How IP-Backed Loans Work
Your intellectual property is usually the hardest-fought asset you have. Intellectual property, and particularly patents, are often the most valuable intangible assets your company owns.
There are several ways to use your IP in finance, and the most straightforward is to borrow against your company’s IP assets. This form of intellectual property financing is becoming more and more sophisticated, with several specialized lenders entering the space.
Big Banks Typically Do Not Value IP Assets
Many large banks routinely put security interests on patents and other IP when they do loans, especially for startup and growth companies. In most cases, the banks do not have the specialized IP knowledge to put values on the intellectual property, so their loans are typically based on the company’s past revenue.
A typical bank might provide a line of credit of 2 or 3 month’s worth of revenue over the last 12 months. Banks like to see a track record of 24 months or more of revenue as well. These banks are doing conventional business financing, and they usually just evaluate what they know best: tangible assets, not intangible assets.
IP-Backed Loans are Different
Many IP finance companies are giving much, much larger loans than conventional banks. In a typical IP financing arrangement, a company with $5M annual revenue might be able to get a loan for $20M.
This is a loan that is more than annual revenue. No regular bank will take that kind of risk.
IP finance companies can do this type of loan because they understand the value of the intellectual property assets. Their valuation of a company is much more than their balance sheet and last 12 months revenue.
Patent Loans Are Designed for Growth
IP backed finance is designed for the high-growth phase of a business.
Patent loans, for example, are designed to replace a Series A/B venture equity round. Companies who are raising capital in the equity markets typically choose patent loans to get capital for expansion, without diluting the investors with yet another layer of preferred stock from a larger investor.
Structure of a Patent Loan
An IP-backed loan uses patents, trademarks, trade secrets, and copyrights as collateral. In practice, the patents are the big assets used by lenders. The other intangible assets might be collateralized as well, depending on how large a share they contribute to the overall IP value of the company. This is a specialized version of venture debt financing.
The intellectual property typically has a security interest placed on it, although some lenders prefer that the IP be placed in a holding company. These are the assets that underly the loan, and lenders are careful to make sure they have access to the assets in case of a a default.
In some cases, the IP-backed loan will have an insurance component. The insurance varies from one lender to another, but an insurance policy may guarantee the value of some or all of the assets being used as collateral.
This type of insurance is called Collateral Protection Insurance or Residual Value Insurance.
These two terms are commonly used in real estate transactions, but have been applied to IP transactions.
What IP Lenders Want to See
IP lenders want to see two important things: revenue and valuable patents.
The value of a patent is very nebulous. Every inventor believes their patents are ‘valuable,’ but there are two main components to valuation: real value and potential value.
At the beginning of a startup’s journey, the patent value is pure potential value. Yes, there is a giant ‘total addressable market’ and, yet, you might get 1% or 5% of that market. But the real patent value at that stage is zero.
Patents have real value when they are put to use, and this typically comes when the patent owner sells patented products or services. The value of the patent is in the cash flows and revenue streams that it generates.
Cash flow proves that there is product-market-fit and that the business is beginning to create real value in their IP assets.
The most important part of asset based lending is showing revenue.
Valuable Patents with Revenue
When considering IP-backed loans, remember that the underwriter wants to see an overlap between the patents and the products generating the revenue streams.
A company might have a large patent portfolio, but only a small number of patents may actually be put to use.
When talking to IP lenders, we will map the patents to the products. Further, we often show the revenue of each product and the amount of that revenue that can be attributed to each patent. This gives the underwriter a better view of which patents are the most valuable assets in the portfolio.
The Process of Insurance Underwriting and Patent Valuation
The process of getting IP backed loans consists of two main parts: the financial analysis and intellectual property analysis.
The financial analysis is typically a financial spreadsheet with three years of historical data and at least three years of projected or future financials. Most lenders nave very sophisticated analysts who will use your spreadsheet for sensitivity analysis.
The intellectual property analysis will attempt to put a valuation on your intellectual property with respect to the current and future condition of the business. Remember that the valuation of the patents will increase as revenue increases, so they look for the growth of the company as part of their valuation analysis.
Note that none of the lenders will ever tell you what your patent is worth. They will just tell you that you are qualified for the loan or not.
BlueIron is Your Partner for IP-Backed Loans
BlueIron has been providing patent-backed loans for several years. We have established relationships with all the lenders in this space, and we understand each lender’s needs, appetite for technologies, due diligence process, and the best fit for each borrower.
We are happy to discuss whether IP-backed loans are appropriate for your situation.