Securitization of Intellectual Property as a Funding Alternative

Tesis de Máster , 2005 , 149 Páginas , Calificación: Excellent 'A'

Economía de las empresas - Banca, bolsa de valores, seguros, contabilidad

This thesis is designed to introduce securitization of IP rights as an alternative instrument in the corporate funding process. It is set up in a way that the corporate treasury, which has the responsibility for a diversified and economically optimized liability side and hence has a natural interest in new funding alternatives, can get an understanding for the instrument as such. Moreover, a treasurer shall be enabled to assess whether the balance sheet of his company comprises IP assets that have the potential to serve as collateral for a securitization. In case this asset identification process leads to positive results, the thesis additionally points out the crucial issues that have to be faced and analyzed before structuring this type of transaction. Although primarily focused on the corporate treasury’s needs, this thesis also gives other interested readers a holistic view of risks, benefits and economic impacts of an IP backed securitization. To fully understand the whole concept, perspectives need to be switched from time to time, e.g. to understand rating agencies’ or investors’ concerns which in turns lead to certain structuring issues for the originator. [...] This paper is structured in a way that allows readers to put themselves into the position of a corporate treasurer and to understand all associated issues of IP securitization in a target oriented order. Hence, before taking a closer look at IP and securitization in general, it is crucial to discuss the challenges in the corporate treasury’s daily work in section 2. As the respective asset class is the key to the understanding of its securitization, section 3 clarifies basics of IP and introduces its different forms. This is of special importance as IP is characterized by an extreme heterogeneity of the different asset types which makes one of the prime differences compared to traditional securitization. Section 4 analyzes how and to what extent securitization of IP can be and has been applied in practise so far. Existing transactions are used to derive the issues that earn most attention and decide over a transaction’s success. In that context, the knowledge of the market is an essential and indispensable source of information as most originators of IP backed transactions treat their deals highly confidential and research on available secondary literature shows poor results. Having set the scene, the following sections concentrate on the corporate treasurer’s perspective. [...]

OUTLINE

I. LIST OF ABBREVIATIONS

II. LIST OF FIGURES

III. LIST OF TABLES

1. Introduction

2. Challenges of corporate funding

3. Introduction to intellectual property
3.1 Definition and classification
3.2 Different types of intellectual property
3.2.1 Patents
3.2.2 Trademarks
3.2.3 Copyrights
3.2.4 Other types of intellectual property
3.3 Economic weight of intellectual property

4. Intellectual property: a new asset class in securitization?
4.1 Securitization – the tool in brief
4.2 Definition of IP in the securitization arena
4.3 Market overview
4.4 Benefits and hindrances of IP securitization
4.4.1 Corporates
4.4.2 Investors
4.4.3 Banks
4.4.4 Hindrances of market growth
4.5 Funding conditions
4.6 Case Study: BioPharma Royalty Trust

5. Identification of securitizable intellectual property

6. Major issues in the structuring process
6.1 Transaction structure
6.1.1 Introductory remarks
6.1.2 Direct IP securitization
6.1.2.1 IP true sale structure
6.1.2.2 IP sale and lease-back structures
6.1.3 Indirect IP securitization
6.1.3.1 Basic IP royalties structure
6.1.3.2 Conditional assignment structure
6.1.3.3 Secured IP loan structure
6.2 Servicing
6.3 Credit enhancement
6.3.1 Introductory remarks
6.3.2 Internal credit enhancement tools
6.3.3 External credit enhancement tools

7. Execution of an IP backed securitization
7.1 Introductory remarks
7.2 Transaction preparation
7.3 Documentation
7.4 Rating Process
7.5 Marketing and distribution
7.6 Other borrower obligations

8. Conclusion

IV. APPENDIX

V. BIBLIOGRAPHY

I. LIST OF ABBREVIATIONS

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II. LIST OF FIGURES

Figure 1: Classification of intangible assets

Figure 2: Intellectual property types

Figure 3: Number of patents granted in the Europe from 1997 to 2003

Figure 4: Share of intangible assets in S&P 500 corporations in 1979 and 1997

Figure 5: The transition from the ‘Labour Economy’ to the ‚Knowledge Economy’

Figure 6: Securitizable asset types

Figure 7: Growth in worldwide ABS and CDO issuance by region

Figure 8: Asset backed securities outstanding in 2003 by asset type

Figure 9: Worldwide number and volume of IP securitization issuance

Figure 10: Worldwide volume of IP securitization: broad vs. the narrow definition

Figure 11: Number and volume of IP deals by deals size clusters

Figure 12: Historical IP asset type distribution by number of deals

Figure 13: Historical IP asset type distribution by volume of deals

Figure 14: IP deal distribution by sector and number of deals

Figure 15: IP asset class distribution by volume of deals

Figure 16: Historical IP securitization by number of deals and country of originator

Figure 17: Historical distribution of funding terms in clusters

Figure 18: Historical average deal size per industry

Figure 19: Structure diagram of the BioPharma Royalty Trust deal

Figure 20: Requirements of IP assets to be securitizable

Figure 21: Example for an amortization cycle of an average movie

Figure 22: Zerit® cash-flow history

Figure 23: Distribution of success multiples of major US film studios in 1989

Figure 24: Securitizability analysis for the HIV drug Zerit®

Figure 25: Transaction type distribution by deal volumes

Figure 26: IP true sale structure

Figure 27: IP sale and lease-back structure

Figure 28: Sale and lease-back IP investment trust structure

Figure 29: Basic IP royalties structure

Figure 30: Conditional assignment structure

Figure 31: Secured IP loan structure

Figure 32: Increase of credit enhancement via sequential amortization

Figure 33: Average transaction size by number of tranches

Figure 34: Example for the functionality of the excess spread mechanism

Figure 35: Illustrative example of typical sales curves of music works

Figure 36: Investor base: IP deals vs. European CMBS

III. LIST OF TABLES

Table 1: IP deal structurers and their track records

Table 2: Practical example for a timetable of a CMBS transaction

Table 3: Advantages and drawbacks of IP securitization

Table 4: Requirements of IP assets to be securitizable

1. Introduction

In a world where technology, brands and information have become the dominant competitive factors, intellectual property (IP) rights are often a company’s most valuable asset. Intuitively these assets should – like any other valuable asset – play an important role for the funding of a company. However, a reality check shows that this is not the case. While tangibles like real estate can be leveraged e.g. through mortgage loans, a portfolio of IP often requires large portions of equity investments. The reason for this inefficiency is that most industries may not recognize their IP assets on the balance sheet although they require active exploitation and management just like (and sometimes even more than) tangible assets (Agiato, 2002). As an alternative to the book value normally the market value or any other reliably appraised value would be used. As there is no general market value for IP assets, lenders have to consider other valuation techniques. It will be shown later that the few markets where IP assets are traded highly depend on the existence of reliable valuation methods. To meet this demand for valuation tools, some techniques have been developed. However, compared to the evaluation of tangible assets these techniques are in their infancy and do not comply with debt capital market’s required level of accuracy. Consequently, lenders do not have a benchmark they can use to accept and evaluate IP as collateral for their funds.

