As some of us may know, Malaysia announced an Intellectual Property (IP) financing scheme in 2013. The main idea being that the IP could be used as collateral for loans by small and medium enterprises (SMEs) for business expansion. A number of government agencies, some sector/ industry focused, are encouraging innovation by providing support, training and funding ecosystem for sound business ventures.
For an IP financing scheme to succeed, the government support and participation was always going to be important. After all the government has largely a social and nation building motive unlike other financiers including, banks or investment funds/ venture capitalists, etc. which are answerable to their shareholders with profit maximization being the main motive. As such there is a difference between how risk may be perceived by the government vs other lenders. Although social agenda does not equate to lending to any venture or losing money and still requires careful consideration of the risks involved in lending. The valuation of the IP thus becomes important to understand the future potential, risks involved, amongst other things.
Although banks generally acknowledge IP as an asset, due to IP assets not being on the financial books in most cases, the perceived challenges (real in some cases) in liquidating or selling these assets in case of a default, the challenges in valuing IP assets coupled with their unfamiliarity with valuation techniques, has resulted in banks being more conservative by providing loans on traditional business assets only as collateral which are mostly tangible in nature. For a bank to provide lending, it must ensure that the credit risk is at an acceptable level. In order to fully appreciate the risk involved in providing lending based on IP, a robust valuation becomes important.
Of all the funders, the angel investors/ venture capitalists seem to appreciate IP or the idea/ technology more than other funders. This is the reason behind the initial funding of many silicon valley startups which have gone on to become household names – Google, Facebook, WhatsApp to name a few. Unlike in the U.S, ventures in most Asian countries do not enjoy much of angel/ venture capital support. There is always a ‘gut feel’ factor behind angel/ venture capital investing which also comes down to their acceptable level of risk and is not always quantifiable by figures. Don’t expect the same ‘gut feel’ from your bankers or other financiers!
Anyone involved with IP be it financing, valuing or legal will know that it is a complex area. Any business valuer will tell you that although all valuations are subjective, IP valuations are the most subjective of all. There are many reasons for this. You don’t sell your copyright or patent as you sell your property, vehicle or equipment and you can’t google (unlike most things these days) to find the answer to what your patent might be worth. There is limited public information if you’re trying to find details of IP assets including the sale and purchase data. Anything otherwise would defeat the purpose of developing, protecting and enhancing the IP assets which for most companies are the key business assets and you don’t divulge details of your key business assets.
I didn’t say that complex means it cannot be done. IP valuation is a specialist area and generally requires many years of experience (or many valuations under an experienced valuer) to appreciate all the nuances involved. There is always a risk of over-valuing or under-valuing something if it is not properly understood. Some of the key questions to ask are:
- What are the key IP assets in the business?
- Who owns the IP assets?
- How are they protected/ insured?
- Are the IP assets unique?
- How do the IP assets assist in the derivation of revenue and earnings?
- Are they licensed to group entities or to third parties?
- Are the IP assets fully commercialized and what is the stage in the life cycle of each relevant IP?
- What phase is the industry in – growth, mature or declining?
- How strong is the competition and what are similar products/ services in the market underpinned by similar IPs?
- What are the risks relating to the IP assets?
The generally acceptable methods for the valuation of IP fall into three broad categories. These are cost, income and market based.
It is important to note that each IP asset is different and hence a valuation methodology applicable in one case may not be applicable or may be inappropriate in another. An e.g. is a patent in final stages of testing vs a patent which has been commercialized. The cost approach may be more applicable in the former vs an earnings base approach may be more applicable in the latter.
In summary, the IP financing scheme is a very important development in the funding landscape particularly for SMEs and early to mid-stage companies. The banks may follow suit in due course which would expand the funding options available to Malaysian companies. However, it will be important to understand the risks by all parties involved and in depth analysis of the IP and a robust valuation will go a long way in a successful credit analysis and development of this area in the future.
By Adie Gupta
Director, Censere Group. Adie provides valuation and related advisory services to the public and the corporate sector in Asia and Pan Pacific.