Utilising Intellectual Property Assets As Security In Finance Transactions

1. INTRODUCTION

The use of Intellectual Property Rights ("IPR") in financial transactions is a more pertinent discourse today than ever before, particularly due to the explosion in the digital revolution and creative economy. Stakeholders from the creative economy and the business world are increasingly exploring means of harnessing the value domiciled in IPR to facilitate access to finance. Given the evolution of the global economy and the need for companies to leverage their available assets, intangible assets such as IPRs have achieved a status of commercial significance. This development has spotlighted the opportunities in using IP assets for various transactions.

This is evident from technological advancement and data revolution, intangible assets are becoming considerably more important to business operations. IPR commercialisation is predicated on the rationale of turning an original concept, an invention or an innovation into a financial asset, with the IPR serving as collateral to raise funds. Utilising IPR as security is not particularly a new idea. Still, the use of intellectual property rights and other intangible assets as collateral for loans has not received universal recognition, and Nigeria is no different. Besides equity financing, a handful of advanced economies lead the way in IPR-based debt financing.

Using IP assets as security for financing is not a new concept or practice; we will explore how businesses in Nigeria can leverage this approach to their benefit. We will review the nature, structure, and types of contracts where IP assets are used as security for financing, the key factors to be considered by the parties, and the benefits and challenges faced in IP financing. Finally, we will explore opportunities that abound for businesses willing to adopt IP asset financing in Nigeria.

2. INTELLECTUAL PROPERTY ASSETS AND FINANCING

IP assets, by their characteristics, are intangible, which means they are not transacted physically. Intellectual property may be defined as the result of creativity protectable by copyright, trademark, etc., which lack physical presence but have long term financial value for the owner. They typically include copyrights in works, patents, trade secrets, industrial designs and patent registration in Nigeria.¹ Due to the exclusive trademarks, design rights granted to the owner of IPR, they typically hold some intrinsic value for the owner and the owner's business.., Ownership of IP assets grants the owner some rights, such rights includes the right to generate profit in the same way one can generate profit from dealing in physical assets². Similarly, the legal protection afforded to an owner of tangible properties.

It is, therefore, possible, in principle, for an owner of the IPR to secure financing or raise a loan from a prospective lender and use the existing IPR as security for the loan. In the context of IPR, this security would constitute the borrower's obligation to pledge specific IP assets as well as future cash flows from those assets, rights to exploit the assets, and the lender's right to recourse in the event of loan default. Since IP can be utilised as an asset, IP owners can choose to leverage their holdings into profitable ventures.

In seeking to use IP assets for financing, a clear connection between the company/business and IP strategies must be present. This implies that businesses need to be able to demonstrate their IP assets (registered, valid and subsisting), how they connect to their main lines of business and income streams, and why they provide a differentiating value proposition in their industry. IP assets would only have a strong possibility of being considered a reliable security depending on their liquidity and the ability of the IP to be financially reliable independent of the individual/company's business. This means that not all IP assets may be viewed as viable security. Lenders would typically view a record hit album as more liquid than a single painting or artwork as the former, thanks to streaming revenue, would be considered more liquid and have better cash flow.

3. METHODS OF SECURING FINANCING WITH IP ASSETS

There are various ways in which parties can structure financing using IPR as security. Some of the common methods include:

1. IP-Backed Lending: This method is similar to traditional asset-backed loans on tangible assets. Here, the lender is granted an interest in the borrower's IP assets as security in exchange for a loan advancement³. IP-backed loans are commonly used by businesses or individuals who own valuable IP but lack sufficient capital to meet certain financial obligations. IP-backed loans allow the borrower (and IP owner) to access loans without necessarily selling its IPR. As a matter of fact, the Nigerian Startup Act 2022, under Section 29(3)e, recognises registered IPRs as sufficient collaterals for startups to obtain financial support under the Credit Guarantee Scheme established by the secretariat of the National Council for Digital Innovation and Entrepreneurship.
   This highlights the increasing acceptance of IPRs as valid security for finance transactions even in Nigeria. However, it's important to note that not all types of assets may be suitable for IP-backed loans, as lenders would typically prefer assets with established value and market recognition.
2. IP Sale- Leaseback: This method entails an investor acquiring an IP asset and, in turn, leasing the asset to the company. The Company would then pay a lease or licensing fee to use the asset. The advantage of this structure is that it allows the IP asset owner to secure some funding through the sale of its IPRs without inhibiting the utilisation of the IPRs in its business operations. It also provides the lender with secured rights in the IPRs, as the lender may sell the assets to get liquidity if the need arises. A repurchase option would usually be included in the IP sale-leaseback contract to enable the borrower to buy back the IPRs over a determined period, provided the borrower has satisfied its obligations.
3. IP Royalty Securitisation: In this case, the owner of the IPRs assigns a stream of an IP-related income for a fixed duration in exchange for a lump sum for the benefit of another party. For example, the owner can assign the income derived from streaming a song or royalty payments from licensing a patent. This method is attractive because it shifts the immediate burden of repayment away from the IP owner to the designated pool of assets. The IP owner is not charging its assets but is rather selling a stream of anticipated future cash flows that would otherwise accrue to the owner.
4. IP Auction: An IP auction refers to a competitive bidding process where intellectual property assets, such as patents, trademarks, copyrights, or licensing rights, are sold to the highest bidder. IP auctions provide a platform for IP owners to monetise their assets by attracting potential buyers who are willing to pay a premium for the rights to use and exploit the IP. The IP owner and the successful bidder will finalise the terms of the sale, including the purchase price and transfer of ownership.

