intellectual property finance: securitization to venture capital

ABA 2002 Summer IPL Conference

Intellectual Property Finance:

Securitization to Venture Capital

James E. Malackowski

Duff & Phelps Capital Partners

June 28, 2002

2

Background…

• Financial impact of IP

• Finance continuum

Strategies…

• License securitization

• Internal tax driven strategies

• Sale-license back

• Enhanced buyout

• Corporate carve-out

• Venture IP

Process…

• Due diligence

• IP on IP Finance

Overview

3

Financial Impact of IP

Lon

g-te

rm E

ffec

ts

Financial Impact

High

HighLow

Low

Recognition of Intangible Market

Values

License Revenues

IAM Consulting

Rev.

Changes to Acct. Standards

4

License Revenue

Annual Revenues - U.S. Patent License Royalties

$8$18

$62

$100

$116

$0

$20

$40

$60

$80

$100

$120

$140

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

$ in

Bill

ions

Source: KPMG LLP Intellectual Property

5

Intangibles as a % of Market Capitalization

80%

20%

1978

Source: Brookings Institute

54%

46%

1988

Market Capitalization

27%

73%

1998

Intangible Assets

Tangible Assets

6

Goodwill write downs

Impact of Accounting Standards

Amount (write down)

AOL $54.2B

JDS Uniphase $40.0B

WorldCom $20-30B*

Clear Channel $16.8B

Nortel $12.3B

* Company Estimate

7

IP Finance Continuum

Ris

k P

rofi

le

Frequency of Transactions

IP Venture

License Securitization

Sale-License Back

Stick LicensingIP Buyout

Tax Strategies

High

Low

Low High

8

IP Finance Continuum

Ris

k P

rofi

le

Frequency of Transactions

IP Venture

License Securitization

Sale-License Back

Stick Licensing

Tax Strategies

High

Low

Low High

IP Buyout

9

STRATEGIES

10

License Securitization

Process

Operating

Agent

Credit Enhancement Provider

IP Funding

(SPE)

Lender(s)/

Purchaser(s)

Third Party

Licensees

Parent

Company

IP Holding

Company

Insurance Premium $

Wholly OwnedSubsidiary

License Fees, Patents, & License Agreements

Guarantee of P&I on Loan

Loan Proceeds

Licenses, License Fees, & Patents

Loan Proceeds $

Loan Proceeds & Service Fee

Licenses

License Fee $

SPE Lockbox

•Underwrites & Monitors Collateral•Manages Debt•Provides Administration•Provides Marketing Support

Source: GE Capital Technology Group

11

License Securitization

Process

• Type of asset-based financing backed by contractual payment flows

• Requires sale of underlying assets to bankruptcy remote special entity (”SPE”)

• Transfer of assets must be arm’s length

• SPE is usually wholly-owned

• SPE must be legally separate entity (independent director(s))

• Covenants, reps & warranties, corporate procedures

• Relies only on the cash flows from the securitized assets for repayment

• Collections segregated into lockbox controlled by SPE

• Non-recourse for credit losses

• Uses structure to offset the increased risk associated with the lack of a general recourse claim

12

Tax Driven Strategies

Charitable donations

Identify Potential Donation Candidates

Independent Technical/ Market Expert Report

Post-donation Support & Performance Monitoring

Technology Transfer/ Tax Benefit

Qualified IP Appraisal

Donor business units identify potential IP assets for donation

An independent technical/market expert generates a report which includes benefits, market size, market share, probabilities of success, etc.

IRC Section 170requires donated property to be appraised by a qualified appraiser.

Donor transfers assets to donee. Donee and Appraiser sign IRS Form 8283. Donor realizes tax bebefit on current year tax return.

Donor monitors donee performance and provides support to help donee realize the potential of donated IP assets.

1.

5.

4.

3.

2.

Source: InteCap, Inc.

