【Trade Secret】
Hedging Structures for the Financing of IPR's
By Tommy Soebbing
Dr. Soebbing, LLM. Is Corporate Counsel & Member of Management Team at Deutsche Leasing Information Technology.
I. Introduction
The investment to build intellectual property (IP) can amount easily to triple-digit million Euros. Accordingly companies (inventing company) usually do not finance such an investment on their own. In cases the volume of credit has been exhausted with one financial intuition it makes sense to look for a financial vehicle that can be supported by a consortium of institutions and investors (e.g. banks, leasing companies and venture capital enterprises). Another benefit of this approach will be that with such a consortium the involved risks can be shared which makes the risks for a single investor more predictable. Therefore, an involved financing institution (first investor) will try to refinance its investment by selling a part of the stake (so-called forfaiting-French a forfeit which means without recourse to the seller). It is custom for refinancing institutions to demand the transfer of ownership of the IP to be to avoid to rely on the liquidity of the first investor or the inventing company. The key challenge in this context is that if more than one financial institution but there is only one IP asset that can be transferred as a security. With regard to traditional assets which are being financed a division might have been possible (e.g. financing of a whole car fleet only the number of cars need to be transferred which are required to secure the amount that has been financed). It is in the nature of IP that it cannot be divided. Accordingly the transfer to a number of financial investors is extremely difficult. A solution to this problem is the foundation of a Special Purpose Vehicle (SPV) which is the sole owner of the IP in question. The investors can get a stake of such a company according to the investment which needs to be hedged.
II. Intellectual Property as Assets
The financing of traditional real estate or movable goods, either by lending or leasing structures, is part of the day-today commodity business of financial institutes. Even the financing of intellectual property is no longer new territory for such investors. However, the continuous growth and the increasing complexity with regard to the financing and refinancing of intellectual property by financial institutions are facing increasing challenges. This area promises exiting business opportunities for a rapidly growing number of investors in the field of intellectual property.
Software products (also known as custom software as standard), concepts and studies which can be protected by copyright can be an interesting opportunity for investors. Accordingly the implementation of a new Enterprise Resource Planning System "ERP system" (e.g. based on Microsoft Dynamics NAV) or a new Core banking systems (possibly based on SAP Banking software), which consists of standard software, custom software, templates and frameworks, are effectively protected by copyright (except from the so-called customizing measures, i.e. adjusting the software to the needs of the customer).
Trademarks, which are protected by trademark laws, are mainly of interest with regard to financing models in connection with sale and leaseback transactions. Needless to say that such models require that such trademark must be tradable at all and must be a brand of a certain value. A high value of a brand can be assumed if it is established and sustainable in the market. An example for such established and sustainable brands are Coca Cola, Lenovo or Porsche 911.
The right to a name is protected by the law of names, appear to be not very interesting for the financial investors, because such right is difficult to measure, e.g. by increased revenues at first glance. This view has been strongly influenced by the internet hype in the late nineties. The law of names does not only protect names in general but also the assignment of names in URLs (uniform resource locator), such as www.superbowl.com. The value of such URLs equals the accessibility to potential customers and can therefore easily amount to millions.
The financing of patents in particular for machine design patents and established pharmaceutical products certainly has a long tradition with specialized financial institutions. But the very creation of new products such as solar photovoltaic systems in the environmental technology and research for new drugs, e.g. against cancer or against Malaria, are an interesting and socially important for investment for such a financial investor Institute.
These IP is the results from all creators, that they are not always divisible or not divisible. Certainly there are for example Copyright in the possibilities of co-authorship or the issuance of a rights-fold. In the light of copyright the possibility of co-authorship or the issuance of "quota-rights" may exist. However, this does not lead to the desired goal to be able to make a collateral assignment of such IP to protect according investments.
III. Finance Model
In case a company has successfully created new IP which was financed by debt, it usually turns a financial investor to cash in this new invention (e.g. by loans), by a leasing or a venture capital vehicle). It is custom for such an investor to secure the provision of cash (as a kind of loan hedging) by demanding the collateral assignment of the rights in the corresponding IP. In case the inventing company becomes insolvent, the financial investor can hold itself harmless by exploiting the IP.
In cases the financial investor does not finance the investment on its one, there is the possibility to sale of future of receivables of potential financial claims against the inventing company (so-called forfaiting). In case the financial claim against the inventing company allotted in installments, it is possible to pass the security transfer of the IPR to the refinancing institution.
This approach will become challenging if there is not only one but a number of refinancing investors which all demand the transfer of IP rights. As stated above IP rights cannot be divided in general.
IV. SPV as a Finance Model
In case a customer needs not only one but several investors to finance a loan on the new IP the customer faces the dilemma that it can neither split up the undividable IP right nor can it hand over the complete IP.
The challenge is to make the undividable right dividable. This can be achieved by setting up an entity (e.g. a Chinese limited company) to which the IP rights are being transferred. Such entities are also known as Special Purpose vehicles (SPV). As a next step the inventing company can transfer share of that new company to investors as the required security.
The main purpose of such an entity is the simultaneously assignment of the stakes in the IP of the inventing company to secure the according investors. If required, is the ownership in the concerned IP right is forwarded to the inventing company, as the investor in the forfeiting remain liable for the inventory risk of the claim and the customer also the financing institution as a first contact understands.
V. Outlook
The creation and therefore the protection of IP rights is one of the challenges of the 21st Century. Setting up a framework that allows inventing companies' access to investors and giving investors the possibility to secure their investment is a crucial keystone to achieve this challenge.
Financial institutions as well as refinancing to microfinance institutions require comprehensive safeguards (also known as hedging) to secure their investment into IP rights. Currently complex refinancing structures, such as SPV's are required to secure investments. Next to securing investments an SPV structure will provide a number of interesting side-effects.
It is possible to reduce a potential liability risk of the inventing company to a wide extent. The exact extent of the remaining liability will depend on the chosen entity which is chosen for the SPV (e.g. plc, limited or other). Furthermore, an SPV model might be interesting from a tax point of view. An SPV can also be setup as asset-backed securities (in short as ABS). An ABS opens a refinancing institution the opportunity to link such an investment with other financial products (e.g. with high risk bond) in an corresponding portfolio.