Due to the fact that the ‘real’ value of IP assets can not be measured accurately enough, IP assets are usually considered with the only element that can be quantitatively analyzed: the future cash-flow the asset generates. To come to the anticipated future cash-flow lenders analyze historical cash-flow data, extrapolate it to the future and stress it to come to a sustainable value. However, the ‘real’ value of an IP asset comprises more than the current cash-flow element. Especially the potential future applications in goods and services as well as potential future licensing activities need to be considered when talking about an IP asset’s value. So far, this part of the asset value is typically ignored in the context of corporate funding.

Rating agencies face the same problem when analyzing a company’s credit quality. Although rating agencies are market leaders in the area of risk assessment they face a tough challenge in understanding all associated aspects of assets that are as complex and whose value drivers are as hard to quantify as is the case for IP assets. Consequently, the assessment of credit risk requires thorough due diligence in combination with asset specific expertise that lenders and rating agencies have to acquire before they can handle the ‘IP challenge’. As a consequence, IP backed debt easily leads to unfavourable funding conditions regarding inadequate interest rates, shorter loan terms and limited flexibility. Cunningham (2000) comments: “[…] by making loans secured by hard assets like machinery, equipment and inventory, bankers are overlooking the most valuable collateral: a company’s designer names and brands”. From a macroeconomic perspective this lack of acceptance leads to capital misallocation and inefficient use of resources. Nevertheless, in the last couple of years a trend towards new ways to utilize this misunderstood asset class could be observed. John M. Brosnan confirms: “I am getting more and more inquiries from companies interested in finding ways to leverage intellectual property rights as collateral” (Kossovsky, 2004, p.3).

One promising new way to leverage IP is to securitize it. Securitization, which has been established as a funding tool since the late 1970s, provides completely new opportunities for the corporate funding process and the leverage of IP portfolios. Rudder (2004, p.6) finds: “With the advent of the Bowie Bonds in 1997, the capital markets became a new avenue for the monetization on intellectual property assets”. However, not only originators can profit from the benefits of IP securitization. Also investment banks and investors can earn their stake in this new finance tool. Some market players such as Harris Nesbitt (2003, p.3) have realized that “bulge bracket and league table players need to identify growth in areas outside of traditional ABS sectors to continue their past success”. IP securitization could be such a new area of growth. Otherwise, investors have the opportunity to invest in unique securities and new asset classes without being exposed to the associated company risk. These completely new products can provide both increased diversification for their portfolios and interest rates that have an extra spread on top of the rates of comparable bonds of the same rating class.

This thesis is, however, focused on the opportunities that IP securitization presents for corporates. Being aware of the important role IP assets have for most companies of all size categories, this is an area with substantial upside potential for corporate funding. Using IP in corporate funding can be more attractive than other collateral “because there is generally a lower credit risk, which results in a lower cost of financing, and pledging intellectual property collateral will often allow a borrower to secure financing without the need to alter its capital structure” (Schavey Ruff, 2003, p.1).

My motivation for the topic

The future upside potential in corporate funding leads to the motivation for choosing this subject area as topic for a thesis. Having worked for two years in the securitization business for a German mortgage bank and having participated in the structuring of several synthetic Mortgage Backed Securities (MBS) deals, there is interest to learn more about other more exotic asset classes. Although every deal has its challenges securitization of mortgage loans has become very much standardized. Today MBS is the largest asset class in the securitization arena. Structuring these deals is still challenging, however, creativity in the structuring process is limited and new issues tend to become rare.

Intellectual property on the other hand is fascinating to analyze. Market participants have seen transactions which may seem strange prima facie but that appear to be very efficient having a closer look at them. Apart from the well known Bowie Bonds, a transaction which is backed by sales revenues of David Bowie’s music catalogue, only few deals have reached public interest. Readers will be surprised that many of the recent major blockbusters like The Matrix, Gladiator or A Beautiful Mind have been securitized. The same was done with the music of James Brown, fashion labels such as Guess?, BCBG or Candies, the Formula One Racing and the Madame Tussaud’s Wax Cabinet IP catalogue. As the IP asset universe is almost unlimited the market will see more new asset classes to come. Already today the asset classes range from entertainment deals over securitization of drug patents to deals that are backed by stocks of champagne or revenues generated by crematory chains. Investors are waiting for further innovations coming into the market. However, to date securitization of IP has failed to live up to the hype that the high profile of the Bowie name has created. Year for year market participants had expected the market to grow at a much higher pace but have been disappointed ever again. This thesis is designed to analyze the obstacles and discuss key drivers that hinder the market to develop more rapidly and with more enthusiasm than is currently the case.

The fascination for these exotic assets meets the current problems in corporate funding in Germany and some other western countries. Funding has become extremely difficult for some type of corporates, especially for those who do not have direct capital market access and for those whose assets are primarily of intellectual nature. Often these companies depend on their banks’ and equity providers’ willingness to provide funds. In combination with the above mentioned problem of incorporating the IP’s value in the credit quality assessment, this leads to severe funding problems for this type of companies. Considering the impact that the Basle II capital adequacy rules will have and already do have on the funding of SMEs, the need for alternative funding becomes obvious. On the one hand risk-appropriate Tier I weighting (and as a consequence risk-appropriate loan pricing) has been an urgently needed development. On the other hand, companies whose assets are inadequately considered in a bank’s internal borrower rating process (as is often the case with IP assets) are clearly put in a worse position. As in Germany SMEs make 99% of all enterprises, 70% of total employment and 50% of the GDP (Reich, 2004), this issue is quite substantial for Germany’s and other comparable knowledge economies’ future success. The importance of alternative funding sources is further emphasized when considering the restrictive funding policy banks have established with the beginning of the economic downturn after the burst of the technology bubble. Consequently, this thesis’ intention is to level the ground for alternative capital market funding sources such as IP securitization by explaining it to market participants and highlighting the opportunities it can offer.

Target of this thesis

This thesis is designed to introduce securitization of IP rights as an alternative instrument in the corporate funding process. It is set up in a way that the corporate treasury, which has the responsibility for a diversified and economically optimized liability side and hence has a natural interest in new funding alternatives, can get an understanding for the instrument as such. Moreover, a treasurer shall be enabled to assess whether the balance sheet of his company comprises IP assets that have the potential to serve as collateral for a securitization. In case this asset identification process leads to positive results, the thesis additionally points out the crucial issues that have to be faced and analyzed before structuring this type of transaction. Although primarily focused on the corporate treasury’s needs, this thesis also gives other interested readers a holistic view of risks, benefits and economic impacts of an IP backed securitization. To fully understand the whole concept, perspectives need to be switched from time to time, e.g. to understand rating agencies’ or investors’ concerns which in turns lead to certain structuring issues for the originator.

Summarized, the thesis aims to answer the following five key questions:

I. What is IP, what is securitization and how does it work in detail to use IP as collateral for a securitization transaction?
II. What are the advantages and drawbacks of IP securitization?
III. What are the requirements for IP assets to be securitizable?
IV. What are the major issues of structuring an IP backed deal?
V. What types of companies can profit from securitization of IP?

