One of the newest financial innovations (following on last week’s posting on the history of mortgages) is the monetization of intangible assets (a topic I wrote of before). In just the past few weeks, there have been a number of stories about parts of this phenomenon. The Economist ran a piece – “Securitising intellectual property: Intangible opportunities” – based on Dunkin’ Donuts recent sale of $1.7 billion in bonds back by its franchise royalties. As the story points out, use of a company’s intangible assets can be a smart financial move.
Raising money this way can make sense not only for clever private-equity firms, but also for companies with low (or no) credit ratings that cannot easily tap the capital markets or with few tangible assets as collateral for bank loans. Some universities have joined in, too. Yale built a new medical complex with some of the roughly $100m it raised securitising patent royalties from Zerit, an anti-HIV drug.
The Yale example highlights the most common (and growing) part of this trend: securitization of patents. One of the masters of this “space” is the firm Ocean Tomo. A story in the July 2006 issue of Business 2.0 (not yet on line) describes the company’s range of patent related activities: A. Buy and sell patents for private parties; B. Devise an index of patent-rich stocks; C. Launch a website of classified ads from patent holders; D. Broker technology deals for major companies; E. Create funds that allow people to invest in patents; and F. Run the first-ever public auctions for patents.
Some of these are a work-in-progress. For example, the public auction didn’t raise as much as was expected – in large measure because patent owners set their reserve prices higher than buyers were willing to pay. But the company quickly learned from that glitch and most of the patents were later sold in private sales. (For more on the patent auction, see Ocean Tomo Patent Auction – Payne.org Wiki.)
Another variation of this theme of patents for cash is the “idea-generation” firm of Intellectual Ventures (IV), which was recently highlighted in Business Week – ““Inside Nathan Myhrvold’s Mysterious New Idea Machine”. One of IV specialization is quick patenting of the ideas that come out of expert brainstorms:
Over the past three years, Intellectual Ventures has held about 70 brainstorming sessions. The result: 500 patent applications in areas including optics, biotechnology, robotics, e-commerce, and mobile networking.
But this presumptive patenting in is not all IV does:
Intellectual Ventures is not just a think tank where big brains sit around dreaming up ideas. It also has a second business, one that is generating controversy: buying patents. In fact, that’s a much larger part of the operation. Maintaining secrecy through shell companies and nondisclosure agreements, often swooping in aggressively to seal deals, it has scooped up thousands of patents and is on the prowl for many more. That has many people in the tech world worried.
As a result, IV has become rather controversial:
With its vast hoard of patents, IV could turn out to be the world’s biggest patent troll. It could have the power, at least in theory, to sue a vast swath of Corporate America, becoming a force that smothers rather than nurtures innovation. “There’s just a lot of questions about all of these patents they have and what they are going to do with them,” says Christina Schneider, a spokesperson for Hewlett-Packard Co., echoing concerns heard widely in Silicon Valley.
But IV sees itself as leading the new wave of innovation financing:
In response to charges that he is a predator, Myhrvold describes himself as an entrepreneurial financier, somebody who is devising new ways to fund innovation. He likens himself to the first generations of venture capitalists and private-equity investors, who were also widely vilified. Myhrvold believes that there is an emerging trend to treat intellectual property, and patents in particular, as an asset that people and companies will invest in, the same way they do in real estate or stocks. The result, he believes, will be a boon for invention, just as venture capital and private equity have stimulated enormous growth and innovation in the American economy. “I’m one of the first invention capitalists,” he says.
. . .
Just as venture-capital firms took root in Silicon Valley 30 years ago, Myhrvold envisions an industry devoted to funding the earliest stage of the product-creation cycle. “Today invention is an area that people view as too illiquid, too uncertain, and too risky, so that nobody wants to invest in it,” he says. “The world has shown that if you provide capital and expertise to an area that is starved for capital and expertise,” then “really good things will happen.”
Regardless of the controversy over IV’s tactics, new financial models focused on intangible assets are here to stay. Yet, they face a number of hurtles before they are more widespread. As the IV story illustrates, creating a stable patent system is one, as is finding the right level of protection of these assets as intellectual property. [For the record, I am on the oppose side of IV on the patent fight].
There are also questions of how federal and state security regulations should be applied to these assets. Another is the problem of valuation. As the Economist noted:
It may be harder for investors to decide whether such deals are worth their while. They are, after all, highly complex and riskier than standard securitisations. The most obvious risk is that the investors cannot be sure that the assets will yield what borrowers promise: technology moves on, fashions change and the demand for sugary snacks may collapse. Valuing intellectual property—an exercise based on forecasting the timing and amount of future cashflows—is more art than science.
The valuation issue ties back to the question of how these intangibles should be accounted, the subject of an earlier Athena Alliance report. As a follow-up to that report, Athena Alliance has an ongoing project on the monetization of intangible assets to look at these issues from a public policy perspective. We hope to publish our report later this year.