How European companies can leverage their IP as collateral in China
Many businesses are unaware that around half of their intangible assets could be used as collateral. Intellectual property (IP) has a use that goes beyond ensuring products are not copied. Corporations should be developing a business strategy that takes this little-known fact into account. The China IPR SME Helpdesk outlines how businesses can improve performance and secure their revenue by using IP they already have.
For most businesses, intangible assets represent more than 50 per cent of the enterprise’s value. The most significant group of intangible assets are those that are protected by intellectual property (IP) which can include inventions, designs and brands. Since they compose such a large part of their overall value, their management as financial assets is important to business success.
Businesses that actively manage their IP as a financial asset outperform their peers by up to 30 per cent. They do so by maximising the effectiveness of a business investment, allowing it to drive performance in areas that produce the best return, while managing the operational risk. They may also use their IP assets as collateral in order to secure various forms of funding. Moreover, there are opportunities to gain strategic advantage with regards to the sale or purchase of a business.
Understanding the financial value of particular IP assets is important when moving into a new market, especially with all of the new risks and rewards that come with the various opportunities any new venture brings. Doing business in China comes with its own set of challenges, so knowing how to protect ones IP assets is extremely important. This article discusses why IP assets matter from a financial perspective, and how a business can manage them in an advantageous manner.
Managing return on investment and improving performance
When a business has several IP assets, knowing the comparative return on investment of each one allows the business to focus, and to develop a complementary strategy, on which one will give the best return. It also means that the risk to the viability of the business if certain IP rights are lost can be assessed. This is important in deciding how to structure commercial relationships and operations while doing business in China.
Similar to physical assets, measuring the return on investment requires knowledge of their monetary value and of the amount of investment made in them over a given period. Ascertaining individual IP assets consists of identifying the technology and brand in each product and if any brand is used for more than one type of product.
Providing a security interest when financing
IP assets can be used as collateral in order to provide a security interest when seeking out different ways of raising funds. China has been at the forefront of using patent mortgages which are readily available to both Chinese and European financial institutions.
The numerous ways of raising funds includes:
1. Providing collateral for existing loans: It is not unusual for a company’s IP to be covered by the bank charge at the nominal or nil value. Valuing it separately often increases the value of the security covered by the charge. This can be used either to increase the size of the loan or to reduce the amount of interest already accumulated. If IP assets are to be used to secure the loan, it will be necessary to get the issued security released from any additional bank charge and priced only at the nominal value.
2. Providing collateral for a new loan: This can be to support borrowing from a bank to establish cash flow, or for longer-term debt-to-fund investment in new products or markets. Lending against IP assets is a specialised form of lending usually carried out by dedicated teams within larger lending organisations, or by smaller specialist lending houses.
3. Patent (and other IP) mortgages: A patent mortgage is one form of lending against patents or other IP assets. The significant difference between this and a floating charge is that a mortgage will usually transfer title to the lender immediately in the case of a default. It is a well-established form of lending by some Chinese banks who may have more familiarity with it than their international counterparts.
4. Creating a vehicle for raising equity: If IP assets are owned by a company, which was created for the sole purpose of holding these assets, and that company earns royalties, then shares can be issued in that company for purposes of equity financing.
5. Securitisation (bond issuance): An alternative to issuing shares in an IP holding company is to use the company’s assets as collateral for issuing a bond. This is likely to be an attractive option for medium-sized businesses with brands or technology that are reasonably well-known in its own marketplace.
6. Secure assets to benefit a third party: A further use of an IP holding company is to act as collateral in order to secure the company’s pension fund or a new venture.
IP assets are often undervalued in company accounts. Appropriately identifying and valuing these assets can result in a worthwhile increase in value that lenders will assign for lending purposes. This can be very useful in a credit crunch. The acceptability of IP assets for fundraising will depend, to a considerable extent, on what their valuation is and whether they are owned by an appropriate entity.
There are several considerations that impact valuation, including whether the IP assets are clearly identified, consolidated into one ownership or dispersed, protected from insolvency risks associated with operational activities, protected by appropriate registrations, subject to a structured enforcement programme, licensed to group businesses and/or third parties for the purpose of generating income, or being used to increase the profitability of the business in question.
Drafting an IP strategy
A well-managed IP strategy makes a significant difference to the valuation of a company’s IP assets. An evaluator will assess the economic impact of the IP on the company’s business. Although there are several different valuation methodologies, all of them must take into account the risk to a company’s IP. A realistic IP strategy that is well-documented and one that demonstrates effective support for the overall business strategy will always enhance the ultimate valuation figure of IP.
IP strategy should reinforce the greater corporate strategy and evolve as the business continues to develop. The strategy should also change depending on which market the business is participating in, as development will differ depending on a business’s priorities. The balance of which IP rights are most useful, what should be invested in and their management time allocation will vary accordingly.
For example, when establishing in a new market, the registration of trademarks, patents and copyright is significant. Once a business is established, enforcement of IP is likely to become a higher priority. When a business seeks to improve its market share relative to its competitors, then the focus may be on litigating.
It is essential that company management is involved when drafting IP strategy and that they understand how it will support various business objectives. Key people that need to be involved in the strategising are the chief executive officer, finance director, tax advisor, general counsel, chief technology officer and chief operating officer.
The IP strategy should be reviewed whenever the business strategy changes, which should occur at least once per year.
With a strategic IP management approach and the appropriate identification, valuation and protection of IP assets, one can use their intangible assets to their advantage in order to secure financing and improve their company’s overall performance. However, to use IP assets as a business tool, SME Helpdesk experts strongly recommend that SMEs ensure their key IP asset is protected by being properly registered, in order to prevent IP from being exposed by current/former employees and business partners. They should also structure IP ownership so it is able to be appropriately used as collateral in the event a company needs to raise funds.
The China IPR SME Helpdesk supports small and medium sized enterprises (SMEs) from European Union (EU) member states to protect and enforce their Intellectual Property Rights (IPR) in or relating to China, Hong Kong, Macao and Taiwan, through the provision of free information and services. The Helpdesk provides jargon-free, first-line, confidential advice on intellectual property and related issues, along with training events, materials and online resources. Individual SMEs and SME intermediaries can submit their IPR queries via email (firstname.lastname@example.org) and gain access to a panel of experts, in order to receive free and confidential first-line advice within 3 working days.
The China IPR SME Helpdesk is co-funded by the European Union.
To learn more about the China IPR SME Helpdesk and any aspect of intellectual property rights in China, please visit our online portal at http://www.ipr-hub.eu/.