These questions pave the way to answer the superior question that is embedded in the title:

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Document structure

This paper is structured in a way that allows readers to put themselves into the position of a corporate treasurer and to understand all associated issues of IP securitization in a target oriented order. Hence, before taking a closer look at IP and securitization in general, it is crucial to discuss the challenges in the corporate treasury’s daily work in section 2. As the respective asset class is the key to the understanding of its securitization, section 3 clarifies basics of IP and introduces its different forms. This is of special importance as IP is characterized by an extreme heterogeneity of the different asset types which makes one of the prime differences compared to traditional securitization. Section 4 analyzes how and to what extent securitization of IP can be and has been applied in practise so far. Existing transactions are used to derive the issues that earn most attention and decide over a transaction’s success. In that context, the knowledge of the market is an essential and indispensable source of information as most originators of IP backed transactions treat their deals highly confidential and research on available secondary literature shows poor results.

Having set the scene, the following sections concentrate on the corporate treasurer’s perspective. The mandatory conditions of an IP asset to be securitized and ways to identify them are discussed in section 5. In a logical next step, the most important issues in structuring an IP backed deal are highlighted and analyzed in section 6. Here especially the issue with the asset transfer is addressed: How can a company securitize IP assets that are needed for its day to day business? Finally, in section 7 the execution process of a typical IP backed deal is introduced and discussed thoroughly. On the one hand there are tasks that are not too different from what is known as traditional securitization. On the other hand there are issues requiring intense efforts and patience like the rating and the distribution process which differ significantly from anything market participants are used to. To conclude, chapter 8 summarizes in-depth the answers to the five key questions above to come to a conclusion on the superior key question of this thesis. Section 8 will further explain the way to these conclusions and how the market is expected to evolve in the coming years. Furthermore, it needs to be discussed which questions require further research.

Existing research

As briefly indicated above, research and secondary literature in the field of IP securitization is very rare. Inter alia this is due to the fact that most information about existing transactions is not disclosed by the involved parties. This does not surprise considering IP’s importance for most companies and the fact that it often belongs to a company’s best kept secrets. Additionally, securitizing IP assets is still relatively new and is predominantly applied in the US, whereas Europe and Asia seem to wake and take up slowly.

As major source of information, rating agencies’ market reviews and descriptions of asset type specific rating approaches help to understand the crucial challenges and the major risk drivers of this kind of securitization. In addition, especially law firms as well as selected financial magazines contribute to the research base of this thesis. Neither the large investment banks nor the corporate sector as potential beneficiaries have published background information on their deals. Consequently their contributions to the research base of this thesis are extremely limited. This does not necessarily mean that these parties are not interested in establishing IP securitization as a common funding instrument. It is rather the above mentioned secrecy issue that hinders to get an insight in their deals. As a consequence of this information gap no books have been published on IP securitization yet. Most other sources used for the thesis are predominantly short articles published in industry or finance magazines. These sources serve well to get an overview of existing transactions but do not provide deeper insight. All in all, the level of research in the field of IP securitization is extremely underdeveloped considering that the product is known for 8 years now.

Novelty

This thesis is one of the first of its type. It explains and tries to increase public attention and establishment of IP securitization. Especially the lack of information and the level of secrecy that market participants preserve make it tough to analyze functionality, hurdles and future opportunities of the instrument as such. As a consequence, there remain open questions that will have to be researched in the future. However, the more publicity the funding tool can get in the future, the more it will come into the focus of both investment banks and IP asset-intense industry participants.

As a last comment before getting into intellectual property it is important to mention that for the above mentioned reason, US law is applied where legal reviews are necessary. However, regarding IP law differences compared to Europe do exist but are relatively limited though.

2. Challenges of corporate funding

The corporate treasury is responsible for the management of a company’s liability side. Its role is to collect and provide the funds which are needed to finance the company’s operations and to pursue its business plan. The treasury has the responsibility to provide funds particularly:

- at the time they are needed (liquidity risk management) and
- at the best possible rates (interest risk management).

Apart from liquidity and interest rates, two further criteria have to be considered in corporate funding. Firstly, it is important to create a liability side that is appropriately structured regarding maturities. If the majority of a company’s debt falls due at one point in time, this often represents substantial refinancing and liquidity risk. Consequently, corporate treasurers concentrate on the creation of a liability side that consists of evenly balanced maturity clusters. Secondly, different kinds of funds provide different levels of flexibility. While some investments and projects the treasury needs to provide the funds for are fixed and do not require flexibility, others require tailored funds that perfectly meet the specific needs.

In order to be in a position to assess which funding tools are suitable and which of them could potentially be applied in practice the treasury needs to analyze these specifications thoroughly. As a next step, achievable conditions (especially rates, term and flexibility) should be investigated to get a better idea of which method can come into a close-pitch selection. The complexity of this comparison can differ significantly between firms. For large, externally rated companies, the comparison of achievable corporate bond market rates, secured or unsecured bank loans is ‘relatively’ easy to do. Due to their often less diversified sources of funds, for smaller companies this exercise is only of reduced importance. For a securitization backed by IP, a prediction is tough and is normally not possible without professional support by an investment bank with experience in this specific business.

How many funding sources a company can use primarily depends on the its size, its current capital mix and its economic situation, if applicable expressed in a corporate rating. In general, the corporate funding is based on the following (and a few more but less important) funding tools:

(a) Equity
(b) Debt
(c) Mezzanine capital

Ad (a): Equity

Equity is typically the most expensive capital of a company as it ranks behind all other sources of funds. It can be raised via initial public offering (IPO), stock exchange capital raise, co-operation with private equity firms or from strategic investors. Furthermore, companies can sell parts of their assets e.g. as is done in the factoring business with trade receivables. Typically, corporate investments are only partially sponsored by equity. However, IP portfolios and R&D intensive businesses are often funded by large shares of up to 100% equity as their ability to be used as collateral for debt funds is very limited.

Ad (b): Debt

Debt is typically a significantly cheaper source of funds than equity. This is due to the fact that lenders have a prior ranking right to balance their claims against a debtor who had to fail for bankruptcy. Companies can enter into debt agreements in a multitude of ways. The most common funding tool is the classic bank loan which can be both secured and unsecured. Bank loans, traditionally recourse financing tools, often comprise covenants which force borrowers to prepay or to increase collateral in case its credit standing worsens (Rudder, 2004). The conditions of bank loans are directly linked to the value of the collateral that is provided. Due to its limited acceptance as collateral, IP backed loans often tend to be mispriced. In times of disintermediation, bank loans lose importance and more and more companies try to get an own direct capital market access. In addition to bank loans, corporates typically use bonds for long-term and commercial paper (CP) for short-term unsecured funding. Parallel to these unsecured funding tools, securitization of long-term assets and trade receivables in Asset Backed Commercial Paper programs (ABCP) represent the secured side of debt capital market funding.

It is important to realize that only few long-term assets on a corporate asset side qualify for securitization. Typically, the majority of assets are short-term trade receivables. The remaining part of eligible assets like machinery or real estate often does not reach the required volume for securitization. This is where IP assets as the most valuable long-term assets in many companies’ asset books come into play. Capital market debt typically comprises less covenants than bank loans. Corporate bonds for example are debt instruments whose funds are available independent of changes in the borrower’s credit standing. The risk of worsening credit quality is transferred to the lenders.

