Monday, 28 April 2008

Leveraging IP to finance early-stage technology: Second Part

What are possible choices from a public policy point of view?

Governments need to set an adequate regulatory framework for IP strateges at the micro- and macroeconomic level. The administration can either provide direct funds to entrepreneurs or offer tax incentives to market participants operating in the field of early stage technology. Singapore, Malaysia, Thailand or Indonesia are very active in this area and can look back to a successful track record in promoting early stage technology and an IP culture. After only a year of intensive examination several Thai banks such as the Thai SME bank have started to consider IP as collateral. This probably significantly decreased the cost of capital for entrepreneurs. Firms and research centers may be able to take loans on the basis of their IP assets rather than refering to expensive mezzanine finance that require 20-30% of returns. Indonesia has launched several programs of privately managed public venture capital funds that seek to promote early stage IP. Also, research centers like the Technology Institute of Bandung in Indonesia are very active in licensing IP and forming strategic alliances and partnerships. A recent initiative of the Institute includes a partnership with young entrepreneurs in Indonesia that seek to add value to their business model. Success stories include a small agro-business that started using an invention of the institute and doubled its revenues.

Governments and intergovernmental development agencies can also take advantage of their role in promoting private sector initiatives. The public hand can act as an intermediary, can offer insurance services, provide information, offer a platform for networks and communicate trust to the market. All these activities linked to IP promote an IP conscious investment culture and help raise awareness of the value of IP assets among investors and borrowers.
In many developing countries early stage technology companies know little about how to audit, value or commercialize IP assets. As a consequence investors are not able to grasp the value deriving from the borrower’s IP assets. Public initiatives explaining to borrowers and investors the value of IP assets can help. Training classes for borrowers and investors on the nature of IP assets and their potential for value creation can be an important first step. There might also be scope for the education of IP assets professionals that know how to value IP assets. China, for example, can look back at a certain history in IP assets valuation after taking this type initiative.

A possible reform of accounting standards might allow companies to put the value of internally generated IP assets on the balance sheets. Taking Germany as an example recent modifications of US GAAP standards (US accounting standards) have brought the IP assets perspective on the agenda of CEO’s of major multinational companies operating in the country. Companies listed at the New York Stock Exchange, but doing business in Germany are under SFAS 141 and 142 of US GAAP allowed to put intangible assets (including trade names and trade dresses) on the balance sheet. This is optional.

This novelty has provoked a major shift in the country. It appears that as from 2004 the biggest firms in Germany have been accounting their intangible assets according to US standards. Even though the guidelines in SFAS 141 and 142 are quite vague and far from sufficient to allow for adequate accounting of intangible assets, this has provoked a considerable shift in the market.

Also, the institutional framework for obtaining IP protection needs to function. Obtaining IP protection must be affordable, uncomplicated and reliable. This calls for the strengthening of the role of IP offices. In many developing countries patent search is not conducted at the global level before a patent is granted, obtaining a patent can be very expensive and time consuming (sometimes up to 10 years). As a consequence the borrower’s options to access finance on the basis of IP are limited.

Equally financial regulations need to guarantee investors their rights in the IP assets. At the national and international level several initiatives are currently under way. To cite the most prominent one’s UNCITRAL is currently elaborating a draft convention on financing on the basis of IP assets, equally BASEL II defines collateral as tangible and intangible assets. The Thai and Indian governments have taken steps towards similar reforms.

IP is a key driver of a firm’s value. It can be valued using various credible and established techniques. The biggest obstacle in using IP in financial transactions seems to be the myth that intangible assets can not be valued or accounted and henceforth not be considered as a useful financial tool.
However, these are perceptions and views that do not reflect the intrinsic characteristics of an IP asset. Investors AND entrepreneurs often know very little about IP and how it relates to the value of a company. Also, it is not sufficiently associated with technology and many governments and intergovernmental development agencies have not yet profited from the full advantage the IP perspective offers.
Further problems arise from inadequate communication. Lev (Lev 2000) has proven that the price of a technology stock is positively correlated with the firm’s efforts to announce licensing agreements, royalty revenues, patenting activities and viable technological developments. The valuation of IP remains a forecast, remains a view on potential future income streams, but within this framework it is as feasible and reliable as the valuation of tangible assets.

