Neumyer, Darin

Despite past predictions that intellectual property as collateral would be a mere trend, it looks like IP is here to stay.

Over the past several years, the assetbased lending market has been highly competitive and faced significant pricing pressure. Meanwhile, intellectual property and other intangible assets (collectively referred to as IP) have become a much more substantial portion of the total asset value of businesses worldwide. Many asset- based lenders have begun lending directly against IP to provide additional availability and win deals. Some have suggested that lending against this asset class is a short-term phenomenon, driven strictly by the competitive markets. Evidence suggests, however, long-term trends and economic factors make IP an essential piece to the collateral pool that lenders must be prepared to take advantage of going forward.

Many different definitions are currently used to describe IP, most of which are specific to the objective of the definition, e.g., accounting, litigation, taxation. For this article, IP is defined as nonmonetary assets that cannot be seen, touched, or physically measured and that are created through time and/or effort. We further define two subgroups of IP: legal IP (such as copyrights, patents, trademarks, and contracts) and competitive IP (such as proprietary knowhow, collaboration activities, leverage activities and structural activities). Legal IP derive from property rights that are defensible in a court of law. This is the primary source of IP lending collateral. Competitive IP, while not legally controllable, directly affects effectiveness, productivity, wastage and opportunity costs within an organization. Thus, it can be quite valuable. While competitive IP is the source from which competitive advantages flow, perfecting a lien on such assets is often impractical. Therefore, as used in this article, IP refers only to legal IP as described above.

Third-party studies on the value of IP

Many organizations have conducted studies that have tracked and documented values of public companies’ IP. We have chosen to discuss two that are particularly well known. These studies focus on the growing role of IP in a company’s asset structure.

The first study was conducted by Ocean Tomo in 2005 and examines the market’s acceptance of IP value as reflected in market capitalization. This study examines growth within the U.S. equities market from 1975 through 2005 by considering three major components of companies included in the S&P 500: tangible book value, intangible book value and market premiums. This study indicated:

1. Intangible book value as a percentage of the market capitalization value:

2. Intangible book value as a percentage of total book value:

3. Intangible book value as a percentage of the market value of the S&P 500 less tangible book value

The second study was conducted by Brand Finance. This study focused on IP values on a categorical basis by industry. This study also analyzed companies outside of the U.S., whereas the Ocean Tomo study focused on companies included in the S&P 500 (only 13 non-U.S. companies are a part of the S&P 500, of which some were formerly U.S.-based). According to the Brand Finance study, approximately 62 percent of the value of the world’s publicly listed companies is now intangible. From the 2006 “Global Intangible Tracker” report that covers over 5,000 companies in 25 countries, the following are the IP values as a percentage of total book value by industry:

These studies illustrate that there is a significant basis in the market for placing value on IP. Another interesting observation is that the percentage of total asset value ascribable to IP appears to be increasing in the U.S. This trend is caused by the combination of an increase in the value of IP and a decrease in the value of other assets.

It appears likely that IP values are increasing, in part due to the fact that the U.S. economy continues to shift from a manufacturing-based economy to service-based. Evidence: services accounted for 41 percent of the Gross Domestic Product in i960. By 2000, that number had grown to 55 percent and continued to steadily increase to 58 percent by 20061. The impact of this transformation has clearly been demonstrated in the apparel industry where nearly all manufacturing is sourced from overseas and the assets that remain in the U.S. are primarily the rights to the trade names, which are licensed to third parties. Examples of this business model include publicly traded companies such as lconix Brand Group, Inc., Cherokee Inc., and NexCen Brands, Inc. A similar business model exists for the licensing of patents, and the patented licensing industry is estimated to generate $100 billion in annual revenue.2

The U.S. shift to an information/service economy has also likely reduced the total value of hard assets in the U.S. Obviously, as firms increasingly outsource to foreign manufacturers, the machinery and equipment once required to produce those goods are no longer needed domestically and are often sent to the location where the manufacturing now takes place. Another factor that may be facilitating the decline in the value of U.S. non-IP assets is the continual pressure to do more with fewer assets, which is evidenced by the shifts toward just-in-time inventory systems. One of the desired outcomes of instituting such a program is that inventory is reduced.

IP in asset-based lending

Companies that do not qualify for conventional bank financing typically use asset-based financing as an intermediate form of lending as they attempt to transition towards a cash-flow financing. Traditional asset-based lending considers accounts receivable, inventory (including marketable raw materials), and property, plant & equipment. The nontraditional form includes IP.

