The changing landscape of IP-backed lending and insurance in the United States
Defaults on loans and insurance claims are revealing risk to lenders and insurers, which are responding with more stringent qualifications and higher prices, writes IAM Deputy Editor Angela Morris
The market for intellectual property-backed lending in the United States is changing. So too are the insurance policies that underpin IP lending deals.
IP-backed loan defaults that have incurred losses via claims made on insurance policies have prompted the lending and insurance markets to change their qualifications for deals and the amounts they charge in interest and policy premiums. Further scrutiny is being placed on the IP valuations that underlie these transactions. Some say this is a natural metamorphosis that happens to an innovative finance and insurance solution where the risks are becoming clearer.
To learn more about trends in the US markets for IP finance and insurance, we turned to trusted experts whose bread-and-butter jobs are comprised of these deals. Here are their answers, edited for IAM style, brevity and clarity.
What are your observations about the current interest from US companies in IP-collateralised debt finance?
Phil Hartstein, managing partner and co-founder, Soryn IP Capital: The interest appears to be significant from many companies with sizeable patent portfolios and a strategic need for non-dilutive capital. Where the market is evolving, however, is a retraction in the availability of such facilities for pre-revenue companies or companies whose patents have not yet experienced market adoption. Both insurers and lenders are looking for companies with attractive financials, as well as more mature patent portfolios.
Ted Luse, CEO, Randolph Square IP: With the initial public offering markets slowed down and venture capitalists more selective, the IP lending market is quite attractive as a funding alternative for growth companies.
Jason Goldy, global team leader of litigation and contingent risk insurance, Alliant Insurance Services: Market demand is still there for collateral protection insurance for a wide variety of IP-related assets and portfolios.
Can you explain the recent trends you’ve witnessed regarding US lenders’ interest in offering such loans backed by IP?
Goldy: Lender interest remains due to the prospect of favourable yield with effectively little-to-no risk. However, in the event of borrower default, the policy currently does not pay out until there has been a sale of the IP assets which is not as attractive to certain lenders and may result in more expensive terms. The product’s structure should be as attractive as possible to both lenders and borrowers.
Hartstein: Some funds with private credit mandates (for instance, Soryn) are interested in insured risk from A-rated carriers. In these deals, given the pricing, more due diligence effort is typically spent on the underlying insurance documents and the creditworthiness of the insurance carriers. Where policies are strong, pricing is attractive, and the underlying IP valuation supports the investment, significant capital is being deployed.
What is your perception of how IP insurance offerings are making an impact? What developments have you noticed trending with IP insurance?
Hartstein: There have been clear developments both in the markets vis-à-vis collateral protection insurance, as well as judgement preservation policies. Namely, based on the performance of version 1.0 of these offerings, carriers are changing pricing and refining the risks they are willing to take as they move to version 2.0. In the collateral protection arena, for instance, we do not foresee a bright market for pre-revenue companies whose IP represents unproven technologies. In the judgement preservation market, the cost of policies appears to be rising. There appears to be more of an appetite for portfolios and judgments involving more rather than fewer patents.
Luse: Wrapping an IP loan with insurance has positively impacted the growth of IP lending. After rapid growth over the last few years, recent defaults and subsequent losses have tempered the interest of some insurance companies, with new entrants trying to fill the near-term void.
What happens to this US market for IP-backed lending and insurance in the event of companies defaulting on their loans?
Goldy: The market currently has a very limited appetite for collateral protection insurance due to material losses (claims) incurred over the prior two years or so. The initial solution or product was not well-designed and structural changes, restrictions and more stringent underwriting guidelines will result.
Hartstein: The defaults have already started happening on the collateral protection side. We are experiencing a modification in the way the market will function rather than a disappearance in the market itself. For instance, going forward, carriers are going to want valuations from sources independent of the insurance broker. There is also likely to be more effort spent on traditional credit underwriting due diligence, as opposed to reliance on inflated IP valuations.
Do you think the future of IP-backed lending in the US will focus more on patents and away from other types of IP? Why or why not?
Luse: I think patents and trade secrets will remain the dominant form of collateral for an IP loan because they can be used to gain deeper visibility into the protections that afford the owner-borrower certainty of cash flows to service the IP loans.
Hartstein: Brand values continue to offer ripe possibilities for collateral, and we think that will continue in parallel to patents for quite some time.
Goldy: Currently due to market restrictions if IP forms the sole collateral for a collateral protection insurance policy, that may be especially challenging, but deals are still being considered. Moreover, when the structural changes and more stringent underwriting guidelines are implemented there will be new borrower or company profiles.
Are the US firms offering IP valuation services for purposes of lending and insurance being careful enough with their valuations?
Goldy: This is one of the major structural issues with collateral protection insurance – most of the value chain resided with one entity. The IP valuations need to be independent and far more due diligence is required, including monitoring or regularly assessing the value of these assets.
Hartstein: In our experience, the market needs to evolve when it comes to valuations underlying insurance policies. We see many valuations that are divorced from reality and should not be used by any insurers to support an offering.
Luse: Each IP lending opportunity is unique and requires different levels of diligence regarding IP valuations. IP lenders will approach valuations conservatively and will heavily discount IP valuations in the underwriting process.
How do you feel the US market for IP-backed lending and insurance has been influencing other countries?
Luse: The US market for IP-backed lending and insurance significantly influences global practices, setting trends in innovation, regulatory approaches and market development. The US laws around IP provide the foundation for securing IP assets. The laws in other countries are still far behind and not as well developed, which will remain a challenge for developing IP lending in Europe and Asia.
What is your prediction for what happens in this space in the US in the next year? How about five?
Luse: Intellectual property will continue to grow as an asset class next year and for the next five years. A combination of technological innovation, regulatory adaptation, and the evolving needs of borrowers in a knowledge-based economy will shape the trajectory of the US’s IP-backed lending and insurance market.
Goldy: The following structural changes and underwriting guidelines are likely to be implemented:
- more alignment of interest between carriers and lenders;
- more favourable borrower profiles – meaning companies with proven commercialisation mapped to IP rights;
- independent valuations, more due diligence, and requisite expertise to underwrite growth-stage companies with proven commercialisation;
- better customer targeting and pricing, restricting early-stage development, start-ups, or pre-revenue companies;
- monitoring of valuations; and
- smaller deals – below $100 million.
Hartstein: We believe that the market will continue to evolve, as it has already started to do. There will be more spread in policy costs (right now nearly every policy costs the same to acquire), a focus on larger portfolios that have or are about to experience market adoption, more diversified licensing opportunities (portfolio effect), and a return to credit fundamentals vis-à-vis corporate due diligence.