At the macroeconomic level countries cannot afford to ignore IP assets. Ownership and use of IP is a major driver of economic, social and cultural welfare. At the microeconomic level investors and entrepreneurs cannot afford to ignore IP either. Investors need to understand the drivers of a business. Although IP is a main driver of value, it often goes unnoticed. From an investor’s point of view the ignorance about value creating assets leads to inadequate investment decisions. Nor is it advisable for the enterprise to ignore IP. IP asset management must be an integral part of the strategy of any firm in knowledge based industries. Competing at the edge, be it at the firm, national or international level means picking up the IP assets perspective.

Arrow K.J. Economic Welfare and the Allocation of Resources for Invention. In: Nelson R.R. (ed.) The Rate and Discretion of Innovative Activity: Economic and Social Factors. Princeton University Press. Princeton 1962
Anton J/Yao D. Expropriation and Inventions – Approbiable Rents in the Absence of Property Rights. American Economic Review Nr. 84/1 1994, pp.191-209
Baygan G. Country Reports on Venture Capital Markets in OECD countries. OECD. Paris 1999-2003
European Intelligence Unit (EIU). Country Reports. The Economist. London on-going.
Freeman C. The Economics of Industrial Innovation. Printer. London 1982
Holmstrom B. Agency Costs and Innovation. Journal of Economic Behavior and Organization Nr.12/2 1989, pp. 305-327
Idris K. Intellectual Property. A Powertool for Economic Growth. WIPO. Geneva 2003
Kamien M.I./Schwartz N.L. Market Structure and Innovation. Cambridge University Press. Cambridge 19982
Lev B. Communicating Knowledge Capabilities. Stern School of Business. New York 2000
Rogers M. Firm Performance and Investment in R&D and Intellectual Property. Melbourne Institute Working Paper Nr.15/2. Melbourne 2002
Schumpeter J. Theorie der Wirtschaftlichen Entwicklung: Eine Untersuchung über Unternehmensgewinn, Kapital, Kredit, Zins und Konjunkturzyklus. Duncker und Humblot. Berlin (1934) 1964
Schumpeter J. Konjunkturzyklen: eine Theoretische, Historische und Statistische Analyse des Kapitalistischen Prozesses. Vandenhoeck und Ruprecht. Göttingen 1939
Schumpeter J. Capitalism, Socialism and Democracy. Harper and Brothers. New York 1942
Teece D.J. Capturing Value from Knowledge Assets: The New Economy. Markets for Know-How and Intangible Assets. California Management Review Nr. 40/3 1998, pp. 55-79

by Roya Ghafele[1]
[1] This paper was presented at the OECD conference on Financing University Technology Transfer. St.Petersburg State University/ OECD. St. Petersburg December 14-15, 2004


Anonymous said...

I work as President Strategy in Single Window Capital Group, Coimbatore. I believe that monetising IP assets is the surest way to reduce cost of capital and will also spur IP development . Also we need to keep transfer pricing issues in mind, which can lead to increased transaction costs.
Thanks and Regards
V Srinivasan FCA

Anonymous said...

Thank you for the interesting piece of work.
In fact, the German change in accounting standards together with the effort for standardisation of the valuation of patents (and trademarks) have spurred quite a lot of initiatives.
One of the consequences is that the impact of legal uncertainty on patent valuation is now far better understood. Methods have been developed to handle these questions satisfactorily.
Malte Köllner
Köllner & Partner, Patentanwälte

Rob Harrison said...

Roya's comment about German companies putting a value on their IP assets is possibly a bit premature. Currently the German HGB Accounting Standard explicity prohibits the placing of a value for "self-developed" IP rights (but allows it for IP rights purchased in). The balance sheet modernisation law being discussed in Germany will allow a value to be placed in the future.

Anonymous said...

Dr Malte Koellner further states,

"E.g. it was shown that in monetary valuation of patents in the past, patents were generally overvalued. It was the rule to thoroughly consider the economic role of the patent - and to ignore the legal risk that comes along and may hinder the economic benefit. A proper valuation would have discounted the valued derived from economic considerations by an amount appropriate for the legal risk.I have described this phenomenon in an article for Intellectual Asset Management, Issue 28