Opportunities to finance innovation with IP*
By Alfred Radauer, IMC University of Applied Sciences, Krems, Austria
The "pro-IP era" of the last 30 years has been characterized by steady growth in patent and intellectual property (IP) filings with major IP offices across the world and greater use of IP in business. With the transition towards knowledge-based economies, increasingly, the value of firms is determined by intangible assets, such as know how, brands or technological skills.
A study by the IP merchant bank Ocean Tomo, shows that 84 percent of the value of firms on the S&P 500 Index in 2015 was attributable to intangible assets and just 16 percent to tangible assets such as physical property—a reversal of the situation four decades ago, when in 1973 the corresponding shares were 17 percent and 83 percent, respectively.
Unsurprisingly, public policymakers are working to boost business awareness about the importance of protecting intangible assets against unauthorized use and/or unlawful copying by competitors. And they are advocating the use of IP rights as an important means of doing so. As a consequence, many firms are starting to understand that IP rights are a "should have" form of insurance. While for many that may be enough, such a narrow perspective obscures opportunity to proactively use IP rights to finance further innovation and generate new sources of revenue.
How IP can help secure financing
Corporate finance specifically focuses on bankrolling decisions of businesses, with a view to maximizing company (share) value. As such, it typically focuses on different sources of funding—be it equity, such as investors buying stocks of a company, or debt, such as loans. Arguably, grants for research and development (R&D) also have a financing function. IP rights can play an important role in leveraging finance and funding innovative activities in each case.
IP and equity
In the case of equity, IP can be particularly important in raising investments and investor interest. IP rights, especially patents, are significant for startups seeking to attract venture capital.
Numerous studies show that venture capitalists are more likely to fund companies with an IP focus. They appeal to investors in various ways. First, startups—which typically lack large sales records—can prove their ideas have value insofar as they met patentability criteria during patent examination. Second, patents provide assurance that the inventions behind a startup may not be copied easily by other firms. Third, should the startup go bust, the patents remain and can be sold or licensed to others, thereby limiting possible losses for investors. And fourth, the patents may enable the startup to stand out in the market and successfully attract investors' attention.
The suitability of different IP rights to support finance depends on the industry in question.
The suitability of different IP rights to support finance depends on the industry in question. In the life sciences or other high-tech industries, for example, patents are the currency for business formation, growth, and sustenance. In other industries, IP rights like trademarks, which protect brands, may be significant. And in some instances, entire business models may be built on top of IP rights. Take franchising, as a form of IP commercialization, for example.
IP rights in debt financing
IP rights may also play a role in debt financing, serving as collateral for loans. While the rationale for using IP rights to underwrite loans may be similar to those used to back equity investments, their use for debt financing is far less common than for IP-backed equity scenarios. That said, it may still be a surprisingly buoyant market. Some estimate that venture lenders such as Silicon Valley Bank and other specialist non-bank lenders, supply around USD 5 billion annually to startups. However, some commentators dismiss the use of patents as collateral to access debt finance as purely anecdotal. These viewpoints can be interpreted in two ways. First, there may indeed be opportunities for using IP in debt finance. Second, there may also be challenges ahead, which explains why the market for such finance is small. That said, there is a clear need for more research and data on the use of IP-backed collateral for debt financing of firms.
Challenges in accessing finance have prompted some governments to foster markets for IP-backed debt finance. China, for example, operates government programs that promote the use of IP rights as collateral by subsidizing interest rates, specific bank funds, and valuation guidelines and tools to lower the lending risk. Between 2018 and September 2019, reports suggest that in the Guangdong province alone, patent-collateralized loans worth some RMB 30 billion (more than USD 4 billion) were granted, with “thousands” of companies benefitting from the schemes.
IP in the context of R&D grants
While often overlooked, IP rights can be useful in attracting government-funded R&D grants. Here, we see two main strands in how IP rights are handled.
In the first strand, many government R&D subsidy programs require that patents and other forms of IP are filed or registered as a result of (successful) R&D projects. Governments want to foster research that results in the successful commercialization of products and services, for which having IP rights is a requirement. However, policymakers and firms need to carefully consider how these grant schemes are designed and to recognize that an applied-for IP right is not the same as a marketable R&D result. In fact, considerable follow-up R&D is often required to reach, and move beyond, the prototype stage after a patent has been filed for an invention.
