Increased Demand for IP Assets

Many businesses now exist where the primary revenue driver is IP licensing. Public companies such as Iconix (Nasdaq: ICON), Sequential Brands Group (Nasdaq: SQBG) and Cherokee (Nasdaq: CHKE), derive all of their revenue from the royalties generated from the licensing of consumer brands. The emergence of these licensing businesses has created significant liquidity in the market for consumer related brands and, as well, created new clients for ABLs willing to lend against the value of the brands in their portfolios. On the patent side, companies such as RPX (Nasdaq: RPXC) and privately owned Intellectual Ventures, accomplish the same ends by pooling capital from technology firms and engaging in cross-licensing of the patents they acquire.

Because of the low and generally predictable carrying costs associated with intangible assets, they have become an increasingly popular asset class for financial investment. Large investment funds have been raised to acquire patents and other intangibles for purposes of aggregating licensing fees and royalties. These investors are often referred to as Non-Practicing Entities (NPEs) since they do not use their IP assets in any other business. Similar structures exist with respect to the acquisition of trademarks and copyrighted content.

Another driver of liquidity in the market for intangibles is the increased efficiency of web based models for the sale of consumer products and the distribution of digital content. Many of the operational aspects of these businesses can be outsourced to third parties and licensees thereby reducing execution risks and allowing intangibles to be leveraged in multiple channels.

IP Asset Management and Risk Mitigation

ABLs that are lending against intangible assets have a number of tools available to promote safe and sound underwriting. A key tool is an appraisal of the intangible assets separate and apart from the enterprise in which they are currently deployed. Depending on their risk tolerance, lenders are seeking valuations based on Net Orderly Liquidation Value (NOLV) and Net Forced Liquidation Value (NFLV). The principal difference between the two standards is the compulsion of the seller, the amount of time available for the marketing and sale of the intangibles, and the level of support that will be provided to maintain asset values during the sale process. It is critical that any valuation of intangibles for asset-based lending purposes take a market based approach. Financial models, in and of themselves, might be acceptable for purchase price allocations, transfer pricing and impairment testing; however, they are not appropriate opinions upon which to make ABL underwriting decisions.

Managing From NFLV to NOLV

Unlike assets such as inventory and accounts receivable, an ABL contemplating a realization on its IP collateral may often have several opportunities to enhance recovery values in a work out situation. As always, planning is the key including making sure that contingency plans to preserve IP asset values are being developed as “going concern” options are pursued. Because of their low carrying costs relative to assets like inventory or real estate, intangible assets are often placed on the back burner in workout executions. Unfortunately, this often leads to avoidable losses in value. Lenders must balance the cost of additional investment to support asset values against the improvement/loss in value which deferring those investments will create. For some IP assets such as retail or consumer products brands, it is often the case that a quick disposition process conducted while aspects of marketing and merchandising support are still intact will generate higher recoveries than a longer sale process conducted when the infrastructure supporting the brand has gone completely dark. The value of other types of IP such as technology or content may be enhanced over time with modest investment. In such circumstances, a lender may be able to enhance its recoveries if it is prepared to own the assets.

Both at the inception of a loan and at the exit, expert assistance from firms such as Hilco Streambank will assist ABLs in making sound IP underwriting decisions. Often ABL borrowers will have engaged an investment bank to assist it in raising additional capital or selling the business. In our experience, these types of advisors are typically focused on the preservation of Enterprise Value and not on the preservation of IP asset values. IP asset disposition experts are critical partners in the process of ensuring that recovery values are understood and maximized.

Conclusion

ABLs continue to grow more comfortable with loan structures that include IP in the borrowing base. Our expectation is that this trend will continue as IP asset values increase as a percentage of corporate balance sheets.