AIPPI Report: The emerging role of IP business finance

The AmeriKat particularly likes the taste of Andrew Jackson

While the AmeriKat was busy preparing for an afternoon in court, her firm was equally busy hosting the first post-Congress AIPPI event in the UK.  Allen & Overy's cavernous lecture theatre welcomed the guest of honor, Tony Clayton, Chief Economist at the UK Intellectual Property Office (IPO), who entertained the audience on a topic much-neglected by us IP litigators - the role of IP in business finance.  The AmeriKat is indebted to her colleague, Chandni Sood, who took a thorough note of what she understands were stellar proceedings.  Over to Chandni:

"Tony described that having joined the IPO about four years ago to provide economic evidence to the Hargreaves’ Review of the UK IP framework in 2011, it became evident that there was a gap between the IP world and the financial markets. 

With British businesses spending billions each year creating assets which can be protected by IP rights, it is clear that significant value is placed on IP in a company’s investment. This topic has been a key priority for the IPO in recent years.  Work on this subject to date demonstrates the underlying importance of IP investment to the UK economy.  For a recent summary, see the IPO's commissioned report published in November 2013 entitled “Banking on IP” (see the AmeriKat's summary here).  

Challenges

For firms to grow their business potential and invest in IP assets (without relinquishing control), they need to borrow. Using IP assets to secure this financing for growth can prove difficult as such assets are considered intangible investments. Tony therefore explained the concept of knowledge investment by firms for future returns, in areas such as R&D, designs, business workplace skills, reputation/brands, software and creative works.

It was recognised that most firms do not treat this expenditure as investment in company accounts. Although software and creative works can be counted as investment in company accounts (and R&D is also counted from 30 September 2014 raising UK GDP by £17bn), designs and workplace skills are too complicated to define and quantify, and are thus currently excluded.

Facing this challenge, the IPO attempted to define and quantify this investment by separating tangible assets (such as vehicles, machinery and computer hardware etc.) from intangible assets. Within British businesses, it was found that the share of intangible investments was larger than tangible investments (this trend was also seen globally in Scandinavia and the Netherlands).

However, most intangible assets are detached from the financial markets. As they are generally not reflected in company accounts and are hard to value, it is difficult to secure financing from financial institutions using these assets as collateral. This poses significant challenges - over two-thirds of a business’ investment is in its IP rights (namely software and R&D). It is therefore unsurprising that investment in British businesses is constrained. 

Research results

The IPO has been approached by firms who found the lack of readily available finance to be a key problem. The IPO therefore commissioned consultants to conduct research and 60-65 interviews were conducted with key suppliers.

As a result of this research, it was found that equity finance is currently growing in the UK.  However, thiss eventually leads to an entrepreneur “exit” and lost IP value (especially through foreign ownership). It was also found that credit availability did exist – banks were willing to fund companies if equity finance was also available but the problem was getting banks to understand IP and correctly assess the value of the assets. On the other hand, the real difficulty for firms was explaining to potential lenders how IP will service loans, especially as lenders made it clear that their credit must be repaid, and that ideally, they wish to own the business and not the IP.

As recognised by the Head of Investment Banking at Deutsche Bank, it is clear that if a bank wants to lend, transparency is key. It is important to know what the asset is, who owns it and what the value is. Therefore data must be created first and in turn, this will make the asset more visible.

IPO work

The IPO’s Action Plan for 2014 consists of four key strands: 

• to build awareness – for both firms and financial institutions thus encouraging the understanding of IP as an asset;
• better tools and templates – building on existing good practice allowing businesses to communicate what they have and how it is secured;
• risk mitigation – examining insurance approaches for IP (as banks want the confidence that their loan will be repaid); and
• developing IP markets – requiring good information (both data and analytics). 

Global picture

It is not just the UK that faces these challenges.  The Singaporean government’s objective is to create an “IP trading hub” by providing IP valuation training and government support for insurance guarantees. Taking this one step further, China aims to embed the IP system in business practice making it an inherent part of doing business generally. China has also implemented a government backed loan guarantee fund (locally based) which has had low failure rates thus far.

In the US, the US Patents and Trademarks Office (USPTO) is seeking to improve ownership data (making it easier to register a change).  The US Government has also recognised IP as a tier 1 asset. As a result, auctions and trading platforms are emerging and niche insurers are participating in hefty deals insuring branding and patent portfolios. 

Next Steps for IPO 

In the next three months, working groups are discussing solutions to achieve the above outcomes. Tools and templates will be brought in to create best practice and a common framework. By next spring, the aim is to (i) conduct market testing of these tools and templates in real time and (ii) collaborate with professional IP and finance valuation experts to learn from successful models.

Conclusion 

In practice, the IPO faces a number of challenges. IP backed finance tends to be available for a short-medium term as the technology landscape can readily change with, for instance, the grant of another patent. Ownership of IP assets is also not 100% certain. There is also a huge information and knowledge gap. Financial institutions will find it harder to understand IP assets and value, for example, scope of monopoly and rights, whether the asset ends up embroiled in litigation or a confidential settlement etc. This uncertainty can lead to a greater risk which can deter a bank from taking a leap of faith when assessing IP assets against which loans can be made. The key question is what kind of data will provide financial institutions with a better understanding of IP assets and therefore the confidence to use them to provide the requisite financing? 

In relation to data, it was discussed that all valuation should currently be based on US data as this is currently better than European data due to figures published by the USPTO, company intelligence and valuation models based on analysing values reflected in prior M&A transactions in the US. Interestingly, there was also some lively debate at the end of the presentation on the role of patent trolls influencing the quality of data in the US.

The quality of data is thus a major issue in the UK. Transparency in markets depends on data (the more efficient the data, the greater the value). In order to gain more transparency, the UK may need to adopt the US approach by developing company intelligence and pooling resources to improve the quality of its data to enable a more thorough analysis. Once there is greater transparency with the litigation system in particular, any risks can be identified leading to confidence which can push financial institutions to take the plunge when using IP assets to provide loans."