4. KEY CONSIDERATIONS FOR PARTIES.

4.1. Valuation.

Due to the intangible nature of IPRs, their valuation is considerably nuanced. For instance, valuing the goodwill of a company may be difficult. Therefore, the parties, especially the lending or purchasing party, should conduct context-specific valuation that accounts for the volatility associated with IPRs. The valuation should review historic income or royalty stream from the IPR and project future income. It is worth mentioning that, since IP assets such as trademarks are used to promote the sale of certain goods and services of a business, the market success of the goods is a good indicator of the value of the associated IP. Equally worthy of mention, is the benefit of conducting a variation on IPRs range in different measures in relation to creditors and investors, from accuracy in risk management to risk mitigation, evaluation of investment opportunities, as well as determination of royalty/licensing fees where applicable.⁴

4.2. Due Diligence.

Conducting thorough due diligence on the IP asset should be done simultaneously with the valuation process mentioned above. Due diligence assesses the ownership status of the IP asset, reviews whether the IP owner has complied with regulatory requirements under relevant laws. The outcome of the due diligence and valuation exercise will determine whether or not the transaction is consummated.

4.3. Managing the Transaction.

In structuring the financial arrangement, it is important for parties to consider factors such as interest rates, repayment terms, collateral valuation, loan-to-value ratios, and all covenants or conditions upon which the transaction is hinged. It is crucial for both parties to ensure that the financing structure is aligned with borrower's cash flow and the specific characteristics of the IP assets involved. It is equally crucial for the borrower to assess its ability to repay the loan, a demonstrable ability to repay the loan is critical to securing a favourable financing term. The borrower's ability to repay the loan can be ascertained by analysing the borrower's cash flow projections, revenue streams, and potential risks.

5. BENEFITS OF IP-BACKED FINANCING

1. Avoidance of Equity Dilution: Utilising IP assets as collateral for financing transactions helps maintain the existing equity position in the business since the business can raise finance without impairing its equity or any of its physical assets.
2. Future Cash Flow: The owner of the IP right can tap into their future IP-related stream of income.
3. Available Credit: IP-backed financing serves as an alternative source of collateral that can be used to obtain loans, thus increasing a company's available credit.
4. Cost of obtaining loans: The cost of using IP assets to obtain loans is comparatively cheaper and less strenuous compared to utilising physical assets.
5. Alternative Collateral: IP financing grants the lender an alternative collateral from which the loan could be secured.
6. Retained Ownership and Control: Unlike selling IP assets outright, IP financing allows businesses to retain ownership and control over their intellectual property. This means they can continue to leverage the IP for their ongoing operations and capture future value. The borrower typically retains the right to use and exploit the IP assets throughout the financing period.

6. CHALLENGES OF IP-RELATED FINANCING

1. Valuation: A crucial component of IP collateralisation is IP valuation. Accurate valuation lowers risks for lenders and allows businesses to get finance commensurate with their worth. In instances where the actual worth of an IPR or assets is unclear, valuation should be based on the revenue that is directly attributable to the assets.
2. Loss of IP Rights: A default on a loan could result in the loss of the IP rights, and if the IP assets are a business's primary asset, such a loss could lead to grave financial consequences for the business.
3. Liquidity: Tangible assets are often easier to liquidate than IP assets because the pool of potential buyers of intangible assets may be restricted when compared to the pool of prospective buyers for tangible assets.
4. Transfer of risk: The risk of infringement, the risk of the IP becoming obsolete, licence revocation, dearth of expected royalties is transferred to a lender or purchaser. The purchaser must therefore consider these risks and the potential impact of these risks on its business before consummating the transaction.
5. Lack of familiarity with the Practice: Using IP assets as security for financing transactions is still an emerging practice, especially in Nigeria. This may deter potential lenders from accepting IP assets as valuable security for financing.

