It is easy to value physical objects when we can see their differences and compare their quality. But what about the intangible assets that make up the designs of every car, the brands behind those watches or the patents that fuel the smartphone wars?
The abstract nature of intellectual property (IP) presents a double challenge: its safeguarding can be demanding and it can be equally complex to articulate its value. This issue can represent a significant hurdle for companies seeking to leverage patents in their fundraising efforts, primarily because more and more companies are relying on forward-thinking conceptualizations aided by technology.
Recent years have seen increased financial support for companies seeking debt and equity financing, driven primarily by the innovative ideas of precedent-setting startups and technology companies. From 2011 to 2020, 58% of venture capital went to startups with patents or patent applications. Deal sizes for startups with patents during this same period increased by 40% to 60% than those for startups without patents. When considering valuations during patenting, patent companies raise capital at higher valuations than non-patent companies. If only angel investor round operations are analyzed, the average annual median is 93% higher.
From human resources to car wash companies, technology is now so widespread that assigning value to intangible assets no longer seems out of reach. However, AI and other emerging technologies have added gray areas to the world of patent financing, asking investors to open their minds and their wallets once again.
Determination of patent value
When a company seeks to use patents as collateral for a debt, it is common practice to reference the annual reports published by Richardson Oliver Law Group. Richardson Oliver helps companies make intellectual property decisions and provides average values for a patent or family of patents in the brokerage market.
The abstract nature of intellectual property presents a double challenge: its safeguarding can be demanding and its value can be difficult to express.
Alternatively, if the goal is sell a company to private equity, companies can use the fair market value approach, also called royalty exemption. The royalty exemption figure is based on a company's patent portfolio and details the amount of money a company will not have to pay in patent royalties.
Another option is for companies to collaborate with reputable patent valuation companies when evaluating the integrity of their patent data. This option is particularly valid for companies in emerging fields that need more substantial information or historical benchmarks.
When selecting a patent valuation company, emphasis should be placed on the quality of data that the company can provide. Ideally, companies should look for firms that rely on publicly available data from publicly available legal proceedings or patent transactions. These data should be used to establish a reliable valuation of the patent portfolio tailored to the specific purpose in question. Companies should be cautious when encountering patent valuation teams that present overly optimistic valuations that lack a clear basis in data.
Once a company determines the patent valuation method most appropriate for its particular situation, the path to securing capital and accelerating business growth becomes significantly more transparent.
Know where to start
Since intellectual property debt lending is still in its infancy, companies must demonstrate a return on investment in intellectual property. This involves combining storytelling skills with qualitative and qualitative data.
The right narrative can determine a company's customers, market confidence, and potential opportunities. Quantitative data examines the relationships between companies, partners, customers and shareholders. Funders want to spend time with management teams to connect the dots between IP portfolios, products and strategies. Qualitative data refers to income and the number of patent families.
Funders generally like to see 20-25 unique patent families for debt financing. These “families” refer to several patent documents published on the same invention or several inventions with some points in common. They may be published at different times in one country or another place.
Funders prefer to consider 20 to 25 families or more rather than a smaller number like five or 10 for safety reasons. This is because more families mean more opportunities to extract value. Even if one or two patent families become invalid, value can still be extracted from the remaining patents. Companies looking to raise debt or equity should show more unique patent families rather than one family with 20 patents.
Funders also want to see income to help them envision a path for the borrower to repay the debt. Even with a high-value patent portfolio, this type of financing will only work for companies with revenue, a clear and specific path to revenue, or an exit to market. Debt financiers are not only looking into patents covering products that currently generate revenue for companies; They want to know about predictive patents that chart the future of their company and the industry.
Overall, debt financing, a strong funding source, can be beneficial for companies that are expanding their organization and those with a clear exit event on the horizon. When seeking patent funding, collaboration, mergers and acquisitions (M&A), and equity are three approaches companies can take.
Collaborations
If a company creates and sells a specialized product that fits perfectly with a product from another company, why not join forces? This makes practical sense and collaboration saves companies from spending resources that would have been spent on independent product development. And saving time in the development stage shortens the path to generating revenue.
The key is to look for mutually beneficial relationships. Consider the following questions: How can both brands benefit? How will this get each company closer to their respective revenue goals? Would a possible collaboration cause more harm than good to either company? Answering these questions will help you determine if hiring a potential collaborator is the right choice for you.
Mergers and acquisitions
Like collaborations, mergers and acquisitions depend on how different companies can benefit each other. In this case, patents can be leveraged to significantly increase the value of a company looking to sell. Recently, companies have used their patent portfolios to help achieve business objectives through strategic mergers and acquisitions, collaborations, exits and financing, and have often been more successful than companies without patent portfolios. In the case of acquisition exits, patent firm values were almost 155% higher than the median average for non-patent seeking firms.
When bringing together two or more companies, mergers and acquisitions require the same consideration as a collaboration. Essential questions include:
- How do these brands and technologies combine to create better market opportunities and increase the company's total addressable market?
- How can our company's patents improve the value of this transaction?
- How can they increase or decrease the value of the company, depending on the objective?
- How can we attribute appropriate and foolproof value to patents and what is the ultimate value of the portion we are willing to accept in the transaction?
These answers will reveal the real value behind mergers and acquisitions.
As fundraising becomes more challenging, particularly for growth and late-stage companies, and as the expected IPO market recovery continues to be delayed, coupled with an overall slowdown in revenue growth, makes it imperative for many founders to focus on strategically optimizing their existing IP portfolio investments. This strategy is crucial to improving exit valuations and facilitating debt financing, allowing them to protect and maximize their investments.
Patents versus equity
It is common to use patents to help raise money during equity rounds; however, the added value is generally more abstract.
For example, when you do a debt financing round, a valuation of the patent portfolio is made and you are loaned a percentage of that value; this usually equates to less than 50%. When money is raised in shares, evaluations are generally not carried out.
Through due diligence, buyers and sellers can evaluate all legal documents and information necessary to determine value, including patent portfolios, products of companies covered by the patents, and patents considering where the market is headed . Companies should ask questions and seek information to evaluate overall patent market share. This advice is especially relevant for large financing rounds.
Looking ahead, we anticipate that lenders and investors will pay greater attention to accurately valuing and conducting due diligence on properties intellectuals and its protection, in response to the excesses of the previous market cycle. This, in turn, will prompt companies to strategically consider their intellectual property and its protection at an earlier stage.
The rising value of intellectual property
Even just ten years ago, the use of patents as collateral to secure debt financing was limited to device-based components found in mobile phones, computers or televisions. This was primarily due to court-established royalty rates and sufficient publicly available patent sales data on such device-based components to support patent valuation.
This traditional approach to venture capital focused on physical assets, management teams, strategies and shareholder names to support revenue, leaving intellectual property low on the priority list. There is now enough publicly available data on sales, liquidations, and royalty rates to move intellectual property up the list, regardless of industry. And because the valuation involves real data, patents normally treated as “soft” assets now have a much firmer value.
Intellectual property is a business tool. Patents can be decisive factors for companies seeking to obtain technology reviews, since intellectual property is an asset class that can help a company achieve its business objectives. Once a company establishes clarity on how intellectual property and patents can produce a significant return on investment, the overall strategy must align its growth with its business objectives to determine its value.
As more companies and industries turn to intellectual property to secure debt and equity-based financing, intangible assets are finding their place and blazing a new path with financing that elevates the value of an idea.
