By: David Drews, CLP
Relatively few organizations appreciate the full scope of flexibility available to them in terms of unlocking the value of their patents, trademarks and other intellectual property. One of the most overlooked methods for utilizing the value of IP is its use as collateral. This activity is becoming more common as the importance of proper intellectual property management gains recognition and as increased cash flows associated with the licensing of IP catches the eye of Wall Street. The highest profile examples of these transactions are probably the securitized royalty streams on the copyrights owned by famous songwriters like David Bowie and James Brown. However, there have been numerous instances of valuable trademarks and highly productive patents being utilized in this capacity as well.
There are a number of reasons why an IP owner might be interested in pursuing this kind of strategy. First, it can provide a method for transferring some of the risk associated with the intellectual property. If the financing is non-recourse, the risk of receiving the royalty payments is transferred to the lender. Also, any risks associated with infringement and obsolescence are transferred as well. Second, it may increase the return on the IP through increased leverage. This is because the present value of impending royalty streams is being collected in a lump sum today rather than spread out over the future. This lump sum payment can then be invested in current projects that feature an internal rate of return that is higher than the cost of the financing. Any upside potential residing in the IP is typically retained by the IP owner as well.
Third, it provides a source of capital that does not dilute the current equity structure. With venture capital discounts typically in the range of 25% to 50%, this is very beneficial when compared to equity sources of financing, especially for smaller technology companies. An additional benefit of this kind of financing is that the interest payments are tax deductible. This helps to offset a portion of the discount taken as a result of the present value analysis.
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