Traditional lending is based on an absolute floor to the value in terms of the scrap value of the material. Also, there are often known mediums to sell hard assets, such as inventory brokers, machinery and equipment auctions, and account receivables factoring.

As the economy has shifted away from manufacturing, there has been an increase in the quantity of IP transactions. Iconix Brand Group, Inc., NexCen Brands, Inc. and Hilco Consumer Capital, LLC have all developed through a series of trade name acquisitions. Furthermore, live IP auctions have been occurring regularly. Recently, at one auction, a variety of different types of assets were sold, including the Jimi Hendrix catalog of songs, a patent for online shopping, and a variety of trade names.

One reason that asset-based lenders have historically been reluctant to include IP in their collateral pools is the difficulty in determining the saleable value. Also, for lending purposes it is important to understand how the subject asset values will behave in distress situations and which assets need to be bundled together to ensure value. However, an increase of IP transactions and the emergence of IP valuation specialists have helped to improve methodologies in estimating the fair market value of IP.

As lenders have become more comfortable with the liquidation value of certain intangible assets, loan structures have evolved. For example, when lending against brand names, historically lenders would rarely advance more than 15 percent of the appraised fair market value. Now it is common to see advance rates in excess of 75 percent of the liquidation value of the brands.

This does not mean that all IP has lendable value. The value of IP from a lender’s perspective should rely on numerous criteria including, but not limited to, the type and nature of the IP, the current state and future outlook of the industry in which the borrower competes, and the probable level of demand of potential buyers should a liquidation be required. This should not be confused with the fact that all IP does not have lendable value. Even if the IP has value on a going concern or liquidation basis, the exit strategy employed might drive the level of value received during a transaction.


It is also important to understand the following general risks of lending against IP: market acceptance, obsolescence, maintenance and legal risks.

Market acceptance: It is extremely difficult to accurately predict the level of success or failure of a new product/ patent/service offering in the market place. The price volatility of IP strictly associated with new offerings generally makes it poor collateral for asset-based loans. Older established offerings are generally more stable and provide both appraisers and potential buyers with the market information to assess the value of the IP with a greater degree of accuracy.

Obsolescence: This is essentially the flip side of market acceptance. As new offerings enter the market, the value of IP associated with established offerings often declines. New technologies surpass the old, established brands lose favor to trendy labels, the third edition of a text book becomes the requirement instead of the second edition. Because IP value is generally derived from expected forward sales of the associated products or service, obsolescence will have an impact.

While obsolescence is often the risk with which lenders are the least comfortable, its impact on value is generally not as sudden and extreme as many might think, and it can be reduced through the proper loan structure. It is also worth noting that this risk is similar for other assets that most asset-based lenders typically lend against such as machinery and equipment and inventory.

Diversified IP licensing programs can spread the use of the IP across several markets reducing the likelihood of sudden catastrophic declines in value from the introduction of new offerings in a single market. Furthermore, such licensing arrangements often include minimum payment clauses, which provide a downside cushion contingent on the credit quality of the licensee.

The risk can be mitigated by controlling the length of time capital is at risk relative to the valuation analysis, which would accrue through the use of a limited-term amortizing structure. Asset-based loans with significant IP collateral are often structured as threeto five-year amortizing term loans. The amortizing structure compensates for the potential increase in price volatility of IP in a distressed situation.

Maintenance: Like tangible assets, IP needs to be maintained to retain value. This maintenance takes different forms for different types of IP. For example, trade names and patents need to be protected from infringement. Trade names often need advertising programs to be continually supported. Customer list data files must be constantly updated. Similar to that for tangible assets, maintenance of IP is often neglected when a company is in financial distress. Further, some types of maintenance must generally be continued throughout the liquidation process.

Legal risks: There are a variety of legal risks that can threaten IP. Two prime examples are (i) ownership challenge or infringement and (2) expiration of contracts or legal rights.

Generally, older IP with an established market for its associated products is less likely to experience an ownership challenge, and active monitoring by compliance specialists can also be done to reduce the risk of infringement.

Expiration dates should be fully known by the lender prior to closing the loan. Therefore, the risk comes from remaining in the loan longer than is expected. This should be mitigated by an amortizing structure.

