From The Wall Street Journal Online
Executives at Cambridge Display Technology Inc. came up with an uncommon solution two years ago when the company needed some quick financing.
Without any property or much else in the way of tangible assets, the U.K.-based flat-panel-display technology company didn't seem to have a lot of collateral to borrow against.
Most of the company's patents weren't yet yielding licensing revenue. Still, Cambridge Display was able to work out an arrangement with San Francisco-based Wells Fargo & Co. and London's Lloyds TSB Group PLC by using its portfolio of 75 patents to back a $15 million revolving-credit facility.
"For us, intellectual property is the most valuable asset," says Michael Black, vice president of finance at Cambridge Display, which has 120 employees. "The key for us was to be able to have a financial institution satisfied as to the value of our IP portfolio." The company drew on the line of credit to tide it over while it prepared an initial public offering of shares on the Nasdaq market in December 2004 that raised $30 million.
Borrowing against intellectual property is nothing new. Singer David Bowie is probably the best-known entrepreneur to have done this, raising $55 million in 1997 by issuing bonds backed by current and future revenue from 287 of his songs. But now the practice is gaining wider notice, especially among technology entrepreneurs who are short on tangible assets but long on patents.
This isn't something every company can do. Many lenders remain wary of financing smaller businesses this way, because of concerns about the prospective borrowers' ability to generate sufficient revenue to repay their debts. But investment firms have emerged that specialize in financing based on intellectual property, giving companies another option if banks turn them down.
There's also an important caveat for businesses that do enter into these deals: Financial experts say companies borrowing against intellectual property need to be especially careful to avoid undermining the value of their assets by structuring an agreement improperly.
The use of patents and trademarks to secure loans has gained the attention of borrowers and lenders alike in part because of the U.S. economy's shift away from manufacturing. "There's been a macro shift out of tangible and into intangible assets," says Robert D'Loren, chief executive of UCC Capital Corp., a firm that specializes in intellectual property.
Finding Flexibility
Borrowing against intellectual property can be a godsend for smaller companies, which don't have ready access to capital or equity markets. It also can help companies that don't want to share equity with an investor. And deals can be structured in a number of ways; companies don't always have to endanger assets like patents by putting them up as collateral that would be lost in the event of a default, as they would in a standard bank loan.
Concern about control over patents was part of the reason Dyax Corp., a Cambridge, Mass., biopharmaceutical company, decided to go to a private-equity firm, Paul Capital Partners, for financing instead of seeking a bank loan. The company got $30 million in cash with the option for an additional $5 million. In return, Dyax agreed to pay Paul Capital Partners a percentage of its revenue over 10 years.
Dyax, which has a portfolio of 75 patents and licenses, maintains control of its intellectual property unless it goes into bankruptcy protection, in which case its patents go to Paul Capital Partners.
"This has a lot more flexibility than a bank loan," says Ivana Magovcevic-Liebisch, Dyax's general counsel. The money is being used to further some of the company's drugs in development.
Protecting the Asset
Protecting the value of intellectual property should be a primary concern in any financing deal based on these assets, says David Ehrlich, a partner at Fross Zelnick Lehrman & Zissu, a law firm in New York specializing in trademark and copyright law.
Intellectual property is a "very fragile" asset, he says, "and that's where a lot of borrowers and lenders get into trouble."
Banks that don't deal with intellectual property a lot may treat it the same way they do a tangible asset, Mr. Ehrlich says. For instance, the bank may want a trademark owner to sign paperwork forking over a trademark in case of a default. But if the deal is structured the wrong way, the trademark can be invalidated and rendered worthless.
In one of the best-known instances of a deal gone awry, Mr. Ehrlich says, USA Detergents Inc. transferred ownership of its Super Scrub trademark to Chemical Bank as part of a financing deal. The trademark was to be returned to USA Detergents when the loan was paid off. If the company defaulted on the loan, the bank would retain the trademark. What neither USA Detergents nor Chemical Bank knew was that the transfer invalidated the trademark -- making it worthless to the company or to the bank. That's because the trademark was registered for "intent to use" and thus couldn't be assigned to another party.
Uri Evan, chairman of USA Detergents, says it "wasn't such a terrible thing" that the trademark was dissolved -- even though it forced the company to change the name of the product to Power Scrub -- because it wasn't considered a major asset in the first place. But the glitch still serves as an example of the potential pitfalls in borrowing against intellectual property. (Chemical Bank is now part of J.P. Morgan Chase & Co., which declined to comment for this article on the loan to USA Detergents.)
Burdensome Conditions
A small business thinking about borrowing against its intellectual property also needs to be on guard for unnecessarily burdensome conditions from the lender. It isn't uncommon, for instance, for banks to require the borrower to take whatever means necessary to defend a patent or trademark against infringements -- or risk defaulting on the loan. But this isn't always worthwhile. An infringement might be slight or transitory. A trademark might be one of many similar ones around the country that don't conflict with each other. Or a patent could become obsolete due to unforeseen changes in the marketplace. In such cases, it isn't worthwhile to sue to protect the asset.
"If you make too many promises, you may be building in an automatic default," warns Mr. Ehrlich.
Companies also need to consider whether customers might be scared away from signing a licensing deal if they don't think the firm has full control over a patent.
"Sometimes they're less willing to license if someone else has charge over the patents," Cambridge Technology's Mr. Black says.
Ms. Sheng is a reporter for Dow Jones Newswires in Jersey City, N.J.
Email your comments to sjeditor@dowjones.com.
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