Deploying IP Assets as Loan Collateral: An Emerging Trend

Over the last 15 years, there has been a shift toward more creativity in the monetization of intellectual property. Companies are no longer simply utilizing patents as defensive weapons in actions against aggressors in patent assertions and follow-on infringement actions. Strategic licensing securitizations and collateralizations have provided new and thoughtful approaches to effectively leverage the technology asset value inherent in patents and other IP.

IP Directors, Chief Financial Officers, Chief Technology Officers and others are not yet at the stage where they are working together to ensure the effective monetization of IP in companies. However, a common 'monetization' lexicon is starting to develop across the disciplines of finance, technology and intellectual property law. Successes at IBM, Lucent, Dow, Texas Instruments, Motorola and others in developing and installing a generative capacity to characterize, categorize and monetize patents are providing a template for others to follow.

Ironically, it is not at these large corporations with their extensive patent estates and large IP departments that we see the most creative monetization approaches being employed. Instead, it is at entities like Royalty Pharma, ATD Corporation, and Cambridge Display Technology where new solutions are being adopted. As is often the case, innovative approaches and products emerge from the edge, where companies face challenges to growth and are driven by the exigency of circumstances and the cost of capital, and where need and creativity meet to deliver opportunity.

Most small to midsize companies cannot avail themselves of the resources and superior creditworthiness of companies like IBM and Dow to meet the challenges of IP monetization. It is in this creative realm that the bulk of small to mid-cap global companies are required to delve in order to more effectively harvest their oftentimes disproportionately large investments in patents and create revenue and/or debt capacity to supply the capital needed to fuel future growth.

In the face of the new tyranny of venture capital and the high costs of mezzanine financing, a large pool of IP-rich small to mid-cap companies are recognizing that the safety net of the 1990s is no longer available to them. As such, the first and best path to capital is to look within to the embedded intangible assets of the firm ' its codified and non-codified intellectual property ' as sources of capital. The new approach outlined below, IP collateralization, provides an important tool to unlock the IP-asset value of such companies and ensure greater autonomy and independence, as well as a path to growth.

Two recent examples of IP collateralizations are described below:

ATD Corporation

A maker of thermal and acoustic barrier technology for the automotive and white goods (eg, refrigerators and similar appliances) industries, ATD Corporation holds several of the core patents that support the use of single and multi-layered structures of aluminum, stainless steel and proprietary materials for these applications. Because the automotive and white goods markets are extremely price competitive, ATD has faced challenges to growth occasioned by limited access to capital. The company is steadfast in its commitment to building a strong patent estate that is large relative to its annual revenue. ATD entered 2004 at a crossroads and with a clear-cut mission to leverage its patents beyond its successful but modest licensing program and grow shareholder value. As the number two or three supplier in the markets in which it competes, ATD's strategy involved expanding market share and more effectively utilizing its patents to limit infringement by its competitors.

ATD explored a number of different options. The company investigated securitization and other emerging vehicles in addition to licensing to extract value from its IP. The prospect of securitization's somewhat complicated legal structure in which ownership of its most valuable asset, its patents, would be transferred to a special purpose entity was of little appeal. ATD then investigated an emerging trend in IP monetization, collateralization, and elected to pursue this option as it afforded ATD access to low cost capital without impacting the ownership and onward licensability of its IP.

IP collateralization is essentially the use of IP as collateral in a traditional asset-based loan where a lender extends credit to a company based on an assessment of disposal value of the IP that is taken as collateral in the event the borrower defaults. Since asset-based lenders do not generally recognize IP as an effective form of collateral, ATD had to engage a credit enhancement firm to extend to the lender a commitment that essentially provided a dollar for dollar guarantee of the loan. Drawn on Wells Fargo bank and supported by Principal Financial Group, the credit enhancement firm enabled ATD's patents to serve as an effective form of collateral to support a multimillion-dollar loan from ATD's lender of choice, GMAC (General Motors Acceptance Corporation). Under this approach, ATD leveraged its considerable patent estate to generate additional working capital to expand its prototyping capability, product offering and marketing effort in its target markets. ATD did so without having to resort to two far more costly options ' 1) raise additional equity investment, or 2) suffer the loss of management autonomy and control that is increasingly associated with mezzanine capital.

Cambridge Display Technology, Ltd.

CDT holds fundamental patents supporting next generation flat panel display technology. Applications include mobile phones, laptop computers, wide screen televisions, and electronic billboards. The company entered 2004 continuing its efforts to spur the commercial introduction of its revolutionary polymer-based organic light emitting diode (PLED) technology. Having taken great pains to build an effective business ecosystem of customers, suppliers and partners to support its commercialization goal, CDT entered 2004 with the need for additional working capital. Although held in majority share since 1999 by Kelso and Hilman Capital, two New York-based private equity firms, and supported by strategic investment from the likes of DuPont and Sumitomo Chemical, CDT's management set a goal of being self-sustaining from 2004 onward.

