Keegan Caldwell
Cars, phones, watches.
It’s easy to put a value on physical objects when we can see their differences and compare their quality. But what about intangible assets that make up the designs of each car, the trademarks behind those watches, or the patents fueling the smartphone wars?
The abstract nature of intellectual property (IP) presents a dual challenge: It can be demanding to safeguard and can be equally intricate to articulate its worth. This affair can pose a significant hurdle for companies looking to leverage patents in their fundraising efforts, primarily as more companies rely on forward-thinking conceptualizations aided by technology.
Recent years have seen increased financial support for companies seeking debt funding and equity fueled mainly by the innovative ideas of startups and tech companies that have established precedence. From 2011 to 2020, 58% of venture capital went to startups with patents or patent applications. Deal sizes for patent startups during this same period were up 40% to 60% than those for nonpatent startups. When considering valuations during patent raises, patent companies raise capital at higher valuations than non-patent-seeking companies. Looking solely at angel round deals, the average annual median is 93% larger.
From human resources to car wash companies, technology is now so prevalent that placing a value on intangible assets no longer seems out of reach. However, AI and other emerging technologies have added gray areas to the world of patent funding, asking investors to open their minds and wallets once again.
Determining patent value
When a company seeks to use patents as collateral for debt, it is common practice to reference the yearly reports published by Richardson Oliver Law Group. Richardson Oliver helps companies make IP decisions and provides average values for a patent or patent family on the brokered market.
Alternatively, if the goal is to sell a company to private equity, companies can use the fair market value approach, also called a relief from royalty. The relief-from-royalty number 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 firms when assessing the data integrity of their patents. This option holds particularly true for companies in emerging fields needing more substantial information or historical benchmarks.
When selecting a patent valuation firm, the quality of data the firm can provide should be emphasized. Ideally, companies should seek out firms that rely on publicly accessible data from legal proceedings or publicly available patent transactions. This data should be used to establish a dependable valuation of the patent portfolio tailored to the specific purpose at hand. Companies should exercise caution when encountering patent valuation teams that present excessively optimistic valuations lacking a clear foundation in data.
Once a company determines the most suitable patent valuation method for its unique situation, the path to securing capital and accelerating business growth becomes significantly more transparent.
Knowing where to start
With IP debt lending still in its early days, companies must prove the ROI of intellectual property. This involves combining storytelling skills with qualitative and qualitative data.
The correct 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 pertains to revenue and the number of patent families.
Funders generally like to see around 20 to 25 unique patent families for debt funding. These “families” refer to several published patent documents about the same invention or several inventions with some commonalities. They can be published at different times in one country or elsewhere.
Funders prefer looking at 20 to 25 families or more instead of a smaller number like five or 10 for security reasons. This is because more families mean more chances to extract value. Even if one or two patent families become invalidated, value can still be extracted from the remaining patents. Companies looking to raise debt or equity should show more unique patent families instead of one family with 20 patents in it.
Funders also want to see revenue to help them envision a path for the borrower to service the debt. Even with a high-value patent portfolio, this type of funding will only work for companies with revenue, a clear and specific path to revenue, or an exit. Debt funders are not only looking into patents covering the products currently driving company revenue; they want to know about the predictive patents mapping out your company’s future and the industry.
In general, debt funding, a nondilutive source of financing, can be beneficial for companies that are scaling 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 one company creates and sells a specialty product that fits nicely with a product from another company, why not join forces? This makes practical sense, and collaboration saves companies from expending 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 move each company closer to its respective revenue goals? Would a potential collaboration cause either company more harm than good? Answering these questions will help you determine whether taking on a prospective collaborator is the right choice for you.
Mergers and acquisitions
Similar to collaborations, M&A hinges on how different companies can benefit each other. Here, patents can be leveraged to considerably drive up the value of a company looking to sell. Recently, companies have used their patent portfolios to help achieve business objectives through strategic M&A, collaborations, exits, and funding, often finding more success than companies without patent portfolios. For acquisition exits, patent company values were nearly 155% higher than the median average for non-patent-seeking companies. Public listings were almost 50% higher.
Bringing two or more companies together, M&A requires the same thoughtfulness 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 enhance the value of this transaction?
- How can they drive the company’s value up or down, depending on an objective?
- How can we ascribe the appropriate and infallible value to the patents, and what is the ultimate portion value we are willing to take in the transaction?
These responses will reveal the actual value behind the M&A.
As fundraising becomes more challenging, particularly for growth and late-stage companies, and as the expected recovery of the IPO market keeps getting delayed, coupled with an overall slowdown in revenue growth, it becomes imperative for many founders to focus on strategically optimizing their existing IP portfolio. This strategy is crucial for enhancing exit valuations and facilitating debt funding, allowing them to protect and maximize their investments.
Patents vs. equity
Using patents to help raise money during equity rounds is common; however, the value-add is generally more abstract.
For instance, when you’re doing a debt funding round, you have a valuation performed on the patent portfolio, and some percentage of that value will be loaned to you — this typically amounts to less than 50%. When raising equity money, evaluations are generally not performed.
Through due diligence, buyers and sellers can assess all of the legal documents and information necessary to determine value, including patent portfolios, the products of the companies covered by the patents, and the patents that consider where the market is going. Companies should ask questions and seek information to assess the overall patent market share. This advice is especially true for large funding rounds.
Looking ahead, we anticipate that lenders and investors will pay increased attention to accurately valuing and conducting due diligence on intellectual properties and their protection, in response to the excesses of the previous market cycle. This will, in turn, prompt companies to consider their IP and its protection strategically at an earlier stage.
The rising value of IP
Even just ten years ago, using patents as collateral to secure debt funding was isolated to device-based components found in cell phones, computers, or televisions. This was primarily due to established court royalty rates and enough 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 around sales, settlements, and royalty rates to move IP up the list, regardless of industry. And because valuation involves actual data, patents typically treated as soft assets now hold a much firmer value.
IP is a business tool. Patents can be deciding factors for companies looking to get tech valuations, as IP is an asset class that can help a company accomplish its business objectives. Once a company establishes clarity around how or if IP and patents can produce a significant return on investment, the overall strategy should align its growth with its business goals to determine its value.
With more companies and industries looking at IP to secure debt and equity-based funding, intangible assets are finding their footing and carving out a new path with the financing that elevates the value of an idea.
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