Alternative financing

Here is an interesting story over at XEconomy on Royalty-based venture financing. According to the story, royalty based financing is a technique previously used in mining or other royalty-rich industries, which is now being applied to technology firms:

The concept of royalty-based financing is simple. Instead of buying equity in a young company, an investor agrees to receive a percentage of the company’s monthly revenues–up to a limit of, say, three to five times his or her investment. Instead of waiting five or 10 years for a startup to go public or get acquired, an investor can start seeing returns almost immediately. This approach means investors should be able to fund a much wider range of startups than just those that typically receive venture backing–the ones that have potential to grow huge, fast. The downside is that your returns are capped, so if you do end up backing the next Google or Amazon, you still only get five times your investment back.

The story notes that this could be an alternative to VC funding for start-ups.

Royalty based financing is just one of a number of new alternative financing mechanisms that have developed over the past few years. Athena Alliance has been working on a new report on case studies on intangible asset financing. That report is due out shortly — so stay tuned.

Thanks to Technology Transfer Tactics for the heads up on this article.

3Q 2009 GDP

This morning’s advanced estimate from the BEA of 3rd quarter GDP came out better than expected at 3.5% growth. Economist had expected a 3.2% growth rate, according to the Wall Street Journal. And some had recently been predicting an even lower number.

Many are crediting the upturn to the stimulus package, which boosted consumer spending. As the BEA notes:

The upturn in real GDP in the third quarter primarily reflected upturns in PCE [private consumer expenditures], in private inventory investment, in exports, and in residential fixed investment and a smaller decrease in nonresidential fixed investment that were partly offset by an upturn in imports, a downturn in state and local government spending, and a deceleration in federal government spending.

I would, however, note that the last point of government spending. State and local government spending actually declined and federal spending was less than in the 2nd quarter. I’m sure this will fuel both sides of the “next stimulus” debate.

I would also note that contribution of trade is based on incompletely trade data (from only July and August). Continued progress on the trade deficit depends heavily on the value of the dollar. As the Financial Times noted this morning, the dollar fell on the GDP news — which will help exports and hurt imports. Already, however, some of the US’s major trading partners are complaining about the weaker dollar hurting their economies (i.e. their exports). As a story in this morning’s Washington Post notes:

This week, a top aide to French President Nicolas Sarkozy called the value of the dollar “a disaster” for Europe, warning of dire consequences to the global economy if it remains at its current levels

However, as the story all points out:

the Chinese yuan, still closely pegged to the value of the U.S. currency, has fallen just as much as the dollar on world markets, serving up a double whammy to countries with fast-appreciating currencies like the euro. It also means that China, the country that enjoys the single biggest trade surplus with the United States, has actually seen that surplus grow during the recession.

So, be aware, as I noted with the 2Q data, these are advanced estimates subject to revision. The 4th quarter 2008 and the 1st quarter 2009 figures were substantially revised. The 2nd quarter 2009 number was revised from a -1% percent advanced estimate to a -0.7% final. Today’s figure will be similarly revised as more complete trade and other data are available. The August trade numbers were unexpectedly positive (see earlier posting). The September trade numbers come out on Friday, November 13th.

Still, the data shows a healthy trend:

The patent wars – Nokia v Apple

By now, I’m sure you have heard of the latest headline patent case of Nokia suing Apple. To go beyond the headlines, I suggest you read Joff Wild’s interesting analysis of the implications of the case over at IAM Blog – Nokia v Apple. His take is that, played right, it could be a PR boost for Apple. It could also change the dynamics of the standard setting for wireless.
By the way, Joff wonders what will happen to Apple’s stock price today. The answer is that it immediately rose (along with the NASDAQ) but then dropped a bit. I wouldn’t put to much emphasis on any short term price movements, however. The implications of this suit will take a long time to play out.

