Journal of Intellectual Property：知识产权杂志

Email: in_sk_Journal of Intellectual Property RightsVol 11, January 2006, pp 22-32Financing of Intellectual Property: Developing Countries ContextS K VermaFaculty of Law, University of Delhi, New Delhi 110 007Received 26 September 2005Converting a creative idea into a financial asset is the essential feature of financing intellectual property (IP). IP can besold, licensed, used as a collateral or security for debt finance. Valuation of IP is also important to secure loans or financesfor business. Whereas in the developed world, IP is treated as an asset and a part of the companys portfolio, this is lessprevalent in developing countries because of the level of their development and very meager IP portfolio in general.Financial constraints and lack of infrastructure are also hurdles creating and maintaining IP in developing countries.Capacity building for innovation is a very significant requirement in IP infrastructure. The industries in developing countriesneed to appreciate that a good portfolio makes good business sense.Keywords: IP financing, securitization, IP infrastructure, capacity buildingThe basic premise of financing intellectual property is how to convert a creative idea into a financial asset.Financial assets are the possession of an entity, whichare held for purposes of producing revenues.Intellectual property rights (IPRs), like other financialassets, be they manufacturing plants, bonds, orgoodwill, cost capital to produce or acquire, and areowned for purposes of generating a cash return. Thatis because, they exist to give their owners rights tofuture cash flow, as patents, brand trademarks,copyrighted text, or industrial designs. They areprincipally economic or commercial rights and wouldnot be maintained and defended with such vigour andresources by their owners unless they have financialvalue. Like any other property, IPR can betransferred, sold or gifted. But as economic rights,they are generally held by companies rather than byan individual creator of the right. Many companiestreat proprietary IPRs as patents, copyrights andtrademarks as a discrete asset.In recent years, there has been a growing awarenessthat IP assets can be monetized. IP can be sold,licensed, used as collateral or security for debtfinance, or it can provide an additional or alternativebasis for seeking equity from private investors,venture capitalists, specialized banks and some timeseven from regular banks. IP assets may help acompany to obtain business finance frominvestors/lenders. The investor/lender, in undertakingan appraisal of the request for equity assistance or_loan, will assess whether the new or innovativeproduct or service offered by a company is protectedby a patent, a trademark, an industrial design, orcopyright or related rights. Such protection is often agood indicator of the potential of a company for doingwell in the marketplace. IP ownership is thusimportant to convince investors/lenders of the marketopportunities open to the enterprise for thecommercialization of the product or service inquestion. Ownership of IP rights over the creativeoutput or innovations related to the products orservices that an enterprise intends to market,guarantees a certain degree of exclusivity, andthereby, a higher market share if the product/serviceproves successful among consumers.Though the investors/lenders may attach differentdegrees of importance to IPRs in investing or lendingmoney, there is a clear trend emerging towards anincreasing reliance on IP assets in the developedeconomies as a source of competitive advantage forfirms. The investors/lenders are increasingly focusingon firms with a well-managed IP portfolio, eventhough many problems are yet to be resolved inperfecting security interests in IP.Securitization of Intellectual Property AssetsThe trend of securitization of IP assets started indeveloped economies during the mid-1990s.Securitization is the process of using the cash flowsgenerated by an asset or pool of assets to support theissuance of debt. Collateralizing commercial loansand bank financing by granting a security interest inVERMA: FINANCING OF INTELLECTUAL PROPERTY: DEVELOPING COUNTRIES CONTEXT 23IP is a growing practice, especially, in the musicbusiness, Internet-based SMEs and in high technologysectors.Securitization normally refers to the pooling ofdifferent financial assets and the issuance of newsecurities backed by those assets. In principle, theseassets can be any claims that have reasonablypredictable cash flows, or even future receivables thatare exclusive. Thus, securitization is possible forfuture royalty payments from licensing a patent, tradesecret, or from musical compositions or recordingrights of a musician, feature films, and trademarklicensing