How Intellectual Property Influences Your Existing Loans: (Part 1 of 3). (Issues in Lending)
Hoffman, Rick, Kennedy, Cory, The RMA Journal
Banking professionals at a recent RMA Chapter meeting were nearly unanimous in their assertion that they were not willing to make loans on intellectual property (IP). They said they loaned only on cash flow, receivables, inventory, or fixed assets. Yet, nearly all companies that generate significant cash flows have valuable intellectual property, and many banking institutions regularly take security in a company's intangible assets. Still, few banks do much more than secure "all intangible assets." As a result of the recent economic downturn, many banks are now looking toward those same intangible assets to pay for outstanding loans.
But first, bankers must be able to identify the IP owned by the companies to which a loan has already been made. This article, the first of a threepart series, provides a framework to help bankers identify IP. The next article will discuss how the valuation of established IP is performed. The last article will discuss how the valuation of unproven IP is performed.
Perhaps the most problematic characteristic of IP lies in the speed at which it deteriorates. It's a problem not unlike that experienced by the meat processing industry, which has a saying: "Sell it or smell it." It is precisely because of this problem that it is valuable to analyze the IP owned by your existing loans.
If you have a strategy for extracting the most value in the quickest manner from your IP, you will more likely be able to sell it rather than smell it. In some instances, a valuation of the intellectual property may be preferable. However, in most instances performing the following steps can provide a useful framework for monitoring the IP that is generating the cash flows that are paying your loans.
1. Identify the company's existing IP. Nearly 100% of revenue-generating companies have intellectual property. By identifying the IP prior to placing the loan, a bank can act quickly to take advantage of a security interest in the IP. This is very important, as IP often deteriorates in value very rapidly once a company ceases to maintain the asset. For example, imagine a client owning a favorable assignable customer contract. This is a relatively easy form of IP to sell, unless the terms of the contract have been breached. If you are unaware of the IP and are monitoring only the client's cash flow, you would not have any way of knowing that your client's actions may be ruining the value of your security.
To identify IP, of course, one must be aware of the most common types of intellectual property:
* Marketing-related intangible assets--typically, trademarks and trade names. The value of this type of IP is usually demonstrated in one of two ways:
1) By the owner's ability to charge a premium (such as a Gillette razor versus a generic razor).
2) In the owner's ability to get customers based on their recognition of the store and/or their preconceived notion of the store's offerings (such as McDonalds).
* Customer-related intangible assets--for example, customer lists and sales contracts. This IP is most valuable in industries for which obtaining customers is a big barrier to entry. For instance, major grocery stores frequently buy their produce only from established brokers. Thus, once established, the broker's customer list is very valuable.
* Artistic-related intangible assets--for example, copyrights.
* Contract-based intangible assets--including IP that the owner licensed from another entity. An example would be a clothing retailer that owned the rights to use the Olympic rings in its clothing.
* Technology-based intangible assets. This IP refers to patented technology.
One can most easily identify a company's IP by creating a comprehensive list of IP. The list can typically be customized by business type (e.g., service, manufacturing, retail, etc.). Depending on your loan portfolio, the list can be customized further based on the industry. …