IP in asset recovery and the valuation of intangible assets as collateral are topics which are coming increasingly to the fore in insolvency workouts, as lenders are realising that the IP and intangibles are where much of the real value sits.
Logically, this has to be the case given that in the UK and US at least, more than half of all capital expenditure in the economy is made in intangibles (Goodrich et al, 2016). Intangible assets typically make up a very significant part of firms’ value: an oft-quoted study from the US suggests that up to 80% of the stock market value of the Standard & Poor's 500 biggest US companies is based on intangibles.
As the IP and related intangibles are what often gives the company its innovative competitive edge, it is remarkable that they are not always given full credit – and instead, the plain old bricks and mortar tangible assets get all the focus when the loan is made.
Look at the ongoing J Crew Chapter 11 process in the US – behind the arguments between the different classes of creditors about what the real enterprise value is lies a belated debate about the real value of the group’s IP. Securing IP properly when the loan is being negotiated is key.
Smart lenders back in 2016 realised that J Crew’s remaining value lay with the IP and associated intangibles, and as part of some rescue funding they took advantage of covenant carve-outs to transfer around a 72% interest in its trade marks to an unrestricted Cayman entity, which was then able to offer those trade marks as security to the rescue lenders. These trade marks were then licensed back to the US company, allowing the J Crew trading entity to keep using them.
The value put on that portion of the IP was $250m, and the funds enabled the company to keep trading. Now that Chapter 11 bankruptcy has taken place at J Crew, the value of the Intellectual Property in asset recovery has become a key issue and the original lenders now feel that they are missing out on a significant part of the value of the group.
Other US companies have undertaken something similar; Revlon is currently in a battle with lenders for having similarly moved some of its IP.
Looking at what’s going on makes it clear that some lenders have lost their hold on the assets that really mattered at the heart of J Crew.
They have been left with the conventional tangible assets of stores and the like which, you could argue, have in fact been an ongoing burden to the group. Are those tangible assets really that valuable in a fire sale in the middle of a savage economic downturn in retail?
And whoever ends up buying what is left of the J Crew operation will have to pay a fee to the Cayman Islands entity if they want to continue using the J Crew trade marks in future.
The moral of the story here for lenders is know where the real value lies, and pay close attention to the actual IP a borrower has.
If you want to keep control of IP and intangible assets in the event of difficulties, right when you need valuable collateral, you need to know exactly what’s there at the outset before you can secure it effectively. Otherwise, one day it might be gone – just when you most need it.
James Andrews is Head of Finance and Insurance Markets IP and intangible asset specialists, Inngot. Inngot's suite of online IP identification and valuation tools have been used by lenders and insolvency practitioners to establish indicative values for the IP and intangibles a company owns.