In the second strand, grants for research consortia, and in particular, transnational research consortia, are growing in popularity. The IP in consortia-based R&D funding lies in the contracts (or agreements) that govern the consortia. Here, participants must know the conditions for using or sharing background IP (what each party brings to the table), in other words, what each contributing partner may or may not do with the background IP. Similarly, there must be an agreement as to how jointly developed research results that convert into patents, for example, (so-called foreground IP) are to be shared among partners. Such IP management requires registration and filing of IP as well as strategic thinking and negotiating skills to conclude consortia contracts. The potential benefits—including network formation, access to additional funding and know how by the consortium partners, and learning—may go well beyond the formal legal terms of these contracts.
Exchanges and marketplaces for IP—a source of innovation finance?
If IP can be used for both equity and debt finance, can it be used to leverage financing opportunities through exchanges and marketplaces in the same way firms use stock and/or bond exchanges for capital finance?
The terms “assets” and “property” suggest that IP shares a number of characteristics with financial securities and that there is an ever-increasing supply of IP, which, in turn suggests liquidity (i.e., that it is easy to find buyers and sellers to turn IP assets into cash at well-defined market prices). Even if IP ownership is not transferred, there is clear evidence (mostly bi-lateral) that licensing is an increasingly significant activity to raise money for many companies.
IP differs from real property in that its value is context specific.
The answer to this question is that, indeed, there may be opportunities, but the issue is complex and requires nuanced thinking.
One major difficulty for developing IP markets is that not all patent/IP licensing is the same. A crucial distinction lies in that there are two different market segments —“stick” licensing and “carrot” licensing.
- “Stick licensing” is where a company is already using a technology and the holder of the underlying IP rights (a different firm) wants that company to obtain a license. Such licensing, also known as enforcement or assertion licensing, relies heavily on litigation—or the threat of it—against alleged IP infringers. In discussions on patent/IP monetization markets or brokered IP/patent markets, this type of licensing and market segment comes into play.
- “Carrot licensing” describes a situation in which parties actively pursue a license for the knowledge or technology they are interested in. This often involves the licensing of patents, and know how, or technology licensing. With such licensing, a transfer of technology occurs.
The distinction is important as both types of licensing have different characteristics and potential public support needs—even if the boundaries between the two markets are, to an extent, fluid.
Common issues for all forms of IP-supported finance
Generally, neither stick nor carrot licensing markets are highly liquid. Successful carrot licensing agreements are less commonplace than their enforcement-related counterparts. One barrier to all types of IP finance activity—whether debt or equity finance—is valuation.
IP differs from real property in that its value is context specific. For example, by definition, a patent protects a unique invention, so patents cannot be a uniform commodity, like iron ore. Moreover, the value of the same IP may vary for different companies. One IP portfolio may be valuable for a company in a given technology or market position, while, for another firm, the same IP portfolio may be worthless. One particular piece of IP by itself may be worthless, but as part of a portfolio of rights, it may be extremely valuable. There is no universally accepted standard method for valuing IP.
As IP asset holdings are specific to a particular company operating in a specific market, it is imperative that all proposed approaches and strategies cater to such context-specific issues.
Challenges relating to the valuation, liquidity, and enforceability of IP rights are also major hurdles to using IP as collateral in debt finance. There are also barriers unique to IP-based debt financing, such as banking regulations. Standards like Basel-III set a strict framework of requirements on how much capital a bank needs to set aside to match the risks associated with certain types of collateral. IP may not meet these criteria. While venture funders take a look at the company and its future prospects as a whole, debt funders are restricted to solely assessing the collateral—the IP. This may be an important factor in explaining why equity-based IP finance is currently more successful than IP-backed debt finance, which remains nascent.
Numerous opportunities exist for firms to use IP to finance innovation simply by viewing IP rights not just as an insurance policy, but more broadly as a tool to secure finance. A sound understanding of how the IP system works, the potential value of different types of intellectual assets and IP rights a company owns, and excellent IP management skills are keys to success. While it is evident that some uses of IP finance are quite challenging to implement, others—such as IP in consortia agreements—constitute untapped potential.
Against this backdrop, a bundle of measures may be recommended to policy makers and firms. These include fostering the use of IP audits by firms to increase general awareness of the value of their IP rights. They also include implementing measures to improve the know how of (financial) intermediaries, in particular, for using IP rights in collaborative settings. Measures to improve IP finance markets must be designed with care to avoid failure. Simple electronic marketplaces are unlikely to be able to handle the complexity of IP rights as a specific class of assets. Ultimately, as IP asset holdings are specific to a particular company operating in a specific market, it is imperative that all proposed approaches and strategies cater to such context-specific issues.
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