13

Tax Driven Strategies

Charitable donations

Benefits:

• Realize immediate tax deduction for the full market value

• Benefit society

• Avoid patent fees for underutilized IP

• Strengthen research institute ties

Considerations:

• Defense of fair market valuation of the property

• Identification of qualified donees

14

Tax Driven Strategies

Investment Holding Companies

Unrelated PartiesInvestment Holding

CompanyRelated Operating

Units

Parent Company

IP Rights Stock

Licenses

Royalties

Licenses

Royalties

15

Tax Driven Strategies

Investment Holding Companies

Benefits:

• Focused IP management function

• Greater IP integration in corporate strategy

• Competitive positioning

16

Sale-License Back

Ownership

Transfer Intellectual Assets/Rights

License Back

Investment Trust Indentures

Investment Trust Company

17

• Technology

Company

• CEO

• $5 Million Investment

CustomerA

CustomerB

CustomerC

IC Based Investments

Enhanced buyout

18

Holding Company CEO

• Technology Department

Company

• CEO CTO

• $5 Million Investment

Potential 501©(3) Donee

PatentSecuritization

CustomerA

CustomerB

CustomerC

Acquisition

Acquisition

Acquisition

Enhanced Margins

$200 MillionInvestment

Enhanced Margins

Enhanced Margins

IC Based Investments

Enhanced buyout

19

Enhanced Buyout

• Cash flow based leverage

transaction (90%)

• EBITDA improving IC (10%)

• Patent security / donation hedge

• Proprietary

IC Based Investments

20

Corporate

Carve-out• Derivative of enhanced buyout

• IC generally non-strategic to parent

• Parent first customer

• Unique opportunity to enhance shareholder value

IC Based Investments

21

Patent Based Venture

• Derivative of traditional venture capital

• Enforcement initiatives

• Royalty monatization

IC Based Investments

22

PROCESS

23

IntellectualCapital

Phase I - Review

Portfolio Fit Deal StructureSales &

MarketingCompetitionTechnologyFinancial

BusinessModel

Management

Phase II - Evaluation and Development

PortfolioSynergy

Debt LeverageMarket Size &

GrowthMarket ValueProduct DemoProfit %

MissionStatement

ExecutiveSkill Set

Existing IC

AcquisitionStrategy

CustomersDifferentiateTech PlanCash FlowPartnershipBoard ofDirectors

Future IC

Risk FactorsOutside

InfluencesUse of FundsMega-trend

EmployeeSkill Set

CompetitiveIC

Sales StrategyValuationFuturing

Phase III - Due Diligence

FinancialCustomerRelations

Industry NewsExternal Lab

ReviewDebt

SupplierRelations

EmployeeAgreements

Patent Doc

LegalDistributorRelations

Tax Status &Planning

AgreementsComp/

IncentiveTrademark

Doc

Audit ReviewEmployee

IssuesTrade Secrets

PropertyShare-holdersIC Threats

IC Due Diligence

24

IC Due Diligence – Intellectual Capital Phase I

YES POTENTIAL

Utility patents

Process patents

Brands

Domain name

Employee knowledgebase

25

IC Due Diligence – Existing IC Phase II

• Review key issued patents noting particular claims of interest and prior art search process

• Assess current patent application decision process

• Identify current patent counsel

• List company brands and domain names

• Are core products currently on sale or being offered for sale? For how long?

• Has any technology been licensed in?

• Cross licensing rights?

26

• Review pending and potential future patent applications

• Evaluate budget for future IC development and fillings

• Identify current and potential domain names

IC Due Diligence – Future IC Phase II

27

IC Due Diligence – Competitive IC Phase II

• Consider known competitive patents

• Describe efforts to identify and track competitor patents and applications

• Assess budget for future IC intelligence

28

• Inventory existing and pending patents

• Identify all license agreements providing the company with 3rd party patent rights

• Assess the company’s patent marking policy and practice

• Review recent PTO correspondence on all pending patents

IC Due Diligence – Patent Documentation Phase III

29

IC Due Diligence – Trademark Documentation Phase III

• Catalog company’s trademarks and domain names

• Check for domain equivalents (use and availability)

• Contact trademark counsel to assess status of key marks

30

IC Due Diligence – Trade Secrets Phase III

• Obtain copies of trade secret policy

• Review employee confidentiality / assignment agreements

31

IC Due Diligence – IC Threats Phase III

• Confirm with company and counsel that no legal threats / infringement accusations exist

32

IP on IP Finance

• Patent Application – System for and method of risk minimization and enhanced returns in an intellectual capital based venture investment

• Patent #6,330,547 – Method and apparatus for establishing and enhancing the creditworthiness of intellectual property

• Patent #6,018,714 – Method of protecting against a change in value of intellectual property, and product providing such protection

• Others