Ad (c): Mezzanine capital

In addition to the classic funding instruments, equity and debt, there are some hybrid capital sources which cannot be classified as one or the other. Consequently they are classified as mezzanine capital. Typically, mezzanine capital investors to a certain extent profit from the upside of the project their funds are used for while their downside is limited to their investment (except for default). However, as mezzanine investors rank behind classic debtholders, their risk exposure is higher. The pricing of mezzanine components is not limited to interest, but may include profit participations or other ways of participation. Mezzanine funds can be provided as subordinated loans, loans which comprise equity structures or via atypical silent participations (IKB, 2005). Depending on the risk/return ratio, mezzanine providers may require and receive veto rights for certain important decisions.

As indicated above, it is obvious that for specific situations where funds are needed for a certain purpose, only a few of these tools can be considered to satisfy the relevant requirements. In addition to the suitability of a funding tool, the corporate treasury has to consider which of the above options it generally has. The availability of a funding tool depends on the following crucial factors:

(a) Company size,
(b) Current capital mix and
(c) Economic condition.

Ad (a): Company size

Larger firms such as public limited companies often have easier access to fresh equity and more often have a direct debt capital market access. Smaller companies such as partnerships usually have more opportunities when it comes to the entry of a new strategic investor or the raising of funds via private equity firms. Sure, these statements are far too general and do not necessarily reflect the individual case, however, they are true for the majority for firms. So far, true sale securitization remains – due to the high structuring cost – reserved for larger companies. However, more and more banks provide platforms which enable SMEs to utilize their assets to borrow secured funds. Recapitulating, the key to a diversified funding mix is the access to capital markets which provides a variety of different funding sources.

Ad (b): Capital mix

The current capital mix of a company can limit the availability of funding tools. For example, highly leveraged firms have in average more problems to get new equity from their shareholders as debt ranks ahead of equity. In the case of extremely leveraged firms even uncovered debt issuance can become problematic. Once more, the level of leverage in the specific case depends on the specific industry (e.g. telecoms vs. consumer goods). Similarly, any type of secured debt – including IP securitization – will lead to a worse-off position in case of the company’s bankruptcy for both unsecured lenders and equity investors. Secured lenders have the right to sort out their collateral to satisfy their claims, thereby reducing the overall bankruptcy mass available to repay unsecured debt and equity investments.

It is a treasury’s obligation to create a liability side with a healthy balance of equity, debt, mezzanine and other capital types. In that context, intellectual property securitization can substantially add variety and value to the treasurer’s toolbox. This is especially true when considering that most IP does not appear on a company’s balance sheet. One could argue that IP securitization does not dilute equity to the same extent as it does in debt issuance that is covered by tangibles or recognized intangibles. However, especially equity investors incorporate the intellectual property’s value in their company valuations to figure out the ‘fair’ stock price. Consequently, securitization in general and securitization of IP in particular can dilute their security interest.

Ad (c): Economic condition

A company’s economic condition has an impact on its funding situation as lenders thoroughly analyze the probability of getting their investment back. Apart from few exceptions, where strong names facilitate capital market debt funding like the German Tchibo Group bond issuance in 2004, externally rated corporates have advantages compared to unrated ones. Firstly, their credit standing is approved by a third party that confirms the own assessment. Secondly, there are market participants such as insurance companies or pension funds whose investments are limited by company and regulatory policies to externally rated securities. Independent of ratings or size, funding becomes more difficult if a company is in bad shape or financial difficulties. In these situations, most funding sources dry up which can easily lead to a downwards spiral. In such a situation, even a company’s shareholders will only provide further equity if they see a realistic chance to stabilize and recover their investment. Hence, the less strategic investors and the more short- to medium-term yield-oriented investors are involved in the ownership structure, the more complicated it is to get new equity. In a situation where no funds are available any more, IP securitization can be the last way out. A good example for a situation like this is the Athlete’s Foot securitization transaction (Glasner, 2004). As the sports and shoe retailer had written losses for the past five years, it could not get affordable funds anymore. It consequently restructured its operations from company owned retail stores to a franchise system and securitized the resulting franchise license agreements of the next decades. In a situation of this type, the funds that the treasury can generate upfront via IP securitization are much more valuable than the future cash-flows, even when transaction fees and discount rates are factored in (Fishman, 2003). The same applies in the case of start-ups and other types of companies with a narrow funding pipeline.

Insufficient recognition of IP as valuable collateral

To convince lenders to provide additional debt funds in bad times, borrowers have to provide reliably valued collateral. The lending value of such collateral does, in the classic case of a bank loan, depend on the asset’s price volatility and its market fungibility. While equity investors implicitly price the company’s IP by trading shares at the assumed ‘fair value’, most banks tend to claim IP pledges in addition to the traditional loan collateral without giving them substantial value as collateral. “Even if a borrower’s intellectual property is not independently valuable, it is often times an essential piece of a creditor’s ability to realize upon another asset that may be primary source of the financing” (Schavey Ruff, 2003, p.1). A fashion industry executive complained that “bankers do not give enough consideration to harder quantify values like the creative power of a designer or the value of a brand” (Cunningham, 2000). Deborah Schavey-Ruff, partner in the intellectual property group of the law firm Mayer, Brown, Rowe & Maw, LLP criticizes (Morphy, 2002): “Unfortunately most lenders as well as most borrowers think IP is like a piece of property, no different than the land that a building sits on. Whereas each IP is unique and has unique laws that attach to it that have to be fully understood in order to minimize risk” . This is even more important since companies with a high portion of IP in their asset book traditionally have huge funding needs as they often have above average R&D expenditures.

As a consequence, only few assets from an average company’s asset side can be considered as appropriate collateral. Real estate, lands or machinery are possible assets, however, their volume in an average firm’s balance sheet (compared to the total size) is rather negligible. The majority of an average company’s balance sheet assets are trade receivables resulting from sales of goods and services as well as financial and strategic investments. The trade receivables’ limited maturities as well as the costly and time consuming process of analyzing their credit quality limit the ability of the treasury to monetize them at their real value. In short, traditional assets which qualify for currently existing types of securitization are rare on the average company’s balance sheet.

Securitization of trade receivables as a funding alternative?

Due to the lack of eligible collateral, the market share of securitization transactions arranged by corporates is rather low. Securitization has not become an accepted funding tool in the corporate world yet. However, in some countries banks are working on funding platforms for especially for SMEs. In Germany for example the bank West LB is working on a project called ABSproM, a securitization conduit for SMEs that have an annual turnover of above EUR 150m. and revolving portfolios of trade receivables of at least EUR 10m. (Puffer and Gaida, 2005). The receivables which have to meet certain pre-defined eligibility criteria are sold to a SPV which in turn refinances the purchase by issuing notes with short maturity that are secured by the portfolio of receivables. These programs require a high level of standardization and are the more economically efficient the more clients they have. A unique advantage of these structures is the maturity transformation from short-term assets to long-term funds that can be achieved. This and similar programs will further increase the importance of securitization as a funding tool for the corporate world. The challenges in corporate funding discussed above as well as the mature stage of the ABCP market in the US underline that the demand for these types of projects is there.

Securitization of IP as another long-term funding tool?

