Nguyen: Banking on intellecutal property

December 16, 2015
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By Xuan-Thao Nguyen

What do startups and high-growth companies have in common? Intellectual property is their most valuable asset, separating one company from the others in a fiercely competitive tech environment. Traditional banks are afraid to lend to startups and growth companies because these companies simply operate in the red and are years from making a profit. Traditional banks don’t want to make loans to these companies against the intellectual property assets because the banks are concerned about valuation of the intellectual property collateral. There is a new breed of banks specializing in startups and high-growth companies. These banks think and behave like their clients. They also think like venture capitalists and know how to valuate intellectual capital.

Silicon Valley Bank is an example. SVB is a commercial bank catering to growth companies in technology and life sciences. Like typical commercial banks, SVB carefully conducts due diligence of the enterprise to ascertain the financial health of the enterprise. Unlike other banks, SVB also focuses on the enterprise’s intellectual property development, identifies the enterprise’s milestones relating to the IP, and monitors the enterprise’s growth. Also, unlike other banks, SVB identifies the key, attractive IP assets that can be quickly liquidated in a distress situation. Equally important, SVB knows the enterprise’s industry players ranging from competitors and partners to entrepreneurs and investors. This knowledge assists the bank in its lending decisions and becomes very helpful, by knowing who would be potential purchasers of the collateral, if the bank needs to foreclose on the IP collateral. Overall, the IP collateral improves the bank’s risk-reward balance and minimizes the bank’s loan loss.

Let’s be more specific in the following hypothetical. Consider the bank loans $1 million to IndyTech, a growth company, for three years at an interest rate of 5 percent and a 1 percent loan fee, and obtains a warrant for 0.4 percent of IndyTech’s shares. A year later, though IndyTech does not make any profit, its tremendous growth attracts investors. Investors buy IndyTech for $60 million and assume all the debts. That means the bank will get $50,000 in interest, a $10,000 fee, and $240,000 in warrant income, totaling $300,000 or 30 percent. This example illustrates that the bank understands growth and is able to benefit from the company’s growth.

What if a year after the bank’s loan, no investors acquire the growth company and the company has to file Chapter 7 bankruptcy? In that case, the bank foreclosed on the IP assets and sells them to purchasers who could very well be some of the industry players the bank identified before it closes the deal with the company during the due diligence phase of the loan. The purchasers will pay $1 million for the IP assets. The bank will get $50,000 in interest, $10,000 in fees and full principal payment recovered from the sale of the foreclosed IP assets.

SVB, Comerica, and other similar banks, however, are not the first lenders to accept intellectual property as collateral for loans. The seminal case is Waterman v. Mackenzie, decided by the U.S. Supreme Court in 1891, concerning patent mortgage.

In that case, Mrs. Waterman borrowed $6,500 from Asa L. Shipman & Sons on Nov. 25, 1884. To secure the payment on the promissory note, Mrs. Waterman mortgaged the patent relating to inventions of fountain pens obtained by her inventor-husband by executing a conditional assignment that contained an express provision that the assignment should be null and void if the payment obligation was paid on the due date. As mortgagee, Asa L. Shipman & Sons and its subsequent assignee, Asa L. Shipman, timely recorded the patent mortgage with the Patent Office. Mr. Waterman transferred the ownership in the patents to his wife on Feb. 13, 1884, received a license to manufacture under the patents from his wife on Nov. 20, 1884, and brought a patent infringement action against an alleged infringer. The alleged infringer, in turn, challenged the plaintiff for lack of standing to maintain the suit, as the patents had already been mortgaged. At the time of the infringement suit, Mrs. Waterman had not fulfilled the payment obligation to Asa L. Shipman.

By recording the patent mortgage with the Patent Office, the court ruled that the entire title in the patent, both in law and equity, was acquired by the mortgagee, Asa L. Shipman. Therefore, the mortgagee enjoyed all rights in the mortgaged patents, including the right to maintain a patent infringement action. 138 U.S. at 258.

Unlike land rights, the right conferred by a patent is limited in years, and the patent’s value is primarily “in the profits derived from royalties and license fees.” The court therefore declared:

“In analogy to the rules governing mortgages of lands and of chattels, and with even stronger reason, the assignee of a patent by a mortgage duly recorded, whose security is constantly wasting by the lapse of time, must be held (unless otherwise provided in the mortgage) entitled to grant licenses, to receive license fees and royalties, and to have an account of profits or an award of damages against infringers.” 138 U.S. at 261.

Waterman is significant, paving a path for the financial industry to provide financing to individuals and entities with patents and other intellectual property assets that could be used as collateral. Some banks today have embraced the use of IP assets as collateral in their lending practices. They understand the tech industry and growth companies and take the warrant contract in addition to the IP collateral. They are truly banking on intellectual property.•


Professor Xuan-Thao Nguyen is the Gerald L. Bepko Chair in Law and director of the Center for Intellectual Property & Innovation at Indiana University Robert H. McKinney School of Law. The opinions expressed are those of the author.