesses, opportunities and threats of both the business and the intellectual property.

Figure 1. The so-called ‘hockey-stick’ effect

Research

The section on the business as a whole and the IP rights will include references to the market in which the intellectual property will operate and how it will fit in.

The importance of market context may seem obvious to most people, but it is surprising how often it is neglected. Most patent agents or attorneys have war stories of being asked to file patents for inventions which might well be eligible, but apply to a product with no conceivable use. The question is therefore not what the market share will be, but whether there is a market at all.

It must also be considered whether the intellectual property is aimed at one specific project and whether it is clear to the business who its customer is likely to be, or more commonly, whether the market is open and there are (hopefully) several potential customers.

As a result, a thorough analysis should be carried out, covering at least the following:

  • Type of industry – is this a new industry that is growing rapidly or a more mature industry, where growth will be far more conservative? An example of the former could be renewable energy, whereas the latter could be packaging.
  • Marketing strategy – where and how will customers be targeted? What is the target market and demographic?
  • Distribution channels – how will the product come to market and what will this cost?
  • Pricing strategy – how will the product be priced? Is it likely to be of such benefit to customers that the savings will justify a premium price or is the market so competitive that prices will need to be kept as low as possible? The bottom line is that the business will need to achieve the following:
    • be competitive;
    • recoup its initial investment; and
    • have sufficient cash flow to pay off creditors and still make a profit.
  • The target market and demographic will need to be ascertained to ensure that the projected revenue is achieved.
  • It would also be useful to ascertain whether a licensing model is the best way to get the intellectual property to market.

Financial information

The financial information supplied will be of prime importance to a potential lender and the valuation process. First, the lender and valuer will be interested in the business’s historical performance. To this end, the business should supply full statutory financial statements (including detailed profit and loss schedules) for the last three years or covering the period since it started trading (if shorter), as well as the latest management accounts for the business showing profit and loss performance for the year to date, plus budget forecasts for the current financial year.

This should always include a narrative giving details of the figures and background to the results, including whether the business is meeting targets and explaining any unusual fluctuations.

Next is the important profit and loss forecast for the business for the next three to five financial years – in particular, those including annual forecasts for sales and operating profit. This should include breakdowns of actual and forecast sales illustrating what is driving growth (eg, new and existing technology, new customers or new trading locations). This section is particularly important and should be driven by the market research outlined above. If you are going to forecast 20% growth per annum, you must be in a position to demonstrate where the customers will come from. It is unreasonable simply to claim that the market is expanding without explaining why you will be expanding into it and not one of your competitors.

If the intellectual property requires further work to bring it to market, then you must make this clear, giving details of any further development spend required either to bring the intellectual property to a state where it can generate sales or to make necessary upgrades to deliver forecast sales.

Finally, if any income from your intellectual property is to be driven by licensing agreements, this should be made clear and full details provided – especially if you are considering a strategic partnership to bring the product to market. This is particularly popular in the life sciences industry, where small players will often team up with one of the giants to utilise their resources in taking a drug through expensive clinical trials and eventually bringing it to market.

New opportunities

IP financing schemes such as those in Malaysia and Singapore are likely precursors to wider acceptance of intellectual property as security for business funding. The requirements of these schemes will likely be used as a basis for future schemes in other jurisdictions.

Businesses looking to secure finance using their intellectual property as security – whether in Malaysia, Singapore or another future location – need to prepare well.

Action plan

To take advantage of the Malaysian and Singapore schemes, businesses should take the following steps:

  • Ascertain exactly what intellectual property they own.
  • Ensure that this is fully protected.
  • Have a credible business plan in which they have:
    • defined and researched their market;
    • established a reasonable percentage market share;
    • calculated a pricing structure;
    • ascertained likely costs; and
    • established that their cash flow will be sufficient to cover debt payments.

Ian Brewer is a partner in Valuation Consulting LLP, London, United Kingdom

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