IP rights as part of a fundraising strategy

After years of economic downturn, investors are recovering their appetite and intellectual property can prove key. A management team that understands the importance of its brand and how this can be leveraged is likely to bolster any pitch for investment.


Picture: Africa Studio

After years of hesitation, investors are once again on the lookout for businesses in which to invest, with investment levels reaching highs only previously seen during the dotcom bubble. According to Dow Jones VentureSource, European start-ups raised more than $2.8 billion from venture capital businesses in the second quarter of 2014 – an amount last seen in 2001. Data provider Prequin tells us that, as of August 2014, private equity firms had $1.19 trillion in funds to invest in companies.

Opportunities abound for businesses seeking investments – whether that be securing start-up capital, restructuring or raising capital to fund major expansion. Intellectual property has a significant role to play for investors, whatever the life stage of a company or the type of investment being sought. However, businesses need to consider early on what investors are looking for when assessing the strength of their intellectual property. When an investor undertakes due diligence on a potential deal, it is searching for a robust and dynamic IP portfolio – but what does that look like?

Much can depend on the nature of a business. The assessment for a technology-based company will be different from that for a brand-led business. We read a lot about the development of patent portfolios and associated investment, so this article focuses on brand-led businesses, such as fast-moving consumer goods, luxury goods and service providers, where patented technology can play a much lesser role.

Investors’ attitudes to IP portfolios

First, it is important for a business to understand fully why an IP strategy and portfolio are necessary and why they appeal to investors. A sound IP strategy reflects well on a business’s management. Early-stage and mid-tier investment is often about investing in a management team and its vision. Thus, a business’s IP portfolio and plans for portfolio expansion need to reflect the business plan in order to encourage investors.

The trademark portfolio can demonstrate clearly where a business intends to focus its marketing and expansion plans and can help to define the scope of any potential growth. As businesses think ahead to the next project and the next investment, the trademark portfolio needs to be adapted as early as possible. Securing registration is not an instant process and time needs to be allowed for dealing with issues and challenges to registration that arise.

Investors do not want to consider the implications of ongoing disputes because of the uncertainty that they bring, so these need to be settled by the time a business sets out on fundraising. As common as oppositions to trademark applications are, particularly insofar as Community trademarks are concerned, investors are reluctant to deal with them and an ongoing trademark opposition may discourage investment or at least affect the value of a proposition.

Above all, a well-organised and maturing trademark portfolio can demonstrate an ability to trade and carry out the plans for the business into which investors are buying. It suggests that any potential third-party disputes have already been minimised or dealt with. It also pinpoints the business’s key products or services, as well as the products and services it anticipates moving into, and confirms that the business is free to do so with adequate protection. Key markets are also defined and, if not part of the existing portfolio, additional markets for protection and expansion will need to be included in any strategy and investment plan.


Value, in $ trillion, of private equity funds for investment

What does ‘attractive’ look like?

Accepting that investors will pay particular attention to an IP portfolio and strategy, businesses should consider what makes for an attractive proposition.

The first step, which can often be overlooked, is to cover the most basic portfolio management principles. The trademark portfolio needs to cover the relevant goods and services and be registered in the appropriate jurisdiction. While this is an obvious part of any strategy, regular review of the portfolio is required to ensure that it is kept up to date. New businesses can identify new opportunities and move quickly to take advantage, and it is dangerous to allow the IP protection to fall behind the business strategy, which is an integral element and must be treated as such.

Clear title is key to investors, whether they are looking at investing in a start-up or a multinational. They will want to ensure that there are no issues surrounding ownership of the intellectual property and be confident that the business owns it undisputedly and benefits from and will continue to accrue any goodwill.

In addition to title, investors need to be aware of any encumbrances associated with the IP portfolio. These might include licences to third parties or agreements restricting use. Such encumbrances will not necessarily harm investment potential, but any limitations and requirements need to be clearly understood and factored into the plans for growth. Where possible, they should be minimised.

Where out-licences are in place – for a franchising business, for example – investors will examine whether these are secure and fit to maximise sales potential, or if not, whether they can be terminated or renegotiated.