Importantly, it is necessary to see if the IP has been registered or updated with the respective regulatory agencies. The lender must perfect a security interest in the patents, trademarks, and unregistered copyrights by filing security interests with the state Uniform Commercial Code (UCC) in the jurisdiction of organization of the borrower and with the United States Patent and Trademark Office (USPTO). If the unregistered copyrights become registered, the UCC filing is insufficient to perfect and the lender must record the security interest in the U.S. Copyright Office.

Lending against trade names

When considering all categories of IP, trade names tend to be the most saleable. There are typically product or service revenues attached to the trade name being sold, and there are companies that are set up to buy trade names and license their products or services.

In valuing trade names for lending, an appraiser’s valuation opinion should assume the unencumbered and free use of the trade names, trade dress and rights, if any, to the packaging designs used by the subject company for its various product lines. While the analysis should provide a valuation of the trade names isolated from other company assets, the trade names would likely need to be bundled with the existing inventory and other associated assets in order to draw sufficient interest. Liquidating these assets separately, particularly the inventory, may negatively affect the value of the trade names as it may hinder a buyer’s distribution relationships and continuity of sales. In valuing brands with retail operations, it is necessary to consider the current state of distributor relationships and whether or not there are other methods for distribution during a liquidation prior to lending.

The following are key “prevaluation” issues lenders must consider when lending against trade names:

1. Is the brand currently licensed? Streams of licensing revenues boost the value of trade names and provide additional input regarding market interest in the names.

2. Are they consumer or commercial brands? As a general rule, businesses are brand neutral and give no consideration to brand name in purchasing decisions.

3. Does the brand drive purchasing behavior? Does the brand allow the company to charge a premium versus off-branded products? Does the brand influence the quantity sold?

4. Are the branded products easily replicale? Are products highly complex? Is the brand transferable to other products?

5. Is the brand personality based (i.e., Martha Stewart, George Foreman)? Personality-based brands have the potential to implode based on the actions of the associated personality.

6. Is the brand separable from the company (i.e., people, technology)?

7. Lastly, lenders should not lend on brand potential. This should be left to equity investors because that is a part of the realm of venture financing.

When using trademarks as collateral, lenders should file security interests with the state UCC level, with the United States Patent and Trademark Office USPTO, and with a State’s Office (if any state registration exists) to put subsequent purchasers on constructive notice of the lender’s security interest within three months of executing a security agreement. The lender should also verify with the USPTO records office that the borrower has title to the collateralized trademark. They should also require that the trademarks be maintained. Finally, the lender should execute a power of attorney from the borrower allowing the lender to transfer the collateralized trademark in the event of default.

Case study: Trade name – food processor

The company was a producer of uncooked and cooked sliced beef and other meat-related products and snack food items. At its height, the company was a market leader in its niche with a 36 percent market share and sold to large grocery store chains.

A lender provided a $10 million facility including a $3 million revolver and $7 million term loan. The loan was secured by accounts receivable, inventory, machinery and equipment, land and building, and the company’s brand name. The loan was funded to assist the company in repositioning its brand and to provide a bridge to a potential sale. Unfortunately, the potential sale was unsuccessful and the company defaulted on its loan.

The lender took possession of the company and its collateralized assets, including the brand, and proceeded to sell them, piecemeal. The brand was eventually sold at auction to another food products producer. However, prior to selling the machinery and equipment (to a different buyer), the lender saw to it that a sufficient supply of product was produced to ensure that the failed company’s distributors would be kept supplied until the brand’s new owner could ramp up their own production. Had the lender not taken this step, distributor relationships may have been strained and the value of the bids on the brand name might have been lower to reflect the additional efforts a buyer would need to undertake to restore those relationships and the goodwill the trade name carried. As a result, the lender was fully paid upon liquidation of the collateral.

Lending against patents

Patents are a set of exclusive rights given by government to the owner for a fixed period of time in exchange for disclosure of an invention to the general public. The requirements and procedures for being granted a patent vary by nation. There are two types of patents that a lender should consider when including a patent as collateral.

The first type is called a design patent. These patents cover new and original ornamental design of a functional item. Designs on containers, jewelry and furniture are examples of items that can be patented. In the United States, the registration term for design patents expires 14years from the date the patent is granted.

The second type is called a utility patent. These patents relate to functionality and may pertain to manufactured articles, machines and processes. In the United States, the registration term for utility patents expires 20 years from the date the patent is filed. Once a utility patent is issued, the owner of the patent must pay maintenance fees to the USPTO after 3.5,75 and 11.5 years. Lenders using utility patents as collateral should monitor the payment of the maintenance fees.