Further growth potential for securitization as a corporate funding alternative emerges from the growing importance of intellectual property. In the majority of cases a corporate’s IP assets are worth much more than what is shown in the balance sheet; their recognition in major accounting frameworks such as US-GAAP or IAS is extremely limited. For industries like the film industry, whose core assets ‘movies and the associated copyrights’ are of intangible nature, the US and some other accounting authorities have enacted industry specific rules (e.g. for the film industry the AICPA’s SOP 002 guidelines have to be applied). However, the situation is different for most other types of companies. They cannot fall back on that kind of regulatory support and may not recognize their self-created IP assets, no matter how much cash-flow they generate and how important they are for the corporate’s business and funding process. As a consequence, valuation methods for most types of intangible assets such as patents or trademarks have remained in their infancy. Elliott explains the impact of this phenomenon the following way: “For CFOs, intellectual property can seem like a money pit. Creating intellectual property consumes cash, shortens the balance sheet, and reduces current earnings, which threaten stock value” (2002, p.460). Max Azria, executive head of the fashion company BCBG Max Azria Group which securitized most of its license agreements in late 2004 comments: “Our intellectual property is a sleeping asset. […] We put to work the IP assets to give us room to grow comfortably” (Young 2004). Another market participant emphasizes: “Intellectual Property and Intangible Assets have represented the financial world’s most under-valued group of assets” (Author unknown, 2004c).

It is obvious that the time is here to reconsider the role of IP in the funding process of corporates. Considering their tremendous role for the western economies, underutilizing IP assets is not an option any more. Especially companies that are focused on IP business need new alternatives for their funding in order to compensate for the changes in the context of Basel II and the more restrictive bank loan policies. Mullen et al. agree that there is urgent need for further research in this subject area: “[…] because this securitization market is in its infancy, and because of the nature of the financial assets involved, these securitizations will present both opportunities and issues that differ, both in kind and degree, from the business and legal issues faced in other types of securitizations that artists, investors, rating agencies, investment bankers and their counsel would have to consider in analyzing and structuring this type of transaction” (Mullen et al., 1997). In increased worldwide competition companies cannot afford to neglect the most valuable assets. In more illustrative words: “Leaving ‘knowledge property’ on the sidelines is sort of like telling a coach to pay millions for an all-star quarterback to sit on the bench for his entire career” (Elliott, 2002, p.470).

3. Introduction to intellectual property

3.1 Definition and classification

This section is designed to introduce the several different intellectual property types. It is of major importance for the feasibility of IP backed securitization transactions to have an exact understanding for the type of IP that is dealt with. The knowledge of an asset type’s characteristics, strengths and weaknesses enables to derive implications for the structuring process of an IP deal. After defining IP and differentiating it from other intangible asset classes, the different types of IP are briefly introduced. The major differences regarding their use as collateral are discussed in more detail. A final subsection will highlight the importance of IP for the economy as a whole. Being aware of the weight of IP assets is an important basis to foresee the future potential of a funding tool based on it.

The term ‘intellectual property’ describes any product of human intellect that is unique, novel, unobvious and that has some (not necessarily easy to assess) value in the marketplace. Such property can be of multiple nature: inventions, literary and artistic works, symbols, (unique) names, images, business methods, chemical formulas computer programs or designs used in commerce. Coming from the rather abstract definition describing the requirements of an intangible asset, the legal perspective can help to understand how it is possible to securitize these intangible assets: An intellectual property right is a legally protected property right over intangible assets for the purpose of (WIPO, 2004):

- Decreasing the likelihood of copying or imitation by competitors,
- Increasing the options for commercializing new or improved products and
- Dealing more effectively with any violations of their IP rights.

From a macro-economic perspective and in more practical terms the purpose of intellectual property right protection is (Jaiya, 2001):

- Protecting parties investing in R&D,
- Incentivizing market participants to invest in R&D and
- As reward for inventors and creators.

From that definition it can be derived that IP has to be either legally protected like patents or impossible to copy (no protection needed) to qualify for securitization.

Any IP which is possible and legally permitted to commercialize without paying certain fees for its use cannot be securitized as they do not generate sustainable cash-flow.

Regarding the protection of IP it is important to mention that IP rights are territorial rights (WIPO, 2004). This means that the protection filed with a specific office does only protect against misuse in the region, the country or the member states of a treaty the office is responsible for. To make things even more complicated for companies, the ways to protect are different for each type of IP (and will hence be discussed in the relevant IP specific section). Especially the western governments have pushed the process to simplify registering IP rights and to enlarge their range of efficiency to the whole world. However, the process of IP protection is still a hassle for inventors and companies.

An interesting remark is that a single product can be protected by a variety of IP rights. A good example is the invention of the CD player (co-operation of Philips and Sony). The technical features are protected by patents whereas computer programs needed for the production process are protected by copyrights. Additionally, the appearance of the CD players is usually protected as an industrial design. Their trade names are normally registered trademarks (WIPO, 2004). Depending on the respective strategy, the inventors can decide whether they want to prevent others from using the technology or they want to establish new market standards and thereby can increase revenues by claiming license fees for the commercial use of their IP rights.

To understand IP appropriately it is crucial to comprehend the different kinds of intangible assets that do exist and what their main differences are. Please see the figure below for an overview of the different types of intangible assets.

Figure 1 : Classification of intangible assets

illustration not visible in this excerpt

Source: Own figure, based on Wurzer (2004), p.12.

The term Intellectual Capital (IC) is used to describe the competitive advantages arising from a company’s staff (human capital), its business model, its industry network (relationship mandates etc.) and its trade secrets. Trade secrets are, broadly speaking, “any confidential business information that provides an enterprise with a competitive edge” such as formulas, manufacturing techniques, personnel records etc. (WIPO, 2004, p.63). Although being of major importance to an enterprise and being responsible for competitive advantages with a value of billions of dollars, trade secrets cannot be securitized. This is quite intuitive when considering that they cannot be reliably protected (implicitly they are, however, enforcement would be hard to ensure). As a consequence, if they were supposed to serve as collateral for debt funding, they would immediately lose their value as they were just no secrets anymore.

Goodwill on the other hand is the value which is expected to be monetized from acquisitions that have been priced above book value. The most important difference between intellectual property and the two other intangibles is best described by WIPO (2004, p.4): “[…] IP protection makes intangible assets a ‘a bit more tangible’ by turning them into exclusive assets”. This exclusivity enables owners of intellectual property rights to generate cash-flows via application in goods and services as well as licensing activities. Being aware of the differences between IP, intellectual capital and goodwill, IP can be classified further. The following figure illustrates different types of intellectual property existing (dark blue boxes) and the tools by which they are typically protected (light blue boxes).