The intangible known as reputation

Reputation is an interesting intangible.
Take for example, the case of the Washington Redskins (or as some wits would say, yes, just take them, please). In a recent interview in the Washington Post, John Kent Cooke, son of the former owner Jack Kent Cooke said this about the current owner: “Dan Snyder destroyed the reputation of this franchise.” Now Cooke was the loser in a bidding war with Snyder for the team after his father died, so there may be some “sour grapes” reaction at work here. And Snyder has doubled the value of the franchise from the $800 million he paid for it to an estimated value today by Forbes of $1.6 billion. Snyder has built the franchise into a marketing powerhouse. As Forbes notes:

The Redskins remain the most profitable team in the league, posting operating income of $90 million. FedEx Field has 91,704 seats, the most in the NFL, and even though the team has struggled on the gridiron it is hard to find an empty seat come game time. Premium seating is also a hot commodity in D.C., as the Redskins generated more than $45 million in luxury suite revenue for the Redskins last year, the most in the NFL.

However, Snyder has not produced a winning team, let alone come even close to the glory days many remember under the elder Cooke.

The timing of the Cooke interview is not coincidently, I suspect. The Redskins are off to a dismal season — to such an extent that I recently heard a Washingtonian tell people that he came from a city with no professional football team. In an unrelated WP article, Steven Pearlstein
summed up this situation like this:

What do you call a business that consistently overcharges its customers for an inferior product, hires the wrong people and pays them above-market wages, and yet still manages to be one of the most profitable and valuable franchises in its industry?
Here in the nation’s capital, we call it the Washington Redskins.

(Pearlstein’s piece was on the pending Supreme Court case on the NFL’s anti-trust exemption)

The team may be a moneymaker right now. But I would note that the Forbes article was written about the past — and as the caveat goes, past performance is no prediction of future results. Reputation is built on performance. If a sports team fails to deliver, past reputation will only carry you so far. Yes, there will always be the diehards. But diehards don’t fill stadiums (ask me about the new Nationals baseball park). A story in today’s Post -“As Redskins fumble, some fans are saying, ‘See ya'” describes how some fans are staying home:

In most cities, a few thousand fans skipping NFL games during a bad season wouldn’t be remarkable. But in Washington, the empty seats reported recently at FedEx Field have raised a question long unthinkable in Redskins Nation: Are significant cracks appearing in one of professional football’s most rock-solid fan bases?

So, even if you aren’t a football fan, watch the progress of the Redskins. It may be an interesting case study in the nature of the intangible we call reputation.

A different path to commercialization

Over at the Technology Transfer Tactics blog, there is a posting entitled Hospital TTO takes a different path to commercialization with private sale of IP. The story is about a pending IP sale:

The technology transfer office at Childrens Hospital Los Angeles (CHLA) is veering off the traditional path to commercialization, with a pending sealed-bid private sale of a portfolio of 10 issued U.S. patents and foreign patent applications for noninvasive substance detection, including a noninvasive blood glucose monitor. The TTO has hired the IP brokerage firm ICAP Ocean Tomo, LLC, in Chicago to conduct the private sale for the hospital. CHLA had tried the traditional commercialization route with this particular technology for several years, says Jessica Rousset, director of the hospital’s TTO. However, the standard path was slow-moving, particularly given the limited availability of the inventor, who is also a healthcare professional, she reports.

What is interesting about this both the patent sale and the description of patent sales. At first blush, it sounds like patent auctions are a radical new concept to the technology transfer offices. The article uses terms like “veered off the traditional path” and contrasts the sealed-bid sale as different from “standard path.” One wonders about why the concept of IP sales is such a non-traditional idea to technology transfer offices.

Turns out that the sale really is a different path. As the piece explains further:

CHLA worked with ICAP Ocean Tomo to negotiate a customized template license agreement, which in turn will be conveyed to potential bidders. The agreement is a hybrid between a straight sale and a standard license agreement with all of the reporting obligations and various triggers for payments to the IP holder, she explains. CHLA isn’t granting the IP rights as an assignment, which is ICAP Ocean Tomo’s traditional model, “but as an exclusive license, which is necessary for federally funded IP,” she [Rousset] explains. “Furthermore, we were able to get the appropriate reservation of rights in the terms and conditions that is customary when licensing government-funded technologies,” allowing CHLA and other academic institutions to continue to work with the licensed IP.

The way this is phrased it sounds like this is a model to overcome barriers for sale of federally funded IP. This may be variation of a sale-lease back arrangement OceanTomo has done before and the auction of some NASA patents earlier this year. I am especially interested in the restrictions allowing academics to work with the IP – which overcomes the sometimes problem of universities patenting a foundational technology.