As a licensing company, CDT understood that the lion's share of its revenue would come from royalty revenue once the likes of DuPont, Siemens/Osram, Philips, Seiko-Epson, and other of its licensees entered commercial production of PLEDs, expected to begin in mid-2005. In an effort to maintain its own research and development, process refinement, and commercial collaboration with prospective licensees in advance of the realization of significant royalty revenue, the collateralization solution offered great appeal to CDT's management and ownership as an alternative to bringing in additional investment and the attendant dilution associated therewith.

On the strength of its patent portfolio, extensive licensing history, unprecedented upfront licensing fees (considering that PLED is still essentially a pre-commercial technology), size and growth trajectory of the market for the products supported by the PLED patents, and the level of industrywide investment in the commercialization of the technology to date, CDT received a $15MM loan in July 2004 from Lloyds TSB, a UK asset-based lender. As in the case of the ATD loan, the loan to CDT was fully guaranteed by a credit enhancement firm, IP Innovations Financial Services. In the absence of the credit enhancement, CDT would have qualified for a loan against only its traditional collateral ' property, plant and equipment, accounts receivable, and inventory, which would have likely necessitated a costly, time consuming, and dilutive capital raise.

It is important to note that the $15MM loan and credit enhancement facility represents only a fraction of the total value embedded in CDT's portfolio of patents, as IPI's loan guarantee commitments only support extremely conservative loan advance rates. The guarantor, IPI, uses conservative loan to value ratios and short transaction tenors (typically 3 years on patent transactions) to hedge its risk in valuing and underwriting the IP and to ensure the timely remarketing of the IP in the event of a default and foreclosure on the note collateralized by the IP.

Conclusion

The emergence of IP collateralization is enabling small to mid-cap companies with significant IP assets to leverage them and gain access to cost effective debt capital to facilitate growth. Through the provision of credit enhancement vehicles, lenders can remain in their comfort zone while expanding their loan portfolios with new and existing clients. IP will not become a recognized asset class for asset-based lenders overnight, but by providing assessment and management of risk it has come a long way toward that goal. Credit enhancement entities which are willing to share the risk associated with IP financial transactions enable IP collateralization to take place and to join licensing, factoring, and securitization, as effective vehicles to unlock the value of many companies' most prized intangible assets.

Over the last 15 years, there has been a shift toward more creativity in the monetization of intellectual property. Companies are no longer simply utilizing patents as defensive weapons in actions against aggressors in patent assertions and follow-on infringement actions. Strategic licensing securitizations and collateralizations have provided new and thoughtful approaches to effectively leverage the technology asset value inherent in patents and other IP.

IP Directors, Chief Financial Officers, Chief Technology Officers and others are not yet at the stage where they are working together to ensure the effective monetization of IP in companies. However, a common 'monetization' lexicon is starting to develop across the disciplines of finance, technology and intellectual property law. Successes at IBM, Lucent, Dow, Texas Instruments, Motorola and others in developing and installing a generative capacity to characterize, categorize and monetize patents are providing a template for others to follow.

Ironically, it is not at these large corporations with their extensive patent estates and large IP departments that we see the most creative monetization approaches being employed. Instead, it is at entities like Royalty Pharma, ATD Corporation, and Cambridge Display Technology where new solutions are being adopted. As is often the case, innovative approaches and products emerge from the edge, where companies face challenges to growth and are driven by the exigency of circumstances and the cost of capital, and where need and creativity meet to deliver opportunity.

Most small to midsize companies cannot avail themselves of the resources and superior creditworthiness of companies like IBM and Dow to meet the challenges of IP monetization. It is in this creative realm that the bulk of small to mid-cap global companies are required to delve in order to more effectively harvest their oftentimes disproportionately large investments in patents and create revenue and/or debt capacity to supply the capital needed to fuel future growth.

In the face of the new tyranny of venture capital and the high costs of mezzanine financing, a large pool of IP-rich small to mid-cap companies are recognizing that the safety net of the 1990s is no longer available to them. As such, the first and best path to capital is to look within to the embedded intangible assets of the firm ' its codified and non-codified intellectual property ' as sources of capital. The new approach outlined below, IP collateralization, provides an important tool to unlock the IP-asset value of such companies and ensure greater autonomy and independence, as well as a path to growth.