Figure 2 : Intellectual property types

illustration not visible in this excerpt

Source: Own figure

With regard to above definition, all types of IP are securitizable as they represent value and can be protected by sort of domestic or international regulations. However, IP protection is everything but worldwide harmonized. Whereas some types of IP are known all over the world, others do not exist in certain countries. For example “China and Hong Kong do know patents but do not know trademarks protection” (Morphy, 2002). International IP protection is primarily based on the Paris Convention and the Berne Convention, which were adopted in 1883 and 1886 respectively (WIPO, 2004). To stay in line with the asset-wise changes of the last 120 years, the system was expanded via further treaties. The most recent significant change happened in 1995 when the 146 members (November 2003) of the WTO signed the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), thereby setting minimum standards for the protection of the most important types of IP. Over the last years it has especially been the World Intellectual Property Organization (WIPO) pushing the worldwide process of harmonization of IP protection. For example it initiated the so called Internet Treaties in 2002 which set up a legal groundwork to safeguard the interest of artists when distributing their work over the internet. The agreement to set up the WIPO was concluded in 1967 in Stockholm and entered into force as of 1970. At present, the organization has 157 member states. Nevertheless, there remain multiple significant differences between the frameworks of different countries. For IP securitization purposes this means that the collateral is eventually not completely protected against plagiarism. This drawback does have an impact on the value of the asset a well as its ability to be securitized (Curci, 2003).

In general there are three ways to apply for IP protection, the national, the regional and the international route (WIPO, 2004). The recommended way depends on the needs of the inventor in his specific situation. The national route stands for country by country registration, including all associated legal, translation and registration cost. Due to high cost, national registration only makes sense where a specific market has been identified as a major source of income. One will get the most reliable protection in return. The regional route describes a strategy of applying protection with regional IP protection union such as the European Patent Office or the African IP Organization. The certainly easiest way to protect IP is the international route. The WIPO administers international registration systems which simplify the registration process to one single registration, in one language, with the advice of one lawyer and causing just one fee payment. At the same time protection of the IP asset is achieved for all countries which have signed the respective treaties. The following sections go into further detail of ways to choose for different kinds of IP.

Different types of IP generally qualifying for a securitization deal are introduced in more detail in the following sections. In addition to a general definition the section focuses on the possibilities to protect the relevant IP right in one action all over the world as well as on its ability to generate the cash-flow needed to use it as collateral for debt issuance. Due to the lack of market value for most IP rights, the valuation issue is mentioned as well. To enable readers to compare the different asset type specifications, the four sections are organized identically.

3.2 Different types of intellectual property

3.2.1 Patents

Definition

“Patents are the means by which an inventor protects his or her idea from being utilized, manufactured or sold without his or her permission for a prescribed number of years” (Howard & Howard, 2005). A registered patent gives its owner the right to exclude others from copying, commercially using or directly monetizing the invention. Each patent registration ends with paragraphs known as ‘claims’ that describe the patent in a way which proves its uniqueness. A patent does not necessarily apply to a complex mathematical or physical process. Patents may be registered for any area of technology, ranging from everyday products such as a simple paper clip over bicycles to the more complex x-ray apparatus. Referring to the initially discussed underutilization of IP in corporate funding, patents are probably the best example for disproportion of production expenses and generated value. The creation of a patentable invention often requires tremendous investment of funds for R&D without having a guarantee to get a monetizable asset out of it. These R&D expenses often have to be funded with large investments of equity, partially with zero leverage. There are two major types of patents (National Inventor Fraud Center, 2005):

(a) Utility patent
(b) Design patent

Ad (a): Utility patent

The utility patent protects all inventions that have a useful function such as product novelties, production processes, machines, composition of matter or – if not completely new – improvements to these types of inventions. Since June 8th1995 a utility patent is protected for 20 years from filing. For utility patents filed earlier than that, the calculation of the protection term is a bit more complicated, however, the protection term still lies around 17 to 20 years. In case of delays in the US Patent and Trademark Office (PTO) registration process, the life of a utility patent can be extended. To maintain a utility patent periodic maintenance fees have to be paid. Compared to design patents, utility patents are usually more desirable due to broader protection provided.

Ad (b): Design patent

The design patent is meant to protect the appearance, i.e. the ornamental instead of the functional design features of a product. Examples for a design patent are the classic design of the Coca-Cola or the Vittel water bottle. A design patent expires 14 years from the date of issuance. Registration of a design patent should only be pursued where the sole appearance is of importance.

In addition to these types of patents some countries use the concept of the utility model. The main difference compared to patents are the lower registration requirements, the simpler, faster and cheaper registration process as well as the reduced protection term of 7 to 10 years. It can e.g. be used to simplify registration for products with short life cycles.

Patent protection

As indicated earlier, the protection of most intellectual property types is an essential requirement for their commercial use. To qualify for registration of a patent an invention needs to be ‘novel’ and ‘not obvious’. Novelty meaning there has to be a substantial difference between the inventive product or process and its predecessors whereas the differences do not necessarily need to be major. In practise those patents which describe minor improvements have proved to be the most valuable ones. As a consequence, most inventions meet the test of novelty (Howard & Howard, 2005). More difficult to answer is the question whether an invention is obvious or not as the invention may not have been obvious to “a person of ordinary skill in the art” (Howard & Howard, 2005). The second test for patentability is whether the invention would have been obvious to a person of standard skill in the art at the time the invention was made. That definition is better explained when considering whether the invention would have been obvious at the time before the invention was made. An inventor should ask himself whether the invention provides benefits which would not have been available without his invention. Alternatively it could make sense to contact an experienced patent attorney to find out whether the invention is patentable.

Referring to the above mentioned classification of the different ways to protect one’s IP, the international way is often the one to choose. In the case of patents the application would be registered under the Patent Cooperation Treaty (PCT). The PCT comprises 123 nations (January 2004) including all major national economies and all western countries. It additionally provides the right of priority (right to reserve a patent to explore commercial exploitation possibilities) for 18 additional months (WIPO, 2004). Nevertheless, as simple as this procedure may seem, there exist major differences between the countries, leading to problems when trying to register via the PCT. While some countries follow the registration rule ‘first to invent’, others still pursue the easier to handle but sometimes unjust ‘first to file’ approach (Curci, 2003). In the specific case of a company seeking protection of its inventions, the specific needs have to be analyzed thoroughly before deciding for one registration route.

Ability to generate cash-flow and asset evaluation

Patents are well suited to generate a sufficiently sustainable cash-flow. Especially patents from and for markets with high growth rates like pharmaceuticals or microelectronics generate large sustainable cash-flows. To generate cash-flow, inventors need to transform their patents into a product or an application which can be distributed directly to the end-user or licensed out to other companies. However, especially in fast growing and moving markets there is a certain threat of obsolescence. A drug supposed to be best-seller can be easily outdated a year later. Possible countermeasures are a strong branding policy and the consideration and exploitation of alternative uses. However, a portfolio of patents or products based on patents seems to work best to mitigate the shortfall effect of a single product. This argument receives support from the market as the only single product transaction being based on a patent, BioPharma Royalty Trust, performs poorly (Dorris, 2003). In addition, the cash-flow can be floored by licensing out the patented formula etc. to third parties. This enables analysts and investors to partially shift their focus from the patent’s value to the licensee’s credit quality. The patent license market is quite promising for securitization purposes. In case of the pharmaceutical sector for example, the volume of royalty payments lies around USD 7-10bn. ( Dorris/Wilkes, 2004). In 1997, rumours indicated that there were ideas of securitizing S ilicon Valley ’s huge patent and patent licensing books (Mullen et al., 1997). The asset base for future patent backed securitization certainly exists. Please see the following figure as an indication for the future potential of patents.