So may be this really is a new approach after all.

and taxing patents

A new report from International Law Office – “Tangible Tax Relief for Intangible Assets” highlight changes being in Ireland’s tax treatment of intangibles. The proposals dramatically broaden what qualifies for tax relief as an intangible asset. As the report cites, the definition will now include

 • patents and registered designs, design rights and inventions;
 • trademarks, trade names, trade dress, brands, brand names, domain names, service marks and published titles;
 • copyright or related rights within the meaning of the Copyright and Related Rights Act 2000;
 • certain plant breeders’ rights;
 • know-how generally related to manufacturing or processing;
 • sale authorizations in relation to medicines or products of any design, formula, process or invention;
 • rights derived from research prior to authorization, on the effects of items covered directly above;
 • licences in respect of such intangible assets referred to above;
 • any ‘non-Irish’ right similar to those outlined above; and
 • goodwill to the extent that it is directly attributable to the items set out above.

These changes may also rekindle the debate on intangible tax havens. As the report notes:

It is anticipated that the changes to the tax regime will encourage more companies to develop and exploit intangible assets from an Irish base and should help to increase Ireland’s portfolio of overseas investors.

It is this portfolio of overseas investors that is at issue. As we discussed in our earlier report Intangible Asset Monetization: The Promise and the Reality, the issue here is company transferring their intellectual property to subsidiaries located in countries where the royalty income is tax at a low rate or not taxed at all. The parent company “sells” the IP to the subsidiary and then pays royalties to that subsidiary for the use of the IP. Key is whether that “sale” is a fair market value and therefore the appropriately taxed.

As I noted in various earlier postings, the Obama Administration has highlighted this as something to be dealt with in a tax reform package. But that earlier report was a Treasury Department proposal. President’s Economic Recovery Advisory Board (headed by Paul Volcker) has been tasked with coming up with a tax simplification plan. We will have to see if they take on this issue as part of their work.

Thanks to IP Finance for bring attention to this report.

Patenting taxes

In a posting a couple of years ago, I raised the issue of patents for tax strategies. Since then, the issue has been quietly percolating along. A ban on these types of patents (essentially a specific form of business process patent) was included in the House passed version of patent reform, but not in the Senate bill as reported out of the Judiciary Committee. Now an interesting coalition has written a letter to the House Ways and Means Committee asking that they move on a stand alone bill. The group is made up of consumer organizations, taxpayer rights groups and tax planners including the American Institute of Certified Public Accountants, the American College of Tax Counsel, the American Society of Appraisers, Citizens for Tax Justice, US PIRG, and Consumer Action (to name a few).

This may be a useful strategy. The talk in Washington right now is about some stand alone tax bills passing this year, such as a jobs creation tax credit and extension of the first time homebuyers credit. Even if a stand alone bill doesn’t pass, there are multiple avenues to enactment. There is the patent reform bill (which we continue to hear may be moving this year). The NY Times Economix blog also raises the question if the Administration’s tax simplification efforts will take is on as well. And there is the Bilski case before the Supreme Court on the broader issue of business process patent. With all these venues, something may finally be done about banning patenting tax strategies.

Thanks to Tax Prof Blog for highlighting this letter.

New small business lending initiatives and intangible

This afternoon, President Obama announced a set of new initiatives on small business lending. According to the fact sheet, the Treasury Department will make additional funds from the Financial Stability Plan available to community banks and Community Development Financial Institutions (CDFIs) for small business lending. The Small Business Administration will raise the loan limit in the 7(a) loan program from the current $2 million to $5 million, raise the loan limit for 504 project loans from the current $2 million to $5 million for standard borrowers and from the current $4 million to $5.5 million for manufacturers, and increase the limit on the microloan program from the current $35,000 to $50,000. The purpose of these changes is to make more credit available to small businesses that were too big for SBA programs but were having trouble getting bank loans.

It should be noted that recently the SBA rewrote its standard operating procedures to explicitly allow 7(a) loans to be used to purchase intangibles. Before there were severe limitations on the purchase of intangibles — which were lumped into the amorphous (and risky) category of “goodwill.” This is a change we called for earlier this year when the President announced a previous SBA loan program (see earlier posting).

