[This piece has been authored by Raunak Rai Maini, a student at the National Law University, Jodhpur.]

Abstract

This article seeks to highlight the emerging need for a statutory mechanism that could facilitate collateralization of Intellectual Property (IP) assets by traditional banks that primarily demand a tangible asset for extending credit in the backdrop of India’s emerging start-up culture that opens up multiple employment opportunities while driving the economic growth of the country into the 21^st century.

Introduction

 The displacement of traditional manufacturing concerns by companies that offer a software as a service (SaaS) and have little to no physical assets in possession is a trend that has been witnessed in the developed world in the past decade or so.

Increased penetration of the internet, government support and globalization are certain key factors that have commenced this trend in the developing economies where start-ups are the growth drivers of the economy.

While surveying the reasons for the failure of most start-ups in India, IBM Institute for Business Value cited insufficient funding as one of the major reasons for failure.  Considering that start-ups have been registering their trademarks and patents early on to prevent their product from being replicated by larger organizations, modifying collateral requirements by banks to include intellectual property assets would potentially open up formal credit lines to multiple nascent organizations — while leaving the valuation part of it subjective and ambiguous.

The sway of intellectual property over the dominant business enterprises is also apparent from the share of intangible assets that the top 5 most valuable companies in the world (as per market capitalization) possess. As per the Global Intangible Finance Tracker 2020,physical assets account for only 4% of Amazon’s net worth, while the corresponding numbers were 6% for Apple, 7% for Microsoft, 16% for Facebook, and 26% for Alphabet. While the aforementioned companies are well-established, the liquidity of the intangible assets of newer entities might prevent conservative banks from extending credit lines to them.

What does IP Financing entail?

Monetization of IPR is premised upon exploiting the financial value of an IP asset. The concept of IP Financing is not particularly new since even Thomas Edison had used his patent on the light bulb as security to borrow the money needed to launch the General Electric Company in the 1880s.

While the traditional methods of monetizing IP dealt with either selling off the asset or earning via royalties, the new method involves pledging the asset as a collateral to a financial institution that extends a loan on the basis of that asset.

Prevailing constraints in the Indian Market

 Despite having one of the most vibrant start-up presences in the world, India lacks certain key factors that could further the ease of doing business and securing access to formal credit lines. Some factors identified by Bibekananda Panda et alare:

1. Infrastructural bottlenecks

 A vibrant IPR-based debt financing ecosystem requires creation, maintenance, and proper valuation of IPs to raise money and use IPR as collateral. The practice of debt financing against IP assets is not prevalent in India. Thus, most start-ups get equity finance primarily sponsored by venture capitalists (VC) and private equity investors.

2. Negative experiences of Banks with IP Financing

 Several banks are already extending financial support to the start-ups based on tangible assets as collateral but IP financing is not treated as a profitable business by Indian banks. One particular incident of lending to Kingfisher Airlines (that subsequently went bankrupt) on the basis of its trademark value has made financial institutions risk-averse.

3. Under-developed valuation mechanisms

 The valuation of IP assets remains difficult, costly, and unreliable in India. Given the unreliability of the valuation, start-ups fail to borrow sufficient money at a competitive rate, ultimately hampering the market mechanism and discouraging lenders and start-ups from debt financing using IPR as collateral. The absence of a central valuation agency works as a significant hindrance in the development of the market. Fearing over-valuation, conservative lenders tend to look the other way.

4. Absence of a market that provides liquidity to these assets

 An established and formal secondary market that provides liquidity to these assets is absent Thus, price discovery and asset disposal is a challenge that lender have to contend with if they wish to take exposure. Lenders find it difficult to exercise security rights over the IPRs when they use IPRs as collateral. In the case of change in ownership, IPRs are not considered worthy and buyers aren’t willing to but them.

5. Inseparability from the business

 Due to the intertwining of IP assets with the main function of the business, it is difficult to exercise security rights for the lender. As IPRs are developed under the specific context of the business, companies do not consider the possibility of using IPRs in a different setting. A prospective buyer, also, might not be able to utilize an asset that is directly linked to the service that a different entity is providing.

Legal framework

 The National IPR Policy is India’s first policy which specifically aims at securitization of IP rights, allowing them to be used as collateral to raise funds for their commercial development. The policy also suggests financial support for developing IP assets through banks, venture capital, angel funds and crowdfunding mechanisms.

The Indian Banking System has already made provisions for the acceptance of intangibles as collaterals. Section 2(1)(t) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) defines the expression property, and it specifically includes intangible assets being knowhow, trademark, copyright, licence or franchise.

Way ahead

Now that the Government has initiated the plan to allow banks to lend capital by treating IP assets as collateral by proposing a policy, what remains to be addressed is the institutional mechanism that shall actually value the asset that is sought to be collateralized by the organisation. If traditional banks fail to extend formal credit lines to start-ups, the finance market might itself move into a parallel space dominated by VCs who seek dilution of the stake to led capital to the start-up.

Enabling infrastructure in the form a regulated market for the disposal of separatable IP assets could also yield substantial tax revenue to the government in the form of transaction fees and provide an avenue to lending institutions and investors alike to transfer IP assets through a transparent price-fixation system.