Figure 3: Number of patents granted in the Europe from 1997 to 2003

illustration not visible in this excerpt

Source: Own graph, figures taken from European Patent Office (1998-2004)

This graph is a good indication for the countries playing a leading role in worldwide inventive activities. Due to the fact that this graph only shows patents registered at the European Patent Office, the order of inventory nations is inappropriate. However, it proofs to be a good indication for the worldwide figures as the world’s most active innovative countries in fact are the US, Japan and Germany (Germany representing roughly a quarter of all European inventions). Additionally, the drastically increasing activity in patent registration is an indicator for the importance IP has for companies and the overall economy. The increase in inventive activity has been even stronger for corporates than for private individuals, thereby increasing the likelihood of the development of IP as an asset class in corporate securitization.

The ability of patents to be securitized is mitigated by two factors, regulatory hurdles and the product liability issues. The United States Food and Drug Administration (FDA) can restrict manufacturing or even mandate the withdrawal of a problematic drug from the market as recently happened in the case of Pfizer’s bestselling drug Vioxx. Additionally, previously unknown problems with a drug may result in costly product liability suits. Even if the drug is not withdrawn from the market, the cost of litigation can significantly decrease a patent’s or product’s value leading to severe problems in a securitization transaction’s cash-flow. The drug company Wyeth for example was subject to thousands of lawsuits regarding its diet drugs Redux and Pondimin. Wyeth entered into settlements with a potential liability of more than USD 3bn. (Dorris, 2003). There are many other possible situations that can destroy a patented asset’s cash-flow. Pfizer Inc. for example recently faced heavy defeat in a patent lawsuit. An Indian drug company, Dr. Reddy’s Laboratories Ltd., marketed a drug which used chemical sister compounds for the patented chemical formula used for Pfizer’s blood pressure drug Norvasc. Pfizer made the mistake not to expand its patent to other ingredients that can be used in the chemical structure used for Norvasc (Dorris, 2003). Those factors imply that patents that have proven to be justified and do not cause liability issues are better qualified for securitization purposes.

Due diligence of patent securitization transactions is focused on the evidence of the patent’s existence (protection) in general, its proper maintenance and the possibility of enforcement for each jurisdiction separately. Additionally, rating agencies and investors carry out a patent specific analysis, check the license agreements’ correctness and analyze the licensees’ credit quality. In case of the patent portfolio missing its cash-flow targets, its stand-alone value has to be considered for a potential sell-off to a third party. There are three major approaches for patent evaluation (Wurzer, 2002):

- The bibliographic approach is based on the number of citations of the patent in the industry as well as in the public press and the number of litigations. The approach of measuring value via attention can probably serve as indicator but is definitely not enough for a market evaluation as it does not measure value in monetary terms.
- On the other hand the portfolio approach is working like a scoring tool. First, the market value is determined via scoring of the structure of the patent’s possible market (40% value contribution), the market entry barriers (20%), the general competitive environment (15%) and the patent activity of competitors in this sector (25%). Further, the value of the patent for the company is scored via relative share of the revenues of possible products compared to the company’s total revenues (45%), the quality of the innovation in the sense of utility for customers (40%) and the availability of non-protected alternatives (15%). The portfolio approach is – due to its adequate procedure and the separation of market and company driven value – more suitable to evaluate patents. However, the facts that scaling in the scoring tool has to be determined and harmonized and that no direct monetary evaluation is possible are crucial drawbacks of this method.
- The economic approach is much more focused on the cash-flow generating aspect of a patent. After scoring the different aspects of the patent by specialists in e.g. marketing, manufacture, patent law, technology, R&D and the corporate’s business plan, the possibly achievable cash-flow is estimated and discounted. This approach has several advantages compared to the others as it combines the legal, the technology and the economic aspects of the patent. In addition it can be used to apply the real options approach to it (for more information see Hull, 2003, p. 660-677).

This short introduction to patent evaluation methods confirms what has been said in the beginning. There are no evaluation tools yet that enable to carry out a reliably assessed valuation. The only approach that could yield results that can be used in business practice is the economic one in combination with real options pricing technology.

After introducing patents, the following section emphasizes trademarks as the second major type of IP. Particularly important issues regarding patents that have not been fully explored here are discussed in more detail when it comes to the crucial issues of an IP securitization.

3.2.2 Trademarks

Definition

Trademarks are the means by which a company's goods and services can be identified by the public and can be distinguished from those of competitors . Trademarks enable companies to manage and improve their reputation. They further serve as incentives for them to maintain their products’ and services’ quality. Trademarks can consist of words, letters, numbers, drawings, certain colours, pictures, shapes, logotypes or combinations thereof (WIPO, 2005). In some countries, slogans such as ‘Come to where the flavour is…’ may be registered as trademarks, too. In other regions even the appearance of a product (e.g. Toblerone chocolate), audible signs (MGM’s lion roaring that precedes its movies) or smells may be registered as trademarks. Trademarks play a crucial role for most industries as each designer and manufacturer strives through its marks to create brand recognition and customer loyalty (Howard & Howard 2005).

It is important to differentiate between trademarks and trade names. A trade name equals the company name which includes the legal type of the firm. The trade name is also used as trademark in some cases. Other companies have a trade name but own and commercialize multiple different trademarks. Some parts of expressions may not be registered as trademarks. Generic terms such as ‘table’ or merely descriptive terms such as ‘innovative’ cannot achieve exclusivity. Misleading names or logos which e.g. are confusingly similar to existing ones as well as words and illustrations with scandalous matters which violate public norms may not be protected (WIPO, 2005 and Howard & Howard, 2005). Apart from trademarks there do exist four different types of marks:

- Service marks serve as marks for the service sector. Banking, travel, advertising or catering services may be protected by service marks.
- Collective marks are normally owned by a collective body representing multiple companies. E.g. specific types of grapes or apples are protected by collective marks.
- Certification marks prove a product or service fully complying with certain manufacturing, raw material or similar standards. The internationally known Woolmark for example is reserved for products made of 100% wool and German beer is protected by a purity mark called Deutsches Reinheitsgebot.
- Well-known marks are further protected against competitors who are trying to profit from the reputation of well-known marks. McDonalds for example is in a position to take a competitor to court who is trying to free-ride with the name McRonald or similar.

Trademark protection

The registration of a trademark is relatively simple. In some countries simply the use of the trademark in practise has to be proven in order to prevent competitors from using it. Often trademarks are protected by the sign ® or by the letters TM to inform and warn third parties of infringement. The term the mark is protected for is unlimited as it – in contrast to patents – does not play an important role for public interest such as the use of technologies like the classic car engine.

Similar as with patents there are the three possible ways to register for trademark protection. Once more the international way seems to be the easiest and most efficient route to achieve protection for IP. In case of trademarks registration has to be filed under the Madrid System, a system which consists of the Madrid Agreement Concerning the International Registration of Marks and the Madrid Protocol (WIPO, 2004). The Madrid System comprises 74 member states including most major national economies. However, as not all states have signed both treaties (e.g. US and UK only the Madrid Protocol) it has to be identified thoroughly for which countries protection is needed. Once again protection can be achieved in a large number of countries with one single application, in one language and by paying one fee (less than CHF 1,000.-). In case a trademark does not comply with the regulation of a specific country or does exist there already, it may be rejected, which leads to the need of thorough analysis in the due diligence of a securitization transaction backed by trademarks. Apart from the Madrid System, the Paris Convention, the Nice Convention and the TRIPS agreement further push international harmonization of trademark protection (Curci, 2003).