Enforcement of patents are typically enforced via civil lawsuits, although criminal suits can be sought in the case of wanton infringement. Patent owners typically seek monetary compensation for damages, injunctive relief, or royalties from patent licensing as restitution.

Currently, only the inventor has the right to file for a patent in the United States. This is called the “first-to-invent” system that gives rights to the inventor assuming that the inventor is able to prove that he or she invented it first. Inventors are able to assign their ownership rights to a third party (i.e., a corporate entity), typically for either monetary compensation through licensing or as a condition of employment. Excessive patent litigation has recently elicited response from Congress and the Supreme Court. These responses may reshape the influence of patents as a source of collateral.

Patent Reform Act of 2007

The Patent Reform Act of 2007 (the Act) allows an inventor to assign his or her rights to a third party so that the third party would be able to file for and/or enjoy the benefits of the patent. As with any asset, the ability to assign the ownership rights greatly increases the value and liquidity of that asset.

* The goal of the Act is to reduce the number of patent lawsuits brought to the courts and to decrease the number of patents granted each year. The Act makes it harder to get a patent, and easier to challenge one. Also, the Act changes the method used by the courts to determine the value of the patent. The following are important reforms to patent law under the Act:

* The Act will create a “first-to-file” system with the USPTO. The U.S. remains the only country that grants patents to the first inventor, rather than the firstto-file. Under the first-to-invent system, inventors who were able to prove that they came up with the idea first and used it commercially were able to get the patent, even if they were not the first to file. This provided a great advantage to smaller companies and individuals who did not have the resources to quickly file their patents.

* The first-to-invent approval process requires that the USPTO undertake lengthy and complicated “interference” proceedings to try and determine who invented a given technology when claims conflict. The switch to first-to-file will not only standardize U.S. patent law with the international standards on filing, but will also “inject much-needed certainty into the patent application process.” The first-to-file rule, though, does not automatically grant approval of the patent application. The patents must still be derived from the invention and not from another. At the same time, the shift to first-to-file may create greater confusion in the patent application process as companies race to mail their patent applications in at the expense of proper documentation. This might create greater confusion as it does not correct for problems involving the submission of broad inventions.

* The Act also addresses the issue of obviousness. According to the proposed legislation, “A patent for a claimed invention may not be obtained though the claimed invention is not identically disclosed as set forth in section 102, if the differences between the claimed invention and the prior art are such that the claimed invention as a whole would have been obvious before the effective filing date of the claimed invention to a person having ordinary skill in the art to which the claimed invention pertains.”

* The Act also addresses the issue of damages. This bill requires the courts to look at the “free market” value of the patent if it were licensed in an “arms length” transaction.

* The Act also addresses the issue of “post-grant opposition” review. After a patent has been issued, a third party may file for a post-grant review to challenge the patent. A special review board with the patent office would mediate disputes outside the courts by allowing parties to challenge issued patents and present prior art. If the review board denies the opposition’s petition, then the opposing party will not be able to seek damages later in a civil suit. You may file for a civil suit only if you have not sought relief via the post-grant opposition review.

KSR International Co. v. Teleflex, Inc.

The Supreme Court’s decision on April 30, 2007 in the matter of KSR International Co. v. Teleflex, Inc. addresses the issue of obviousness. The USPTO or a court is able to determine whether or not a granted patent is invalid on the basis of being an obvious combination of two preexisting patented inventions. This ruling has had a significant impact on the lower courts, which are now being given a more “expansive and flexible approach” in their analysis of obviousness, as is the USPTO. In essence, if the lower courts determine that a person of ordinary skill in the relevant subject area is “able to fit the teaching of multiple patents together like pieces of a puzzle” then the patent is deemed obvious. After the ruling, the USPTO issued a memorandum to all of its directors instructing them that, when making a rejection on the basis of obviousness, “it remains necessary to identify the reason why a person of ordinary skill in the art would have combined the prior art elements in the manner claimed.”3

Effect on patent collateral

A patent troll is a term used to describe a person or company who purchases patents, traditionally from distressed companies, and then sues other companies on the basis that one of its products infringes on the purchased patent. A patent troll’s source of revenue includes settlements, royalties and licensing fees, or injunctive relief. In a bankruptcy scenario, lender would seek out these individuals/companies as the primary exit strategy.