An often-overlooked area is the issue of unregistered design rights and copyright. The use of third-party agencies or contractors to develop brand identity, marketing collateral and product design is common, especially for smaller businesses with less in-house capability. Particular attention needs to be paid to contracts entered into with such third parties. Where possible, all rights – including copyright and unregistered design rights – should be formally assigned to the business. This should also include all rights to preparatory materials and confidential information.

Uncertainty over the ownership of product designs and brand identity is a clear sign to investors that potential problems lie ahead which could seriously affect their investment, and should be corrected to secure investment on the best terms possible.

Common mistakes include the failure to document relationships with third-party suppliers or secure ownership, which may leave a business with nothing more than an implied licence to use a brand identity. Mistakes of this kind should be rectified and all efforts made to secure assignment of all rights prior to seeking investment.

The status of employees should be also given careful consideration, to ensure that any intellectual property created within their role automatically vests in the company. Employment contracts should make this clear and deal effectively with the treatment of confidential information. Effective internal communication of a business’s IP strategy is key to making it work. Employees need to understand clearly their obligations and the internal processes associated with creating and dealing with a business’s intellectual property. The same should apply to third-party contractors and the differing obligations, processes and contractual issues need to be considered carefully.

Building an IP portfolio can prove a significant drain on working capital for a new business and can require significant investment for more established businesses. However, the investment needs to be made and budgeted for carefully.

The trademark portfolio can demonstrate clearly where a business intends to focus its marketing and expansion plans

Suitable registered design protection can greatly enhance a portfolio and provide investors with greater security as to the ability to create market share when a product is new and innovative. Designs can be registered in a matter of days and provide the owner of a business with a right on which to bring infringement actions quickly and effectively, to prevent any copycats seeking to piggyback on a product’s growing reputation and demand.

If a product is succeeds, it is inevitable that similar products will follow. Registered design protection can provide for a more rounded portfolio and improve a business’s ability to protect its competitive edge. Again, this demonstrates to investors that the intellectual property is robust and the management are IP savvy. The addition of registered design protection provides additional options for managing a group IP structure and intra-group licensing arrangements, the benefits of which are discussed below.

The need for management to understand intellectual property

As a business grows, so does the value of its intellectual property. All of the investment made in setting up a business and securing market share is reflected in its intellectual property, including the trademarks and associated goodwill. The ability to license trademarks, patents and registered designs to generate income is also greatly enhanced.

Larger businesses have a greater ability to invest in their intellectual property, acquire relevant portfolios and engage in strategic partnerships. This kind of business therefore needs to develop an IP strategy where the IP rights are divorced from manufacturing and day-to-day operations. The development and management of IP rights should be heavily factored into business and financial planning.

Companies of all sizes need a good understanding of the value and benefits of their IP portfolio as part of their wider management strategy. In particular, investors look to management to:

  • increase returns on capital invested in the business that is tied up in intellectual property;
  • make informed decisions about IP development or acquisitions;
  • create new and diverse revenue streams from intellectual property, especially from underused IP assets;
  • identify the most valuable intellectual property (perhaps within a large portfolio) so as to protect it fully, and divest the business of IP assets that have no significant value through sale or abandonment;
  • reduce overall costs for IP development or acquisition, protection and utilisation; and
  • promote internal awareness of the importance of intellectual property to success.

Businesses of all sizes frequently misunderstand the role of intellectual property, often under-valuing, under-managing or under-exploiting it. A clear warning sign to investors is a lack of coordination between the different professionals dealing with intellectual property in a business.

IP valuation

Thought also needs to be given to external valuation and ownership structure. An effective IP ownership structure can have significant financial benefits for a business and make an investment proposition much clearer and more attractive in order to demonstrate how and where there will be returns for investors.

When approaching a significant investment, investors consider in detail the value of the intellectual property, making it important for the management team to have a good idea of the valuation and an appropriate assessment to inform negotiations and to use as leverage in agreeing any investment.