receivable transactions. In developedcountries, factoring of trademarks and music royaltiesand feature film receivables are already being done.Royalties and returns on their factoring is a big sourceof income and their securitization can be used to raisefinances for the company.1 At present, the market forIP asset-based securities is small because of thelimited number of buyers and sellers of IP securities.For securitization, proper valuation of IP is verycrucial.Valuation of IP is also important to secure loans orfinances for business. The practice of extending loanssecured solely by IP assets, however, is not verycommon as yet; in fact, it is practiced more by venturecapitalists than by banks. The IP assets stand a goodchance of being accepted as collateral financing iftheir liquidity can be proved and can be valuedseparately from the companys business. However,durability of the IP assets for the period during whichto repay the loan, and their marketability in the eventof foreclosure or bankruptcy, need to be established.All this signifies the importance of in-houseawareness of the extent and value of IP assetholdings, including trade secrets, which might be usedto collateralize a loan.So far, the valuation of IP has remained highlysubjective for both lenders and borrowers and isgenerally not understood by most people. However,increasing use of royalty streams arising fromlicensing to determine the value of IP is a welcomedevelopment in enhancing the acceptability of IPassets as valuable assets providing security for debtfinancing and equity participation. In patents, thereare certain risks that need to be addressed in patentrevenue securitization, which include: technologymarketing and acceptance, technologicalobsolescence, license payment risk, servicing risk andlegal risks.1In recent years, copyright royalties from musicpublishing to licensing revenues associated withclothing designs, patents and trademarks (goodwillassociated with them) have been successfullyleveraged in this way. Companies and universitiesthat need capital and that generate significantlicensing cash flow, such as small and medium-sizedenterprises (SMEs) in biotech businesses, can be in anexcellent position to securitize their licenses,depending on the borrowing environment and thestate of the equity markets in the country. For theright owner, under the right conditions, securitizations including those associated with patent licensing can be uniquely rewarding. Among all the IPRs,patents are more popular because of their status asbearers of technology and their crucial role in thetechnological development of a country. They areimportant not only in building a business but also inobtaining venture financing.Selling off or licensing technology is not a newconcept within IP management, but using technologysales to benchmark an IP asset portfolio is new, aslicensing today is charged with different functions.However, before financing of IP is contemplated inthe form of collateral security to raise funds etc., it isnecessary to create and own the property. For thatpurpose, R copyrights in themovie, literature and computer software industries;and trademarks in the entertainment, fashion, andsports merchandising industries.5 To be an attractiveinvestment, an IP-backed asset financing, however,must address the following issues: (i) pricing ofportfolio, (ii) term and payment of IP revenues, (iii)continuity with existing business practices, (iv)multiple market needs of IP owners, IP users, andfinanciers and (v) creating practical entry and exitstrategies.6Developing Countries and IP Financing: AnOverviewThe paradigms to convert creative ideas into assets,however, are different in developing countries.Whereas in the developed world, IP is treated as anasset and a part of the companys portfolio, hencevaluing goodwill, securitization7 of IPRs, licensingthe patent protected technology/assigning thecopyright, outright sale of the IP etc., are commonpractices; none of these are of much importance indeveloping countries because of the level of theirdevelopment and very meager IP portfolio in general.This is predominantly true in the field of patents butless so for trademarks and copyright, which are,compared to patents, quite widely used in developingcountries.8There are certain peculiar features of IP regimes indeveloping countries. There are, in general fewerinventive/ and innovative activities in developingcountries, lesser filing of patent applications and nearlack of IP enforcement mechanisms. These countriesare also predominantly net importers of technology.All these factors have great significance on thefinancing of IP, which requires a number of essentialvariables, including creation, maintenance and propervaluation to raise money and