As a result of recent events, patent trolls might find it harder or altogether lose their ability to seek injunctive relief and/or damages. Companies that have filed numerous patents as a strategic defensive measure to influence against competition, might find it harder to defend such patents in court. Historically, companies that modify or merge existing products to create refined ones, such as pharmaceutical companies, have been able to patent the resulting products as “inventions”. The KSR ruling will make it easier for competitors to challenge the validity of those patents, thus negatively affecting the earning potential of these companies. Also, patent trolls and other synergistic corporations have been seen as the primary buyers of collateralized patents during liquidation. Asset-based lenders might now have to revisit exit strategies on existing facilities where patents are a part of the collateral.

Lenders should also be aware that the value of the collateralized patent is limited by the remaining life of the patent. When using patents as collateral, lenders should file security interests with the state UCC level and with the USPTO to put subsequent purchasers on constructive notice of the lender’s security interest within three months of executing a security agreement. Lenders should also verify with the USPTO records office that the borrower has title to the collateralized patent. Lenders should also restrict the borrower’s ability to abandon the collateralized patent and require that the patents be maintained. Finally, lenders should execute a power of attorney from the borrower allowing the Lender to transfer the collateralized patent in the event of default.

The importance of collateral monitoring

Collateral monitoring for IP is arguably more important than it is for tangible assets. For collateral monitoring, it is important to understand the value drivers. Sales and gross-margin trends are usually key indicators of value for IP, but they can vary significantly depending on the specifics of a particular asset or group of assets. Any appraisal should be for the full lendable value of the IP and should be able to have the same advance rate as the net orderly liquidation value of other tangible asset classes.

The following are recommended steps to consider in the event of default or during a borrower’s financial distress when IP is used as the collateral:

1. Contact the appraiser immediately and have the appraisal updated. This will help the lender to understand:

a. The current appraised value of the assets.

b. The current state of the industry.

c. Who the potential buyers would be?

d. A review of the exit strategy, which might differ from the originally suggested exit strategy given the reason for default and/or financial distress.

2. Determine if the lender has perfected its lien:

a. What is the probability that another entity will make claims to the collateralized IP?

b. If there is a lien on other assets that may affect the value of the IP during liquidation, determine who those entities are and what their next moves will be. For example, a trade name may be adversely impacted if the associated inventory is liquidated separately. Fire sales of branded consumer good inventories may send negative signals to distributors, retailers, and consumers, thus creating difficulties when trying to sell the trade name during liquidation.

3. Establish communication with the borrower’s executives and begin a due diligence process. Gather as much data on the IP as possible to assist you in providing all the necessary data to prospective buyers.

4. Contact an investment banking firm specializing in IP disposition to assist you as a financial advisor during the liquidation process.

Before lending against IP, lenders should understand what liquidation scenario they will most likely pursue in case of default and determine the best premise/standard of value to use given that scenario.

Lenders must also understand what, if any, substitute or complementary products could affect the value of the IP. Understanding the current state of the industry from a micro and macro perspective will often guide the lender and the appraiser in understanding the growth potential and limitations on the economic life of the IP. For instance, patents have a limited economic life because of numerous factors, including the legal limit placed by the USPTO and, for patents that are rooted in continuously evolving technology, technological obsolescence.

It is important to know if the IP being considered for collateral is the right IP to be lending on. Lending on IP carries with it a good deal of risk and not all IP makes sense as collateral. The ability to come out whole in the event of default not only depends on the position of the lender (i.e., senior or junior), but also the loan to value and the liquidation strategy employed. Lenders must ensure that they have taken the appropriate steps to perfect the lien on the IP. TSL

1 U.S. Bureau of Economic Analysis.

2 Jay Eisbruck, Moody’s Investors Service, New York, NY “Credit analysis of patent and trademark royalty securitisation: a rating agency perspective”, Building IP Value 2005.

3 Focarino, Margaret, Deputy Commissioner of Operations, USTPO “Supreme Court decision on KSR Int’l. Co., v. Telejlex, Inc.”, internal memo to USPTO technology art unit directors, May 3, 2006.

Darin R. Neumyer, ASA, co-leads Hilco Enterprise Valuation Services, an intangible asset and business appraisal firm.

Philip A. Sultan and Jarrad E. Anderson assisted Mr. Neumyer with this article.

Copyright Commercial Finance Association Jan/Feb 2008

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