7. THE VIABILITY OF IP-BACKED FINANCING IN NIGERIA

The Nigeria Startup Act,⁵ recognises registered IPRs as sufficient collaterals for startups to obtain financial support under the Credit Guarantee Scheme established by the secretariat of the National Council for Digital Innovation and Entrepreneurship⁶.

Similarly, the Companies and Allied Matters Act⁷ acknowledges the right of companies to create security interests (charges) over their IP.⁸ This indicates that our local laws upholds IPRs as valid security for finance transactions. Nonetheless, there are still opportunities for the government to improve the viability of IP-asset-secured financing in Nigeria.⁹

1. IP Registration: As a creative/inventor/business, the registration of your business IPR is fundamental. For the purpose of raising financing, it is vital that your IPR has legal protection to reduce the likelihood of disputes or contests over ownership. Thus, although there is no requirement for copyright to be registered, the Copyright Act 2022 recognises the registration of works, which grants a presumption of ownership in favour of the person registered.¹⁰ In any financing transaction, it is almost certain that proof of ownership would be required by the lender, and this would only be obtainable where the IPR is duly registered.
2. IP Valuation: In your first steps to determining the viability of your IP as security for financing, it is important that you get a fair idea of the value of your IP. Although we have noted that IP valuation is inherently difficult, it is not a futile exercise. A valuation based on recognised and reliable standards would provide a sufficient basis for a business to pursue financing using the IP as security. Some of the recognised standards that an IP owner may consider for IP valuation are that the IP is uniquely identifiable, the IP can be legally transferable and the IP asset has a verifiable income stream.

8. CONCLUSION

It is necessary to find diverse ways to use IP assets, including as collateral, to finance the commercialisation of creative ideas. Increasing market players' trust and confidence in IP valuation techniques is obviously necessary to promote IP transactions, enable IP-based financing, and provide businesses the means to disclose information about their intellectual property. This would also be helped by further government assistance in establishing institutions to assist in the valuation of IP assets.

In conclusion, the parties must engage in open and transparent communication throughout the IP financing process and seek professional advice from legal and financial experts experienced in IP financing. These experts can assist in evaluating loan agreements, conducting due diligence, and ensuring compliance with legal and regulatory requirements.

Footnotes

1. Section 47 of the Nigeria Startup Act 2022.

2. Notably, the Court of Appeal in relation to copyright, held in the case of M.C.S. (Nig.) Ltd/Gte v. Adeokin Records [2007] NWLR (1052) 616, recognised the rights conferred on a legal owner of copyright works under the old Copyright Act 1988, including the right to claim authorship, the right to share in proceeds of sale, etc.

3. J. Jackson, 'Intellectual Property (IP) Financing and Why You Should Know' (Forbes, January 2022) ( https://www.forbes.com/sites/forbesfinancecouncil/2022/01/31/what-is-intellectual-property-ip-financing-and-why-you-should-know/?sh=23d94d7241c1) accessed on 8th January 2023

4. Avon River Ventures 'Benefits of Intellectual Property (IP) Valuation for Investors and Creditors' (January 2024) ( https://avonriverventures.com/bene%EF%AC%81ts-of-intellectual-property-ip-valuation-for-investors-and-creditors/) accessed on 8th January 2024

5. See section 29(3)(e) of the Nigeria Startup Act 2022

6. The objectives of this Credit Guarantee Scheme is essentially to provide accessible financial support to a labelled startup under the Act, as well as provide financial and credit information and financial management capacity building programmes for startups.

7. See section 222(2)i of the Companies and Allied Matters Act 2020

8. Section 222(1) of Companies and Allied Matters Act 2020 requires that any such charge created must be registered with the Corporate Affairs Commission within 90 days after the date of its creation.

9. For example, under the Singapore IP Financing Scheme, IP valuers approved by the Intellectual Property Office of Singapore determine the value of the patent, and the Singaporean government partially underwrites the loans which are granted by financial institutions.

10. See section 43 of the Copyright Act 2022.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.