Innovative Financing for Innovation: For Innovative Companies to Have Adequate Access to Capital, Accounting and Lending Standards Must Be Updated to Accurately Assess the Value of Intangible Assets Such as Intellectual Property and Other Forms of Know-How
Patrick, Kenan, Ellis, Jarboe Ian, Issues in Science and Technology
Finding funding for a new business or idea is almost always challenging. With the recent near-collapse of the financial system, however, funding innovation is even more difficult. Credit to businesses has tightened dramatically. The market for initial public offerings is moribund, and venture capital has been reduced to a trickle. As a result, the "valley of death" between a promising idea and a marketable product appears to be even more of an unbridgeable chasm. For many innovative companies, funding to move from a promising new concept to commercialization is simply not there.
One sign of hope is the emerging practice of providing funding to companies on the basis of their intellectual property (IP) and other intangible assets. Although IP, effective management, worker know-how, and business methods are widely recognized for their role in propelling the growth of the U.S. economy, the country is still largely failing to acknowledge the real value of these intangible assets and to provide innovative companies with the funding they need to capitalize on them.
In the United States, more than $1 trillion annually is invested in the creation of intangible assets, and in 2005 their total value was estimated at $9.2 trillion. However, only a portion of that value shows up in company financial reports. Likewise, intangible assets rarely merit consideration in the financial system. As a result, companies are unable to obtain the capital that they could use for business innovation and expansion.
Currently, companies can raise money based on their physical and financial assets. Such assets can be easily bought and sold, borrowed against, and used to back other financial instruments. They provide companies with a source of the investment funding needed for the U.S. economy, allowing it to grow and prosper.
In contrast, the $9.2 trillion in intangible assets is largely hidden and therefore unavailable for financing purposes. A huge opportunity cost is imposed on the U.S. economy when such a large source of potential financing is locked up. Because intangible assets are not generally available as a source of investment and risk capital, innovative companies may face higher capital costs or even a dearth of capital to fund new ideas. Unable to use their intangible assets as a financial tool, prospective borrowers face a system that does not understand their true revenue potential and is unable to judge operational risks appropriately. New ideas never gain traction or remain unexplored or undeveloped. Economic potential goes untapped and is therefore wasted.
Rays of hope
The picture is not entirely gloomy. As industry has invested capital in R&D to create new technology and advance other creative activities, a niche market of firms specializing in intangibles-based financing is springing up. Some intangible assets (traditional IP consisting of patents, trademarks, and copyrights) have been used in sale, leasing, equity, equity-debt, debt, and sale-leaseback transactions to finance the next round of innovation.
The easiest way for companies to raise funds using their IP is through sales or licensing. In recent years, we have seen the emergence of an entire marketplace devoted to IP, including public auctions run by ICAP OceanTomo. Numerous patent brokers and Web-based marketplaces augment the vast network of technology transfer offices that seek to sell or license IP. The sale of IP creates upfront cash for a company, whereas licensing creates a future revenue stream. The difference is important if one is trying to fund the next generation of R&D and needs that upfront cash.
This is where the financial system comes in. Financing is the process of granting a security interest (ownership in case of default) in an asset in exchange for capital. The standard method is through traditional debt financing, in which the asset is pledged as collateral, and revenue streams are used to pay off the loan. …