However, as we noted back then (and noted in our earlier report, Intangible Asset Monetization: The Promise and the Reality and paper, “Building a capital market for intangibles,”), there are other changes that need to be made. It is still unclear whether intangible assets can be used as collateral for such loans. Working with its commercial lenders, SBA should develop standards for use of intangible assets as collateral, similar to existing SBA underwriting standards.

The third element of the President’s announcement today was that he is calling for a small business credit conference, to be hosted by Treasury Secretary Geithner and SBA Administrator Karen Mills. The purpose of the conference is to “establish further steps the government can take to help small businesses access the credit that is so vital to their growth, and to economic prosperity in this country.” Helping small businesses unlock their financial resources latent in their intangible assets would be a perfect topic for this conference.

Upping the ante on the R&D tax credit – and an alternative

In a piece in yesterday’s Financial Times (The free market is not up to the job of creating work), Mort Zuckerman includes but goes beyond one of the standard suggestions: more spending on infrastructure. His call for a $65 billion National Infrastructure Bank echoes many others’ push for greater public spending to create jobs. What is especially interesting about Zuckerman’s piece is that he also calls for a 100% research and development tax credit. In other words, the government should subsidize all private sector R&D.

The justification for these proposals is a concern over the type of jobs being created:

If there is any growth in jobs, it will come mostly from healthcare, education, restaurants and hospitality services. Healthcare alone made up all the net jobs created in the last decade. Such service jobs cannot, however, support growth and innovation.

and over the macroeconomic effect of not creating jobs:

Since spending depends on employment it is critical to determine whether the labour market will remain weak. Given the level of household debt, the drop of confidence, the decline in the value of homes and the tightness of credit, it is hard to see how consumer spending will rise enough to improve economic prospects beyond a weak recovery – which creates few new jobs.

I agree with the concern – but am not sure of the remedy.
First of all, not all innovation comes from R&D. Second, while I support a permanent R&D tax credit, 100% is bad policy. It completely removes any market-based reality from the decision process. Third, if the concern is demand creation, it is not clear that more R&D will have an immediate increase in demand. Investments in the R&D infrastructure have a greater immediate impact – which was why it was included in the stimulus bill. Increasing R&D is important for long term growth – but not short term demand.

Let me suggest an alternative. As I’ve argued before, we need a knowledge tax credit that includes worker training and education. So rather than a 100% R&D tax credit, let us use those funds for a 100% worker training and education tax credit. This would have the dual effect: It would increase our human capital — a major input to the innovation ecosystem. And it would immediately increase consumer demand as companies would use the funds to pay workers to take classes (thereby creating more employments slots for others to fill the working hours of those in the classes).

As I have said over and over again, rather than pay workers to stand in unemployment lines, let’s pay them to sit in a classroom.

We're 3rd and 38th – WEF financial index

Last week, the World Economic Forum released its Financial Development Report. Headed up by Nouriel Roubini, the report concluded that:

The United Kingdom, buoyed by the relative strength of its banking and non-banking financial activities, claimed the Index’s top spot from the United States, which slipped to third position behind Australia largely due to poorer financial stability scores and a weakened banking sector.

But on the financial stability index, the US wasn’t even in the top 20. We ranked 38th (and the UK ranked 37th). As the report states:

The breadth of factors covered in the report means that countries with high financial instability scores like the United Kingdom and US could still achieve a high relative ranking in the Index due to other strengths.

In the US those other factors including the strength of the non-banking financial sector and the financial markets. On the down side, the US scored relatively low the strength of auditing and reporting requirements (25th) and the regulation of securities exchanges (29th). Interestingly, WEF’s Global Competitiveness Report had the US at 39th with respect to the strength of auditing and reporting standards (see earlier posting).

Like the competitiveness report, this report used subjective surveys of business leaders. On the only measure related to intangible assets, the US came in 15th. When asked about intellectual property protection (1 = is weak and not enforced; 7 = is strong and enforced), the US had a score of 5.33, right behind Japan. Singapore, Sweden Finland, Switzerland and Austria all scored over 6. The competitiveness report had the US at 19th for the same question, with a score of 5.44. The wording was slightly different in the competitiveness report, where they specifically included a reference to counterfeiting and didn’t include a specific reference to enforcement.

Like the competitiveness report, I would take these rankings with a grain of salt. But the details can be revealing. Those who want to dig into the report’s fine points may find some interesting tidbits.