Mastering IP Financing: A Path to Startup Triumph – A Case Study Analysis
By Aviral Singhai and Ryan Bang (Batch of 2027 – NLIU Bhopal)
[This Blogpost is a 5th Position Entry of the 1st Edition of the National Blog Writing Competition 2023 organized by Centre For Innovation, Incubation & Legal Entrepreneurship (CIILE) in Association with PANDA LAW (TEAM CODE-41)]
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1. Introduction
Intellectual property (IP) financing is a type of financing that allows startups to raise capital using their IP assets as collateral.[1] This provides a valuable option for startups that have strong IP portfolios but may not have traditional sources of funding, such as venture capital or bank loans.
In today’s rapidly evolving business landscape, startups face a multitude of challenges when it comes to securing the necessary capital for growth and innovation. IP financing has emerged as a dynamic solution, offering a pathway for startups to leverage their IP assets to raise the funds they need.
The success of startups through IP financing hinges on a multifaceted interplay of factors. The stage of a company’s growth, the sector of the market, and general economic conditions are other elements that might impact a startup’s ability to succeed with IP financing.[2] Through case studies of prosperous businesses that have utilised IP finance, this research will analyse these factors.
2. Innovative Financing Strategies
Start-ups and companies may make the most of their IP assets by utilising a number of cutting-edge funding strategies,[3] such as:
- IP-backed crowdfunding: By granting investors stock or debt in the firm in exchange for their money, this type of crowdsourcing enables businesses to obtain funds from a large number of individuals.
- IP-backed asset-backed securities (ABS): Collections of IP assets that are bundled and offered as securities to investors.
- Insurance supported by IP can shield companies from financial damages brought on by IP theft.
- Securitisation of IP-backed royalties enables companies to generate finance by offering investors their future royalties.
Some businesses are even employing blockchain technology[4] to issue securities that are IP-backed. Because they may be exchanged on digital platforms, these securities are more tradable and available to investors.
IP-backed peer-to-peer lending[5] is another cutting-edge funding choice. Through peer-to-peer lending networks, this sort of finance enables firms to borrow money from regular citizens. For companies searching for a loan alternative to conventional bank loans, this may be a viable choice.
3. Discussing Valuation of IP Assets
The anticipated future cash flows that the IP assets are projected to provide are frequently used as the basis for the valuation of IP assets for IP finance. For this, a variety of valuation methods[6] might be employed, such as:
- Income Method: The IP asset is valued using the net present value of its projected future cash flows.
- Market approach: This method determines the value of the IP asset by comparing it to the costs of previously sold IP assets that are similar to it.
- Cost-based approach: This method evaluates an IP asset according to how much it would cost to produce or replace it.
The characteristics of the transaction determine the valuation procedures for IP assets. A trademark that is lucrative is normally valued using the market technique, but a patent that is still in development may be better valued using the revenue approach. When employing the income technique, the valuer gathers crucial information and makes crucial assumptions, such as estimating future cash flows.
The valuer provides a valuation report estimating the value of the IP asset after compiling and analysing all relevant data. This report acts as a starting point for bargaining a reasonable purchase price, empowering both parties to make wise choices.
4. Investment Options in IP Financing
Startups often require capital to develop and commercialize their intellectual property (IP). Two primary investment options[7] in IP financing are equity financing and debt financing.
4.1 Equity Financing
Equity financing involves investors exchanging money for ownership in a company. Startups with valuable IP assets can attract equity investors due to the competitive advantage IP offers. The success of a startup using equity financing hinges on factors such as the quality of the IP, the strength of the management team, and the market opportunity.
A key success factor is the equity IP financing model. It should balance interests by ensuring founders retain a significant stake while giving investors a reasonable share without excessive control.
4.1.1 Hampton Creek and Spotify
Hampton Creek and Spotify, despite using equity IP financing, had divergent outcomes. Hampton Creek’s impractical model gave investors excessive control and left founders with insufficient equity. This discouraged the founders from building a successful business. In contrast, Spotify’s equitable model allowed founders to retain a significant stake and provided investors with enough control to protect their investment. These differences had significant impacts on the companies.
4.2 Debt Financing
Debt financing entails borrowing money from lenders like banks or credit unions, with the potential to use IP as collateral. Success depends on factors like the quality of IP, management, and the market opportunity.
In debt IP financing, the model should be balanced, offering fairness and flexibility. The company should avoid excessive debt and secure terms that allow effective operation.
