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Alternative Financing Solutions: Intellectual Property-Backed Loans 

by Marc Adesso, Julian Bibb

Published: September, 2020

Submission: September, 2020

 



As the world begins to adjust to the short and long-term impact and implications of the COVID-19 pandemic, many companies are seeking ways to preserve cash on their balance sheets while simultaneously raising funds to ensure a continuation of operations.


One option to consider is using the company’s intellectual property (IP) portfolio as collateral for funding.


Typically, companies looking at this IP-backed funding option have more than 10 IP assets in their portfolio and generate meaningful revenue with positive, projected cash flows (which are most strongly correlated with the company’s IP portfolio itself). This type of funding can be a good fit for companies that have valuable IP, but a lack of tangible assets. In the case of start-ups with venture capital or private equity sponsors, IP-backed loans provided through a pure-debt structure can allow the company to generate cash without diluting current equity investors’ ownership by bringing in new investors.


IP-backed loans


In the case of more conventional asset-backed loans, lenders typically turn to physical assets, such as manufacturing equipment, or real estate, in determining possible loan sizes and terms based on a percentage of the company’s overall portfolio of equipment or property (and usually, the lender’s ability to liquidate such assets in the event of default). The borrower then grants a UCC-1 security interest in these assets to the lender as collateral against the loan.


IP-backed loans are similar to these asset-backed loans in the sense that a company can borrow a percentage of the value of its IP portfolio, using the IP assets themselves as collateral. IP-backed loans differ from traditional asset-backed loans in two key aspects.


First, internally-developed IP is not typically recognized on a company’s balance sheet; instead it appears as an expense on the company’s cash flows statement. This contrasts with tangible assets such as manufacturing equipment, in which the assets are capitalized and amortized on the balance sheet.


Second, IP-backed loans may have an insurance component to them. Similar to mortgage insurance on real estate, an insurance company underwrites an insurance policy covering the company’s IP in order to protect the lender in the financing transaction who is relying on the IP as collateral. Examples of IP that can be insured include the most common forms of IP such as federally registered trademarks, copyrights and patents, but can also include assets such as common law trademarks, unique and proprietary business processes, trade secrets and data. Thus, firms who have experts that specialize in structuring and valuing IP transactions can assist banks and other alternative asset-based lenders to determine the value and strength of a company’s IP portfolio, and can establish a floor value upon which to determine lendable IP collateral advance rates.


The terms of the insurance policy for the IP collateral align with the terms of the corresponding IP-backed loan, with the typical term of this kind of insurance coverage being no more than five years.


IP-backed securitization


There are ways to achieve funding similar to IP-backed loans, but which involve the company securitizing its IP assets, or in a more extreme case, selling and licensing back the use of its IP assets.


In the case of IP securitization, which is similar to auto and mortgage loan securitization products, the company assigns a portion of its future revenue from licensing its IP portfolio in exchange for upfront, lump-sum funding or more favorable terms for a longer-term IP-backed loan. In addition, the cash received upfront for the future IP licensing revenues (sometimes called royalties) do not show up on a company’s balance sheet as a loan, allowing the royalty monetization to be recognized on the cash flow statements for the company’s current fiscal period. Note that off-balance sheet treatment is contingent on accounting structure and should be assessed carefully before entering into a transaction.


 


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