In some countries (especially countries that follow the ‘common law’ system such as the US, the UK, Australia or India), a trademark is automatically protected through first use. However, to achieve a solid level of security an official registration definitely makes sense (WIPO, 2005). Additionally it enables a company to protect the name before commercialization even starts, it makes it easier to enforce the rights and it enables to use the trademark symbols ® and TM. The fact that marks can be protected via first use increases probability that a mark which is to be used as debt collateral already exists and may not be used any longer. Although this may be a seldom case, it is recommendable to use only marks as collateral where there is no doubt that they are unique and protected properly.

Ability to generate cash-flow and asset evaluation

Trademarks and other marks generate cash-flow by using them to distribute goods and services. A mark has alternative uses as it can be transferred to other similar products and services. This has for example been the case in 1999’s securitization transaction of the fashion designer Bill Blass who licensed his trademark out to manufacturers of sunglasses and other fashion articles in order to generate sufficient reliable cash-flow for a leveraged management buyout funded by IP securitization. In other cases trademarks are closely linked to formulas or patents which make the product unique and make the mark not transferable to other products on a stand-alone basis. Coca-Cola or the Jägermeister trademarks for example are inseparably linked to the formulae that are used for the beverages’ production. These and other criteria which make trademarks a unique asset class should be thoroughly considered by possible lenders using trademarks as their collateral. It is a must for lenders to think of all possible scenarios including enforcement of the collateral and structuring the security interest in the collateral accordingly. Otherwise they are running the risk of being left with worthless or even no rights (Schavey Ruff, 2003).

Trademarks live – even more than e.g. patents – from their proper and active management. The mark as such – without being applied to goods and services – has no material value as it can not generate cash-flows on a stand-alone basis. Consequently, borrowers need to keep a certain level of control over the asset. Lenders at that point need to consider two important issues. Firstly the way a lender structures a security instrument in trademarks can impact the effectiveness and enforceability of the security interest (Schavey Ruff, 2003). Lenders must ascertain that they have full access to the collateral in situations where it is needed. Section 6 will highlight that issue in more detail. Secondly, lenders need to assess which future cash-flow or immediate pay-off could be generated if the asset pool needed to be handed over to an external servicer. If a third party has the permission to use a trademark for its own choice it would have the following options to monetize that right:

- Use of the trademark to sell own goods and services
- Licensing out of the trademark to sell other companies’ goods and services
- Set-up of a franchise system where possible

These are also the criteria that need to be checked and assessed in order to achieve a proper evaluation of trademarks. However, these techniques are not better than those for patents, hence they are not required here and are skipped for the benefit of more general thoughts about trademarks’ eligibility for securitization.

Especially in western societies which are characterized by oversupply of goods and services, brands and trademarks have become one of the most important criteria for the purchase decision of customers Their value to most corporates is indispensable. As a consequence, their ability to generate cash-flow can be assessed as being satisfactory. Nevertheless, especially famous marks in competitive segments such as the fashion industry are exposed to quick and dramatic changes in public taste. As a consequence, treasurers should consider bundling marks to a portfolio to mitigate cluster risks lenders were exposed to otherwise. However, as most companies, especially SMEs, base their business on just one major mark which could serve as collateral, it appears to be tough to achieve this goal. This is exactly what can be observed when having a look at existing trademark transactions, which are primarily based on the use of one single mark. Further, trademarks used for collateral purposes should have demonstrated a long-lasting appeal in order to reduce the risk of going out of style (Moody’s Investors Service, 1999). Again, the discussion of more detailed questions is postponed to later sections.

3.2.3 Copyrights

Definition

Copyrights are a bit different from patents and trademarks as they appeared for the first time in 15th century Europe with the development of printing. European governments granted ‘privileges’ to printers, giving them exclusivity over their prints which prior had been submitted to official censors and approved for publication (Howard & Howard, 2005). 1710’s Statute of Anne became the basis of all future copyright laws. Copyrights affect our daily lives in a variety of ways. The daily news, computer programs, television programs and music we hear are all protected by copyrights. Copying, distributing or sharing them may cause penalties of up to USD 100,000, even if there is no profit from the infringement.

Copyrights are granted by law to protect works of authorship like literary, musical, photographic, dramatic works as well as paintings, movies, computer programs and multimedia products that are fixed in some medium (WIPO, 2005). These assets are protected irrespective of quality or value. To clearly distinguish between copyrights and industrial IP types, copyright law only protects the way an idea has been expressed, not the idea as such. Nevertheless, owners of a copyright do have some exclusive related rights (Jaiya, 2001):

- Initial distribution and reproduction in any form,
- Rental of copies to the public,
- Recording, public performance and broadcasting,
- Translation into other languages and adaption (book into a screenplay),
- Licensing and receiving royalties in return.

The owner of a registered copyright may block the unauthorized commercial utilization of his work. If somebody else has copied the copyright owner’s work, similarity alone is not sufficient. The owner of such a copyright must show that the work has been copied directly or that the two works are similar and that the infringer did have access to the copyrighted work (Howard & Howard, 2005).

Copyright protection

Basic copyright protection does not require official procedures. Any work that falls under the group described above is protected as soon as it exists (in some countries as soon as it is fixed in some material form). Although not applying to all countries worldwide, this is the case for all 151 countries which have signed the Berne Convention for the Protection of Literary and Artistic Works as well as all members of the WTO (a third treaty, the Universal Copyright Convention provides additional protection). Nevertheless, most countries do have national copyright offices and associated national laws. Such formal additional protection can help to prove ownership in cases of disputes. In the US for example, registration with the United States Copyright Office is obligatory if one wants to get statutory damages (Howard & Howard, 2005). Further, the earlier such copyright is attained the more costs (e.g. the attorney’s fees) may be recovered from the party accused for infringement. As there is no international procedure which can be used to protect works automatically, the work has to be registered manually in each country that provides such option. Depending on the importance of a specific market, companies should decide from case to case whether they need additional protection or not. For collateral purposes it is recommended and probably unavoidable to choose the way that provides the maximum level of security.

Due to the Berne Convention, copyrights are much better protected than any other IP rights. Nonetheless, the scope of copyright protection is not necessarily uniform. Japan for example is known as a nation where it is harder to attain enforceable copyrights. Additionally, computer programs and data bases are protected differently there (Curci, 2003). If copyright IP is used to collateralize debt it should be thoroughly analyzed whether the countries where the works generate the majority of their cash-flow provide sufficient protection.

[...]

• Universidad: Frankfurt School of Finance & Management
• Calificación: Excellent 'A'
• Autor: Alexander Kirsch (Autor)
• Año de publicación: 2005
• Páginas: 149
• No. de catálogo: V38915
• ISBN (Ebook): 9783638378475
• Idioma: Inglés
• Etiqueta: Securitization, Intellectual, Property, Funding, Alternative