New frontiers in intangible asset financing
It is not new that intangible assets represent 80% of the economy or that the majority of such assets do not appear on the corporate balance sheet. Financing on such assets is more likely to be handled by specialized PE and hedge funds, since broader financial markets like banks are not interested in providing finance on such assets as a standalone intangible. Part of the problem is the lack of valuation standards and the esoteric nature of these assets – there can be massively different valuations for the same IA portfolio and blind reliance on such models is not recommended. Besides, there is little by the way of balance sheet validation: this does not help either. Without a “base” value, intangibles are often included in the collateral package, backing a debt; valuation may be deeply discounted and is often not valued at all. So here lies the impasse: there is no industry standard for IA valuation -- without which financial markets will not get serious about intangible asset financing.
An insurance solution
A possible solution lies with the insurance industry. An insurance wrap on the intangible asset valuation creates a base value, which can then act as a facilitator for various financial structures. Insurance mirrors the structure of a put option and pays out a pre-determined value for the IA in the event of bankruptcy of the borrower and assignment of IA to the insurer. In certain cases insurers may accept senior rights to IA instead of an assignment and a call option can be attached to the policy by which the financier may buy it back at par in order to reorganize post-bankruptcy filing. Although the product was initially designed for debt/loan markets, in a sense it only provides a stop loss limit and a viable exit market for IA at bankruptcy and obtaining such insurance can be valuable for equity/hybrid financing as long as the financier has senior rights to the insured collateral (sale-lease back structures can be modified to address the requirements).
The equation for the insurer is different from rest of the pack with regard to IA valuation and underwriting. The insurer has a more cushioned position in underwriting and is less exposed to risk than is a typical financier. The first trigger is the need to file a bankruptcy followed by the second where the financier needs to assign IA rights to the insurer. Insurance underwriting in this context will be a combination of credit underwriting and IA selection, due diligence and valuation. Again, the insurer needs to be sufficiently conservative to be able to salvage its claim payment if all the triggers get blown. Insuring core IP will reduce the frequency of final claims.
Company X is a well-established company with highly valuable patents and trade marks and a stable credit profile. In addition to PP&E, inventory and accounts receivable, X is seeking a loan facility using its IA. However, the banks are only offering unsecured rates and a smaller facility for its IA. X can add an insurance wrap on its IA which transforms it into a “hard” asset, similar to its PP&E, and thereby deriving better terms on its facility. If X files for bankruptcy and the bank wants to exit its position, it transfers the covered IA (or IA facility with senior rights to covered IA) to the insurer and gets paid up to the insured limits.
The deal enables X to reduce its borrowing cost, increase borrowing base and, if its intangibles were undervalued in its embedded value (EV) calculations, then X experiences an improvement in its EV.
Was it tried before?
Intangible asset insurance was tried briefly in the pre-financial crisis era. A specialized insurer called IPI offered similar insurance solutions and wrote a handful of middle market borrowers in mid-2000s, notably BCBG Max-Azria and ATD Corporation. However IPI is no longer operational and it is not clear why it closed down.
To make this a sustainable product that makes a difference to the banks and corporations, the insurer must possess a high financial strength rating of at least AA- (S&P) and must be a multiline insurer to provide capital relief to the banks. IPI was more a mono-liner with much smaller balance sheet strength, which might have caused its demise; nevertheless it paved the way for future innovation by larger insurers.
While the structure was applied on IA loans, it can be extended to securitization/bond issuances, and even pure equity financing can be structured around the insurance value.
There are numerous benefits to both financiers and IA owner for accessing insurance markets.
• New source of deal making (loan, securitization, hybrid and equity)IA owner:
• Banks may obtain a Tier 1 capital relief depending on difference between borrower’s credit rating and insurer’s credit rating
• Increase deal size for new deals with significant intangibles
• Higher recovery and viable exit market for intangibles at bankruptcy
• New capital source based on an invisible asset – increases borrowing baseMarket dynamics
• May improve Enterprise value by financing on an invisible asset
• Better terms and larger size on deals
• Continued access to its most valued asset
At present there are only a handful of financial institutions lending against IA. The only bank which lends against IP, and which again is more of a venture debt than a typical bank, is Silicon Valley Bank (SVB). There are a few programmes recently launched in the UK market and again for SME lending, one such programme being from Santander. In the PE space, Fortress Investment Group lends against patents and a few hedge funds finance patent lawsuits.
Apart from this, there is limited participation from the market in IA financing. All of the above target SMEs and start-ups. However IA is rarely considered for larger deals where money central banks participate. IA financing is still considered a “niche” market and, unless the money central banks participate in this market, IA financing will still be a peripheral financing vehicle accessed either as a vehicle of last resort or for start-up funding.
What does it take?
With insurance market participation this might change and it is possible that larger money central banks will start to consider IA as an additional facility in their deal-making. Key to the whole equation will be insurance pricing and a meaningful valuation which is neither too low to make a difference nor too high that insurers face a significant loss.Links to further reading here, here and here
Recently a number of large multi-line insurers and reinsurers S&P A rated and above have been exploring opportunities in the IA lending space for larger more credible borrowers. Up to $200 million of insurance capacity should be available per deal for larger operating entities with significant intangibles. A few money central banks are in advanced talks with the insurers to extend loans against IA using insurance structures as defined. What comes out we are yet to see: definitely a positive for IA financing.
Please feel free to comment on this piece. Aritra welcomes discussion, and so do we.