IP valuation brings together the economic concept of value and the legal concept of property. It can also be extremely complicated and can serve a range of purposes. There is a variety of concepts, the most significant of which include the following:

  • Owner value – this is often used to determine the price in negotiated deals and is often led by the owner’s view of value if it were deprived of the property.
  • Market value – this is based on the assumption that if comparable property achieved a certain price, the subject property will realise a price close to it.
  • Fair value – this is led by a desire to be equitable to both parties. It recognises that the transaction is not in the open market and that vendor and purchaser have been brought together in a legally binding manner.
  • Tax valuation – this has been the subject of significant case law and may be determined by investment value, liquidation value and going-concern value.

For brand valuation, the two methods principally relied upon are royalty relief and brand contribution. Royalty relief hypothesises the cost saved through ownership of the intellectual property, rather than the need to license it in, and involves an assessment of the royalty rates within a sector.

An efficient ownership structure can serve to leverage the value of intellectual property to increase income

Ownership structures

An efficient ownership structure is also seen as good practice by savvy investors and can serve to leverage the value of intellectual property to increase income.

Many companies are aware of the need to protect their intellectual property against external users. However, it is often equally important to take an internal look and ensure that the use of intellectual property is properly regulated within a group of companies. A robust policy on group trademark use is required and consideration should be given to the best ownership strategy.

In the same way as investors would when looking to make an investment, when considering an ownership strategy, the first step is to conduct due diligence on the intellectual property held in a portfolio. In addition, an assessment needs to be made of which group companies have used the rights concerned and whether any licences exist. Once this has been assessed, a business can build up a true picture of the entire portfolio and the structure surrounding it. This will also serve to identify any fragmentation of the IP rights within the business.

Following an assessment of the portfolio, consideration can be given to the location of any IP holding company. The selection of a location will be driven primarily by tax considerations and by the existence of an appropriate treaty network.

While a cost is involved in seeking the detailed advice needed to identify the most appropriate location from a tax perspective, this will then open up the opportunity to create an IP holding company that can function to minimise capital gains tax. The holding company structure also provides the added incentive of separating the intellectual property from the operating businesses, reducing the risk of loss or encumbrance of the intellectual property should the operating business find itself in difficulty.

Once an appropriate vehicle has been set up and the intellectual property transferred, IP licences need to be granted back to the various members of the group. Once the licensing scheme is in place and the IP holding company has licensed all of the operating companies, it will receive a steady income stream. The income stream created by the licences will have a capital value which can be securitised by placing the licences in a special purpose vehicle.

Putting this kind of structure in place not only maximises profits, but clearly demonstrates the ability to generate income to investors, and can make for an attractive proposition and increase the potential for borrowing based on a business’s intellectual property. It also places the business in a position to maximise benefits from specific tax incentives or benefit from a tax-efficient exit strategy.

Any IP holding company should be given very careful consideration, as tax structuring without commerciality is liable to fail. Creating an IP holding company in a specific jurisdiction without substance will not create the tax savings intended, either on the grounds that the company is managed and controlled elsewhere (normally in a higher-tax jurisdiction), or on the grounds that the company is merely a conduit without beneficial ownership rights required under relevant double tax treaty arrangements. However, if the IP holding company employs relevant personnel to manage the IP rights – ensuring their protection internationally, arranging beneficial licensing agreements, dealing with all relevant legal, valuation, tax and other issues, and monitoring royalty receipts – then the substance requirements can be fulfilled with the consequent tax benefits.

Businesses of all shapes and sizes

The nature and amount of work involved in shoring up an IP portfolio, as we have seen here in the case of trademark and design right-heavy portfolios, depend on the nature and size of the business and the complexity of the portfolio. There is no excuse for not having the basics of a portfolio in place, but many of the more complex ways to structure IP rights discussed in this article will not be appropriate for smaller ventures seeking their first rounds of investment.

Investors often refer to their relationship with the management team of a potential investee company as the most important aspect of a deal. A management team that understands the importance of its brand and how this can be leveraged to protect revenue, or even to create secondary revenue when backed up by a secure portfolio, is likely to bolster any pitch for investment.

Matthew Sammon ([email protected]) is head of the UK trademark practice at Marks & Clerk

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