Two recent examples of IP collateralizations are described below:

ATD Corporation

A maker of thermal and acoustic barrier technology for the automotive and white goods (eg, refrigerators and similar appliances) industries, ATD Corporation holds several of the core patents that support the use of single and multi-layered structures of aluminum, stainless steel and proprietary materials for these applications. Because the automotive and white goods markets are extremely price competitive, ATD has faced challenges to growth occasioned by limited access to capital. The company is steadfast in its commitment to building a strong patent estate that is large relative to its annual revenue. ATD entered 2004 at a crossroads and with a clear-cut mission to leverage its patents beyond its successful but modest licensing program and grow shareholder value. As the number two or three supplier in the markets in which it competes, ATD's strategy involved expanding market share and more effectively utilizing its patents to limit infringement by its competitors.

ATD explored a number of different options. The company investigated securitization and other emerging vehicles in addition to licensing to extract value from its IP. The prospect of securitization's somewhat complicated legal structure in which ownership of its most valuable asset, its patents, would be transferred to a special purpose entity was of little appeal. ATD then investigated an emerging trend in IP monetization, collateralization, and elected to pursue this option as it afforded ATD access to low cost capital without impacting the ownership and onward licensability of its IP.

IP collateralization is essentially the use of IP as collateral in a traditional asset-based loan where a lender extends credit to a company based on an assessment of disposal value of the IP that is taken as collateral in the event the borrower defaults. Since asset-based lenders do not generally recognize IP as an effective form of collateral, ATD had to engage a credit enhancement firm to extend to the lender a commitment that essentially provided a dollar for dollar guarantee of the loan. Drawn on Wells Fargo bank and supported by Principal Financial Group, the credit enhancement firm enabled ATD's patents to serve as an effective form of collateral to support a multimillion-dollar loan from ATD's lender of choice, GMAC (General Motors Acceptance Corporation). Under this approach, ATD leveraged its considerable patent estate to generate additional working capital to expand its prototyping capability, product offering and marketing effort in its target markets. ATD did so without having to resort to two far more costly options ' 1) raise additional equity investment, or 2) suffer the loss of management autonomy and control that is increasingly associated with mezzanine capital.

Cambridge Display Technology, Ltd.

CDT holds fundamental patents supporting next generation flat panel display technology. Applications include mobile phones, laptop computers, wide screen televisions, and electronic billboards. The company entered 2004 continuing its efforts to spur the commercial introduction of its revolutionary polymer-based organic light emitting diode (PLED) technology. Having taken great pains to build an effective business ecosystem of customers, suppliers and partners to support its commercialization goal, CDT entered 2004 with the need for additional working capital. Although held in majority share since 1999 by Kelso and Hilman Capital, two New York-based private equity firms, and supported by strategic investment from the likes of DuPont and Sumitomo Chemical, CDT's management set a goal of being self-sustaining from 2004 onward.

As a licensing company, CDT understood that the lion's share of its revenue would come from royalty revenue once the likes of DuPont, Siemens/Osram, Philips, Seiko-Epson, and other of its licensees entered commercial production of PLEDs, expected to begin in mid-2005. In an effort to maintain its own research and development, process refinement, and commercial collaboration with prospective licensees in advance of the realization of significant royalty revenue, the collateralization solution offered great appeal to CDT's management and ownership as an alternative to bringing in additional investment and the attendant dilution associated therewith.

On the strength of its patent portfolio, extensive licensing history, unprecedented upfront licensing fees (considering that PLED is still essentially a pre-commercial technology), size and growth trajectory of the market for the products supported by the PLED patents, and the level of industrywide investment in the commercialization of the technology to date, CDT received a $15MM loan in July 2004 from Lloyds TSB, a UK asset-based lender. As in the case of the ATD loan, the loan to CDT was fully guaranteed by a credit enhancement firm, IP Innovations Financial Services. In the absence of the credit enhancement, CDT would have qualified for a loan against only its traditional collateral ' property, plant and equipment, accounts receivable, and inventory, which would have likely necessitated a costly, time consuming, and dilutive capital raise.

It is important to note that the $15MM loan and credit enhancement facility represents only a fraction of the total value embedded in CDT's portfolio of patents, as IPI's loan guarantee commitments only support extremely conservative loan advance rates. The guarantor, IPI, uses conservative loan to value ratios and short transaction tenors (typically 3 years on patent transactions) to hedge its risk in valuing and underwriting the IP and to ensure the timely remarketing of the IP in the event of a default and foreclosure on the note collateralized by the IP.

Conclusion

The emergence of IP collateralization is enabling small to mid-cap companies with significant IP assets to leverage them and gain access to cost effective debt capital to facilitate growth. Through the provision of credit enhancement vehicles, lenders can remain in their comfort zone while expanding their loan portfolios with new and existing clients. IP will not become a recognized asset class for asset-based lenders overnight, but by providing assessment and management of risk it has come a long way toward that goal. Credit enhancement entities which are willing to share the risk associated with IP financial transactions enable IP collateralization to take place and to join licensing, factoring, and securitization, as effective vehicles to unlock the value of many companies' most prized intangible assets.