If you wish to take out a loan, you will need to take out some form of loan collateral. Loan collateral is often a valuable asset that you can secure against a loan. If you run a startup, you need to decide between securing a loan or seeking investment. Often, there are reasons why seeking investment may not be the most appropriate option for facilitating cash flow. However, startups inherently face hurdles when attempting to secure loans. Intellectual property (IP) assets carry great potential to be used as collateral if you don’t have other appropriate assets. This article will discuss how you may be able to utilise IP assets as a new form of loan collateral in your startup.

Typical Loan Collateral

To take out a loan, lenders will often require collateral to minimise the risk of providing a loan to you, the borrower. This could be difficult for your startup if your business does not have the revenue to guarantee that you can repay the loan. Seeking to supply collateral to secure a loan tends to increase the chances of a lender approving your loan. However, if you cannot pay the loan, there is a real risk that a lender will repossess your collateral.

The value of the collateral that you must provide will depend on the total amount that you intend to borrow. Many lenders will require you to secure your loan with collateral that is worth at least as much as the loan that you wish to secure.

Providing tangible assets as collateral is favoured by lenders as they are generally easier and more cost effective to liquidate if you cannot make your repayments. Typical tangible assets which businesses use as collateral include:

  • residential and commercial property;
  • commercial equipment;
  • inventory; and
  • personal assets. e.g. your home, car or investments.

IP as Loan Collateral

Your startup may require capital to be able to grow. Although lenders generally only accept tangible collateral, there are alternative financing opportunities if your business has valuable intangible assets. One of these intangible assets may be your IP.

A loan that is backed by IP allows you to borrow to the value of your specific IP assets. Offering IP as collateral may be more commercially sustainable in the long term as businesses who monetise their IP have more potential for growth. IP assets that generate ongoing revenue for your business and, therefore, positive cash flow, are well placed for you to use as collateral.

IP as collateral can be beneficial as it:

  • provides you with the option to access financing that might otherwise not be available;
  • can provide financing that does not dilute existing equity; and
  • can potentially be more cost-effective than other methods of securing finance.

Valuable IP Suite

If your startup has a defined suite of IP, you are more likely to be able to use it as financial collateral. There are four key IP rights which will add value to an IP suite:

A suite of IP assets that has multiple registered rights is more valuable than unregistered rights.

For example, an innovative patent which targets a growing need across markets will be significantly valuable for a business.

However, for digital businesses, copyright protection and registered trade marks might be their most valuable IP assets.

Your business will be more valuable to lenders if you have licensed IP rights with consistent cash flow that is directly attributable to the right. However, non-licensed IP rights still contain significant value and are a good option that you can use as loan collateral. The most valuable forms of IP:

  • are high-quality assets;
  • don’t overcrowd an industry; and
  • can be used across many industries or businesses.

Typically, smaller businesses are less likely to register IP rights as registering them may be too expensive. However, if your startup does not have the appropriate legal ownership of the IP rights, this form of lending will not be available. Therefore, protecting the IP of your startup is vital if you would like to secure an IP-backed loan in the future.

Although IP collateralisation is an emerging area of financing, using IP assets to secure a loan is not uncommon within the music industry. David Bowie famously raised $55 million through asset-backed bonds for future royalties for over 20 albums.

Valuation

As IP is an intangible asset, it will not usually be recognised on internal accounts or reflected appropriately in cash flow. To determine the accurate value of your IP, an independent and objective valuation should be performed. Valuation of IP assets is incredibly complex, especially in the case of patents.

Valuation of IP assets also requires the consideration of the lifecycle of the IP. Lenders will need to consider the value of your technology in light of the potential lifespan of your business. This will differ from industry to industry.

For example, IT products inherently face a shorter lifespan than pharmaceutical products.

Valuations also need to consider the market need for the IP right. This will be especially important if a lender ever needs to liquidate your assets.

For example, a patent which meets a significant need within the market is more likely to be highly valued. Whereas, a patent which meets only a niche need is likely to be valued less favourably.

As a startup, it is vital that your IP ownership rights are clear. You should do this regardless of whether you intend to use IP as loan collateral in the future or not. A valuer of IP will also assess the current IP risks that your startup might be facing, including whether you:

  • have IP ownership clauses in your contracts; and
  • are protected from your confidential IP information being revealed by other parties.

The Ultimate Guide for Startup Founders

The LegalVision Startup Manual provides guidance on a number of common challenges faced by startup founders including structuring, raising capital, building a team, dealing with customers and suppliers, and protecting intellectual property.

The guide includes 10 case studies featuring Australia’s top VC fund partners and leading Australian startups.

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Ongoing International Development

In 2016, the British government announced a review of how they could support and facilitate access to long term finance for startups. Following this review, it became a priority for the Government and the British Business Bank to assist IP rich high growth startups in using their IP to access loans. The review recognised the obstacles that the financial industry faced when considering intangible assets for loan collateral. It also explored the reforms necessary to make effectively evaluating IP assets a reality. The review suggested that by stimulating demand for this type of lending, the use of IP as collateral will grow.

The government of Singapore supports the recognition of IP as a valuable asset for many of its startups. To increase the recognition of IP as valuable assets, they commenced trialling an IP financing scheme with three participating local banks and three independent valuation firms. This trial has now commenced a learning process to better understand how to value IP and support the growth of startups who lack other financing options.

In an international context, the United Nations Commission on International Trade Law (UNCITRAL) created a legal guide exploring this issue. This guide noted that national jurisdictions had moved rather slowly in reforming their financial industries. The guide recommended a uniform legal regime regarding secured financing. This will lead to more transparency and legal certainty for lenders globally.

Obstacles You May Face

If you want to use IP as collateral to secure funding, you may face some obstacles. Lenders prefer conventional asset-backed loans as they can rely on a return for the risks that they take on. IP does not necessarily meet the traditional criteria of capital benefits. Therefore, using IP as collateral does not actively reduce the lender’s risks. This low confidence from lenders in using IP as collateral is a significant obstacle that you will face if you want to take on this non-traditional form of financing.

Therefore, the popularity of using IP as loan collateral will require policy action surrounding:

  • banking regulations, especially regarding the capital that banks are required to hold;
  • legal enforceability and the difficulty of enforcing IP ownership rights;
  • valuation and the uncertainty of the methodology of valuation; and
  • liquidity and the challenges in asset disposal due to an inability to access relevant IP markets.

Until these critical barriers are resolved, it is unlikely there will be a significant change in startups having the ability to use their IP as loan collateral in Australia.

You will also need to consider the disadvantages of using IP as collateral. If this is the only valuable asset for your business and you are unable to make loan repayments, the loss of your IP rights might be detrimental for your business’ longevity.

Key Takeaways

Using IP as loan collateral might be a great option if your startup has little traditional assets to provide. However, this unconventional form of collateral comes with many systemic obstacles. Having access to a broader range of collateral for funding will benefit innovative startups, SMEs, lenders and the wider economy.

Creating long term confidence in the IP financing system will lead to market innovation and the overall expansion and monetisation of IP. If you have any questions about securing funding for your startup, contact LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.

Talia Admiraal
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