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Using intellectual property and intangibles assets (IP) as collateral to raise funds is the original light bulb moment – because it’s exactly what Thomas Edison did with his patent for the incandescent lightbulb in the late 1880s. He borrowed the money to start a company that eventually became General Electric.
So, if the most prolific patenter in the world can use his IP to raise finance, it seems only logical for today’s high-growth and scaleup SMEs to do so as well. Unfortunately, it hasn’t been that easy – until recently.
Scaleups around the world tend to face the same challenge when it comes to raising the finance they need to grow. They are usually rich in IP, but poor in tangible assets.
That’s a problem, because historically companies have used their tangible assets as collateral when negotiating for finance. Up until the 1980s, this sort of made sense. Companies invested in tangible assets like buildings, vehicles, machinery and raw materials and delivered finished, physical goods. Banks and investors could see this reflected in companies’ accounts because these items would be listed as assets. Even more importantly, they could offer loans using these assets as collateral.
But the digital revolution has changed all that. Today, the main drivers of turnover, profits and growth for most companies are not tangible assets or products, but intangible ones. According to an analysis of the companies in the Standard & Poor’s 500 index (the biggest public firms in America), 90% of their market value was made up of intangibles in 2020 [Source: Ocean Tomo]. In Europe, the same report found that 75% of the S&P 350 index companies’ value was in intangible assets.
Intellectual Property rights and related intangible assets – like trade secrets, know-how, relationships, and reputation – are now key to economic success, particularly for scaleups.
But while we’ve all heard of scaleups, how many of us know what the definition of one is? The most commonly accepted definition is the one used by the Organisation for Economic Co-operation and Development (OECD)[1]: a scaleup is a company which grows its turnover by 20% or more or its number of employees by a similar amount over a three year period.
However, there is a disconnect facing scaleups when it comes to getting funding – particularly if they are looking to borrow from banks. Existing accounting rules were developed when tangible assets dominated, and balance sheets have yet to catch up with the seismic shift in the sort of assets that generate profits today. They still focus on tangible assets.
But intangible assets like IP seldom appear on a company’s balance sheet. They are largely invisible, at least from the point of view of lenders and investors, and their real value, in terms of what they contribute to turnover and profits, is not obvious. If IP and intangibles do feature on a balance sheet, then it’s usually as a cost, not as a contributor to revenue and profits.
For scaleups, particularly IP-rich ones, the result has been a ‘funding gap’ where high-growth companies have been unable to get the funds they needed to allow them to grow further. In 2020, a report from the ScaleUp Institute, Deloitte and Innovate Finance estimated that this gap was around £15 billion for the UK alone[2].
Thankfully, times are changing. IP and other intangible ‘knowledge assets’ are now increasingly recognised by investors and lenders as significant contributors to business performance and value – regardless of their accounting treatment.
Unfortunately, however, IP is still treated as an unfamiliar asset class by many banks and lenders. While they understand that IP matters, and that it can drive company value, they do not see how they stand to benefit, even if it does – and they worry about what it might fetch if things don’t go to plan.
They are also constrained by rules over capital adequacy – which, put in very simple terms, means that how much they are allowed to lend overall is limited by how much cash they have in their vaults, what their investments are worth and how many tangible assets they control. Tangible assets which have been taken as collateral for a loan count towards lifting this cap. Intangible assets don’t.
So, for most banks, IP and intangibles have been considered too difficult by most banks as an asset class to consider taking as collateral for loans. There is, however, a growing band of forward-thinking lenders which are actively looking for an answer to the challenge of lending against IP and intangible assets.
This is where IP finance (sometimes referred to as IP-backed finance or IP-based finance) comes in. It allows companies with valuable Intellectual Property and intangible assets to leverage the value of these assets to get funding, by using it as collateral.
Research from the British Business Bank and the UK Intellectual Property Office has conclusively demonstrated that businesses that own IP make better lending risks[3]. As the understanding of IP and intangibles, and their impact on company success, grows, more and more banks are launching IP-based lending products.
Inngot was created to support the growth of an IP-based finance ecosystem using IP as collateral that would help SMEs unlock the value of their IP and intangibles.
On the lending side, we are already working with a number of innovative banks and lenders to help them identify the IP that’s fundamental to driving a company’s business so they can more easily value it and use it as collateral.
On the company side, we are providing directors with the tools they need to communicate the value of their core IP in language which bankers (and investors) can easily and quickly understand and which will give them the ‘comfort’ they need to hand over their money. They can also use our tools to better manage their IP and intangibles strategically to drive even more growth.
But we are going further than simply identifying and valuing IP: we have built on our existing IP identification and valuation tools by developing a new Collateral Suitability Check tool. This assesses a company’s valuable IP on three key indicators: Strength (how good the IP is in its market); Securability (how easy it is for a lender to take ownership over the relevant IP); and Saleability (how likely it is that another company is likely to want to buy the IP in question).
This tool, coupled with Inngot’s existing IP identification and valuation tools, can support new lending products which use IP as collateral – like the High Growth IP Loan proposition NatWest Group has just launched.
Products like this will make IP-based finance viable for IP-rich SMEs and scaleups. It will allow banks to lend with confidence while delivering lower financing costs for borrowers by letting them leverage the value otherwise locked up in their IP.
References
[1] Unleashing SME potential to scale up – OECD
[2] The Future of Growth Capital, ScaleUp Institute, Innovate Finance and Deloitte, 2020.
[3] Using Intellectual Property to Access Growth Funding, British Business Bank and UK IPO, 2018