4.2.1 Solazyme and Palantir Technologies
Solazyme and Palantir Technologies, both utilizing debt IP financing, had different fates. Solazyme struggled to commercialize its technology and filed for bankruptcy due to a restrictive debt financing agreement and a high debt burden. Palantir Technologies succeeded due to a fair and flexible debt financing model with a reasonable amount of debt and terms that enabled effective operation.
In conclusion, the choice of IP financing model plays a critical role in a startup’s success or failure. For equity financing, a balanced model incentivizes founders while protecting investors’ interests. For debt financing, fairness and flexibility are vital, with reasonable debt levels and adaptable terms to support the company’s effective operation.
5. Law of the country as a factor
The law of the country can be a significant factor in determining whether or not a startup is able to maintain its IP financing. For example, in US, creditors can seize the assets of a company that defaults on its loans, including IP. This can make it difficult for startups to maintain control over their IP and continue operating their businesses. In UK, the law protects the rights of IP owners, making it difficult for investors to seize IP as collateral. This makes it easier for startups to maintain control over their IP and continue operating their businesses.
5.1 Theranos and Imagination Technologies
Theranos and Imagination Technologies are two startups that have very different outcomes, despite both using IP financing because of the laws of their respective countries.
Theranos was a US startup that developed blood testing devices. It was unable to maintain its IP financing because of the laws in the United States, which allow creditors to seize the assets of a company that defaults on its loans.[8]
The law that allows creditors to seize the assets of a company that defaults is the Uniform Commercial Code (UCC).[9] It is a set of laws that governs commercial transactions in the United States. Article 9 of the UCC deals with secured transactions, which are transactions in which a borrower gives collateral to a creditor to secure a loan. Under this, the creditors have the right to seize collateral if the borrower defaults on the loan.
Imagination Technologies[10] is a British company that designs and licenses semiconductor intellectual property (IP). It has been able to maintain its IP financing because of the favorable laws in the UK. The UK has strong IP laws that protect the rights of IP owners which make it difficult for investors to seize IP as collateral giving Imagination Technologies more control over its IP.
The law in this case is the Copyright, Designs and Patents Act 1988 (CDPA).[11] It governs copyright, designs, and patents in the United Kingdom. Under the CDPA, copyright owners have the exclusive right to reproduce, distribute, perform, communicate to the public, and adapt their copyrighted works. This means that Imagination Technologies has the exclusive right to reproduce, distribute, perform, communicate to the public, and adapt its semiconductor IP. Which means Imagination Technologies’ investors would not be able to seize the company’s IP as collateral without first obtaining a license from Imagination Technologies.
7. Conclusion and suggestions
In the realm of startups harnessing IP financing, critical factors include the strength of the IP portfolio, business plan quality, management team calibre, market sector, and legal environment. The choice of financing model, equity or debt, significantly shapes outcomes. Equity financing thrives with a balanced model like Spotify’s, while debt financing’s success hinges on fairness and flexibility, as exemplified by Palantir Technologies. The legal framework in the country of operation is pivotal; a startup in a country with favourable laws for IP financing becomes a huge factor for success.
In order to thrive in the world of IP financing, it’s essential to lay a strong foundation. This involves fortifying the intellectual property (IP) portfolio, a captivating business plan, and assembling a proficient management team. Selection of the appropriate financing model is crucial, as is a deep understanding of the legal landscape. Moreover, consideration of innovative financing solutions can add flexibility to the financial strategy.
[1] Bibekananda Panda and Sara Joy, Intellectual Property Rights-based Debt Financing to Startups: Need for a Changing Role of Indian Banks, 46, Vikalpa, 143, 143, 2021.
[2] Alfred Radauer, Opportunities to Finance with IP, WIPO Magazine, 2021.
[3] Jag Singh, How startups and SMEs should think about IP: An Investor’s perspective, WIPO Magazine, 2021.
[4] Emmanuelle Ganne, Can Blockchain revolutionize international trade? (WTO Publications 2018).
[5] Varun Gupta, IP-Backed Financing: Using Intellectual Property as Collateral, Duff & Phelps, 2019.
[6] Id.
[7] Supra note 2.
[8] Zaw Thiha Tun, Theranos: A Fallen Unicorn, Investopedia.com, 2023.
[9] Uniform Commercial Code, 1963, Public Law 88-243, 1963 (United States of America).
[10] Ray Bingham, Imagination Technologies commits to the UK as it looks to accelerate growth in new areas of technological innovation, imaginationtech.com, 2020.
[11] Copyright, Designs and Patents Act, 1988, UK Public General Acts c. 48, 1988 (United Kingdom).