use IP portfolio as acollateral.In the last two decades, internationally, there hasbeen an unprecedented increase in the level, scopeand role of IP protection in general and thegeographical extension of minimum standards for IPprotection through the TRIPS Agreement and settinghigher standards through bilateral/ regional trade andinvestment agreements. Newer areas are constantlygetting covered under IPR, viz., computer software,biotechnology. But developing countries are at adisadvantage in these areas due to lack of resourcesand infrastructure. Studies have concluded thatharnessing of an indigenous technological capacity isthe most distinctive single factor determining thesuccess of technology transfer.9It is, however, notable that with the opening up oftrade in goods and services under the WTO, IPRshave become more susceptible to infringementwithout adequate return to the creators of knowledge.There has been a quantum jump in Ror (ii) entering or expanding the existing market forits product or service for which it owns the rightsconferred by a trademark.In copyright, licensing helps in the economicexploitation of the work through entrepreneurs likepublishers, film producers and record manufacturers.Movie industry license agreements, in fact, are typicalexamples of copyright licensing. There are four majorkinds of agreements in this regard, viz.: (i)development and rights appropriation when thecompany enters into an agreement with the author orowner of the original work; (ii) pre-production involves employment agreements; (iii) financing andproduction involve production financing-distribution agreements; and (iv) distribution andexploitation. In copyright licenses, the license costsdepend upon the shelf life of the work, often notextending more than five years; this fact needs to betaken into account while signing the contract.Specific Challenges for IP Financing in DevelopingCountriesThere are certain problems, typical of developingcountries, in IP financing. The whole exercise - tocreate and own an IPR at this juncture of theirdevelopment is an arduous task. The whole journeyfrom inventing, to obtain a patent, then to get venturecapital to exploit the patent, build a business aroundit, grow it larger and then go public is riddled withproblems. Once the product is developed or IP is atthe stage of exploitation, the issue of financing of IParises, i.e., securitization, licensing/franchising etc.The innovators/inventors, mainly companies, lackstrategies in filing the applications, as well asnecessary resources and requisite knowledge. ThePCT route may provide them priority in all thedesignated countries for their invention.IP in the form of a patent once granted needs to bemaintained by paying annual fees for the period of itsvalidity and it needs to be protected against anyinfringement. In IP financing, the risk of infringementlitigation is not uncommon when two companies aredealing in the same stream of technology. Smallcompanies are usually not in a position to pursueinfringement litigation. If the royalty stream has beenfinanced, then the licensor-patent holder has alreadyreceived a significant portion of the anticipated lostrevenue resulting from an infringer entering themarketplace. A licensees loss in this case would bemore. Financing companies have to take into accountthese risks while financing IP as security.As R weightedtax deduction on Rdepreciation allowance in new plant and machineryset up on indigenous technology; tax holiday tocommercial R Radovesic S, International Technology Transfer andCatch-up in Economic Development (Elgar, Cheltenham),1999, p. 242; Saggi K, Trade Foreign Direct Investment andInternational Technology Transfer: A Survey (World Bank,Washington DC), 2000, /wbiep/trade/papers_2000/SaggiTT-fin.pdg; and Rosenberg, N,Inside the Black Box: Technology and Economics(Cambridge University Press, Cambridge), 1982.Saha R, Managing of IPR in small scale industries, inIntellectual Property Rights: A Global Vision by S K VermaPrincipe P, Economics and medicinalplants, in Medicinal Plants: Their Role in Health andBiodiversity by T R Tomlinson and O Olayiwola Akerela(University of Pennsylvania Press, Philadelphia), 1998. Agreat deal of TK is likely to have cultural or spiritual valuethat cannot be quantified in any monetary terms; Cultural andSpiritual Values of Biodiversity by D A Posey (UNDP andIntermediate Technology Publications, Nairobi Blakeney M, Regulating accessto genetic resources in Intellectual Property Rights: A Global12345678Eisbruck Jay H, Credit analysis of intellectual propertysecuritization, in From Ideas to Assets: Investing Wisely inIntellectual Property, by Bruce Berman (John Wiley Intellectual Property as a Lever for EconomicGrowth, WIPO Magazine, July/August 2004 and