For most businesses, intangible assets represent more than50% of the value of the enterprise. The most significant group of intangibleassets is those protected by intellectual property such as inventions, designsand brands. Since they form such a large part of the overall value, theirmanagement as financial assets is important to the success of the business.

Businesses that actively manage their Intellectual Property(IP) as a financial asset outperform their peers by up to 30%. They do so bymaximising the effectiveness of investment in the business, driving performancein areas that produce the best return and managing operational risk. They mayalso use their IP assets as security to obtain various forms offunding. Moreover, there are opportunities to gain strategic advantage inrelation to the sale or purchase of a business.

A good IP management strategy enhances the ability of thebusiness to raise funding by managing the issues that affect valuations of IPassets.

Understanding the financial value to the business ofspecific IP assets is of particular importance when moving into a new market -product or geographic - because there will be new risks as well asopportunities.

China presents some special challenges and practical stepsto protect the value of IP assets are often as important as legal ones. Thisarticle aims to explain how IP assets matter from a financial perspective andassess how to manage them to the greatest business advantage.

Managing return on investment and improvingperformance

Where there are several IP assets, knowing the comparativereturn on investment of each one allows the overall business strategy to focuson those that will give the best return. It also means that the risk to theviability of the business if certain IP rights are lost can be assessed. Thisis important in deciding how to structure your commercial relationships andoperations in China.

As with tangible assets, measuring the return on investmentrequires knowledge of their monetary value and of the amount of investment madein them over a given period. Ascertaining individual IP assets consists ofidentifying the technology and brand in each separate product and any brandthat is used for more than one product.

Provide security for financing

IP assets can be used to provide security for a wide rangeof methods of raising funds. China has been at the forefront of the use ofpatent mortgages and a variety of fund-raising structures are readily availablefrom Chinese financial institutions as well as European ones.

The range of fund-raising options includes:

1. Providing security for existing bank borrowing

It is not unusual for a company's IP to be covered by thegeneral charge taken by its bank but at a nominal or nil value. Valuing itseparately often increases the value of the security covered by the charge.This can be used either to increase the borrowing or to reduce the interestcharged on it. If the IP assets are to be used for another form of security itwill be necessary to get them released from any bank charge. This will beeasier if they are included at only a nominal value.

2. Providing security for new debt

This can be to support new bank borrowing for cashflow orfor longer-term debt to fund investment in new products or markets. Lendingagainst IP assets is a specialised form of lending usually carried out bydedicated teams within larger lending organisations or by smaller specialistlending houses.

3. Patent (and other IP) mortgage

A patent mortgage is one form of lending against patents orother IP assets. The significant difference between this and security under acharge is that a mortgage will usually transfer title to the lender immediatelyon default. It is a well-established form of lending by some Chinese banks whomay have more familiarity with it than their international counterparts.

4. Creating a vehicle for raising equity

If IP assets are owned by a company created for thatpurpose and generate a royalty income then shares can be issued in that companyto raise new equity finance.

5. Securitisation (bond issue)

An alternative to issuing shares in an IP holding companyis to use the company’s assets as security for a bond issue in the market. Thisis more likely to be an attractive option for medium-sized businesses withbrands or technology that is reasonably well-known in its own market-place.

6. Secure assets to benefit a third party

A further use of an IP holding company is to providesecurity to benefit a third party such as the company’s pension fund or a newventure on the same group of companies.

IP assets are often undervalued in company accounts.However, identifying and valuing them can result in a worthwhile increase inthe value that existing lenders will put on them as security for currentlending. This can be very useful in a credit crunch.

The acceptability of IP assets for fund-raising will dependto a considerable extent on what valuation is put on them and whether they areowned by an appropriate entity.

There are several considerations that impact valuation,including whether the IP assets are clearly identified, consolidated in oneownership rather than dispersed, protected from insolvency risks associatedwith operational activities, protected by appropriate registrations, subject toa structured enforcement programme, licensed to group businesses and/or thirdparties to generate income, and being used to increase the profitability of thebusiness.

Drawing up an IP strategy

A well-managed IP strategy makes a significant differenceto the valuation of a company's IP assets. A valuer will assess the economicimpact of the IP on the company's business. Although there are severaldifferent valuation methodologies, all take account of the risk to the IP. Arealistic IP strategy that is documented and demonstrates effective support forthe overall business strategy will always enhance the ultimate valuation figurefor the IP.

The IP strategy reinforces the overall business strategyand will change as the business moves through different stages of itsdevelopment. It will often also differ from one market to another as thebusiness will be at different stages of its life-cycle in each. The balance ofwhich IP rights are most useful and so should get priority in investment andmanagement time will vary accordingly.

For example, in establishing a new market, registration oftrademarks and patents, designs or copyright to protect the product is likelyto be more significant than enforcement against infringers. Once a business isestablished, enforcement is likely to take a higher priority. Where it seeks toincrease market share compared with its competitors, then the focus may well beon defending litigation.

It is essential that the management of the company isinvolved in drawing up the IP strategy and understands how it will support thebusiness objectives. The key people to be engaged are the chief executive,finance director, tax advisor, general counsel, chief technology officer andchief operating officer.

The IP strategy should be reviewed whenever the businessstrategy changes and at least once a year.

Take-away message

With a strategic IP management approach and the appropriateidentification, valuation and protection of your IP assets, you can use yourintangible assets to your advantage to provide security for financing andimprove your company's overall performance. However, to best use your IP assetsas business tools, Helpdesk experts strongly recommend that SMEs ensure thattheir key IP asset are protected by registration, adequately prevent your IPfrom being exposed by current and former employees and business partners and structureIP ownership that it is most appropriate for any planned use as security forraising finance.

The China IPR SME Helpdesk is a European Commission fundedproject that provides free, practical, business advice relating to China IPR toEuropean SMEs. To learn about any aspect of intellectual property rights inChina, visit our online portal. For free expert advice on China IPR foryour business, e-mail your questions to:  question@china-iprhelpdesk.eu.You will receive a reply from one of the Helpdesk experts within seven workingdays. The China IPR SME Helpdesk is jointly implemented by DEVELOPMENTSolutions and the European Union Chamber of Commerce in China.

(Source: IPO ofUK March 2013)