Intellectual Property Finance: Securitization to Venture Capital
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  • 1. ABA 2002 Summer IPL Conference Intellectual Property Finance: Securitization to Venture Capital James E. Malackowski Duff & Phelps Capital Partners June 28, 2002
  • 2. Overview
    • Background…
    • Financial impact of IP
    • Finance continuum
    • Strategies…
    • License securitization
    • Internal tax driven strategies
    • Sale-license back
    • Enhanced buyout
    • Corporate carve-out
    • Venture IP
    • Process…
    • Due diligence
    • IP on IP Finance
  • 3. Financial Impact of IP Long-term Effects Financial Impact High High Low Low Recognition of Intangible Market Values License Revenues IAM Consulting Rev. Changes to Acct. Standards
  • 4. License Revenue Source: KPMG LLP Intellectual Property
  • 5. Intangibles as a % of Market Capitalization 80% 20% 1978 Source: Brookings Institute 54% 46% 1988 Market Capitalization 27% 73% 1998 Intangible Assets Tangible Assets
  • 6. Goodwill write downs Impact of Accounting Standards Amount (write down) AOL $54.2B JDS Uniphase $40.0B WorldCom $20-30B* Clear Channel $16.8B Nortel $12.3B * Company Estimate
  • 7. IP Finance Continuum Risk Profile Frequency of Transactions IP Venture License Securitization Sale-License Back Stick Licensing IP Buyout Tax Strategies High Low Low High
  • 8. IP Finance Continuum Risk Profile Frequency of Transactions IP Venture License Securitization Sale-License Back Stick Licensing Tax Strategies High Low Low High IP Buyout
  • 9. STRATEGIES
  • 10. License Securitization Process Insurance Premium $ Wholly Owned Subsidiary License Fees, Patents, & License Agreements Guarantee of P&I on Loan Loan Proceeds Licenses, License Fees, & Patents Loan Proceeds $ Loan Proceeds & Service Fee Licenses License Fee $ SPE Lockbox
    • Underwrites & Monitors
    • Collateral
    • Manages Debt
    • Provides Administration
    • Provides Marketing Support
    Source: GE Capital Technology Group Operating Agent Credit Enhancement Provider IP Funding (SPE) Lender(s)/ Purchaser(s) Third Party Licensees Parent Company IP Holding Company
  • 11. License Securitization Process
    • Type of asset-based financing backed by contractual payment flows
    • Requires sale of underlying assets to bankruptcy remote special entity (”SPE”)
      • Transfer of assets must be arm’s length
      • SPE is usually wholly-owned
      • SPE must be legally separate entity (independent director(s))
        • Covenants, reps & warranties, corporate procedures
    • Relies only on the cash flows from the securitized assets for repayment
      • Collections segregated into lockbox controlled by SPE
      • Non-recourse for credit losses
      • Uses structure to offset the increased risk associated with the lack of a general recourse claim
  • 12. Tax Driven Strategies Charitable donations Donor business units identify potential IP assets for donation An independent technical/market expert generates a report which includes benefits, market size, market share, probabilities of success, etc. IRC Section 170 requires donated property to be appraised by a qualified appraiser. Donor transfers assets to donee. Donee and Appraiser sign IRS Form 8283. Donor realizes tax bebefit on current year tax return. Donor monitors donee performance and provides support to help donee realize the potential of donated IP assets. 1. 5. 4. 3. 2. Source: InteCap, Inc. Identify Potential Donation Candidates Independent Technical/ Market Expert Report Post-donation Support & Performance Monitoring Technology Transfer/ Tax Benefit Qualified IP Appraisal
  • 13. Tax Driven Strategies Charitable donations
    • Benefits:
    • Realize immediate tax deduction for the full market value
    • Benefit society
    • Avoid patent fees for underutilized IP
    • Strengthen research institute ties
    • Considerations:
    • Defense of fair market valuation of the property
    • Identification of qualified donees
  • 14. Tax Driven Strategies Investment Holding Companies Unrelated Parties Investment Holding Company Related Operating Units Parent Company IP Rights Stock Licenses Royalties Licenses Royalties
  • 15. Tax Driven Strategies Investment Holding Companies
    • Benefits:
    • Focused IP management function
    • Greater IP integration in corporate strategy
    • Competitive positioning
  • 16. Sale-License Back Ownership Transfer Intellectual Assets/Rights License Back Investment Trust Indentures Investment Trust Company
  • 17. IC Based Investments
    • Technology
    • Company
    • CEO
    • $5 Million Investment
    Customer A Customer B Customer C Enhanced buyout
  • 18. IC Based Investments Holding Company CEO
    • Technology Department
    • Company
    • CEO CTO
    • $5 Million Investment
    Potential 501©(3) Donee Patent Securitization Customer A Customer B Customer C Acquisition Acquisition Acquisition Enhanced Margins $200 Million Investment Enhanced Margins Enhanced Margins Enhanced buyout
  • 19. IC Based Investments Enhanced Buyout
    • Cash flow based leverage
    • transaction (90%)
    • EBITDA improving IC (10%)
    • Patent security / donation hedge
    • Proprietary
  • 20. IC Based Investments Corporate Carve-out
    • Derivative of enhanced buyout
    • IC generally non-strategic to parent
    • Parent first customer
    • Unique opportunity to enhance shareholder value
  • 21. IC Based Investments Patent Based Venture
    • Derivative of traditional venture capital
    • Enforcement initiatives
    • Royalty monatization
  • 22. PROCESS
  • 23. IC Due Diligence
  • 24. IC Due Diligence – Intellectual Capital Phase I YES POTENTIAL Utility patents Process patents Brands Domain name Employee knowledgebase
  • 25. IC Due Diligence – Existing IC Phase II
    • Review key issued patents noting particular claims of interest and prior art search process
    • Assess current patent application decision process
    • Identify current patent counsel
    • List company brands and domain names
    • Are core products currently on sale or being offered for sale? For how long?
    • Has any technology been licensed in?
    • Cross licensing rights?
  • 26.
    • Review pending and potential future patent applications
    • Evaluate budget for future IC development and fillings
    • Identify current and potential domain names
    IC Due Diligence – Future IC Phase II
  • 27. IC Due Diligence – Competitive IC Phase II
    • Consider known competitive patents
    • Describe efforts to identify and track competitor patents and applications
    • Assess budget for future IC intelligence
  • 28. IC Due Diligence – Patent Documentation Phase III
    • Inventory existing and pending patents
    • Identify all license agreements providing the company with 3 rd party patent rights
    • Assess the company’s patent marking policy and practice
    • Review recent PTO correspondence on all pending patents
  • 29. IC Due Diligence – Trademark Documentation Phase III
    • Catalog company’s trademarks and domain names
    • Check for domain equivalents (use and availability)
    • Contact trademark counsel to assess status of key marks
  • 30. IC Due Diligence – Trade Secrets Phase III
    • Obtain copies of trade secret policy
    • Review employee confidentiality / assignment agreements
  • 31. IC Due Diligence – IC Threats Phase III
    • Confirm with company and counsel that no legal threats / infringement accusations exist
  • 32. IP on IP Finance
    • Patent Application – System for and method of risk minimization and enhanced returns in an intellectual capital based venture investment
    • Patent #6,330,547 – Method and apparatus for establishing and enhancing the creditworthiness of intellectual property
    • Patent #6,018,714 – Method of protecting against a change in value of intellectual property, and product providing such protection
    • Others