#88 Using IP-Backed Financing to Unlock Innovation
Patents and Intellectual Property as Collateral for Lending; What on Earth is Space Power?
Today, Arindam Goswami writes about the potential of using patents and IP as collateral for lending, improving startups’ access to capital, and stimulating a new wave of innovation.
Aditya Ramanathan follows this up with an excellent explainer of the conception of space power in light of the Indian Air Force’s “Space Vision 2047”.
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Technomachy: Patents and Intellectual Property as Collateral for Lending
— Arindam Goswami
The startup founder paced nervously outside the bank's imposing glass doors, clutching a folder filled with patents. Inside, the atmosphere buzzed with the sterile efficiency of financial transactions—traditional loans secured by brick-and-mortar assets. But today, she was about to challenge the very foundation of conventional lending, armed with nothing but the intangible brilliance of her ideas. Could her intellectual property—the lifeblood of her groundbreaking tech firm—be the key to unlocking the capital she so desperately needed?
This scenario, while dramatised, highlights a burgeoning shift in the financial world: the recognition of patents and intellectual property (IP) as valuable collateral for lending. In today's rapidly evolving economy, innovation stands as the bedrock of progress and competitiveness. Companies across sectors are increasingly reliant on their intellectual assets to drive growth and maintain a competitive edge.
Yet, despite the recognised value of patents and intellectual property (IP), many businesses, especially startups and small enterprises, face significant hurdles in securing financing to fuel their innovative endeavours. One promising solution lies in the use of patents and IP as collateral for lending—a practice that could revolutionise access to capital and stimulate a new wave of innovation.
Historically, traditional lending mechanisms have depended heavily on tangible assets—real estate, machinery, and inventory—as collateral. This approach often leaves knowledge-based companies, particularly those in the technology and biotechnology sectors, at a disadvantage. Their primary assets are intangible, embodied in patents, copyrights, trademarks, and trade secrets, which do not fit neatly into conventional lending models. However, the financial world is beginning to recognise the untapped potential of IP as a formidable asset class.
The concept of leveraging patents and IP for loans is not entirely new but has gained traction in recent years. Patents, which provide exclusive rights to an invention, and other IP can be incredibly valuable, often representing a substantial portion of a company's worth. By using these assets as collateral, companies can unlock capital that would otherwise remain inaccessible, thus supporting their R&D activities, scaling operations, and market expansion.
Global Examples
Globally, several notable examples illustrate the potential of IP-backed lending. In the United States, Ocean Tomo, an intellectual property merchant bank, has pioneered IP-backed financing. In Europe, Germany's KfW Bank has been active in IP-backed lending, recognizing patents and trademarks as valuable collateral. The Chinese government has implemented policies to encourage banks to accept IP as collateral. Shenzhen, a leading tech hub, has seen substantial growth in IP-backed loans, helping technology firms expand their operations and invest in new projects.
With the expansion of the IP lending industry, by September 2023, 119 IP-backed security products had been issued on the Shanghai and Shenzhen stock markets, raising a total of CNY 26.8 billion. The Bank of Communications’ Shanghai Branch has developed a "Smart Intellectual Property Loan" product, which incorporates factors such as enterprise research and development levels, intellectual property rights, and science and technology innovation parks into its credit assessment.
Recent findings show that the market for IP-backed loans is gaining importance in the United States and the United Kingdom, primarily driven by specialised non-bank institutions. These intermediaries benefit from not needing to value intangible asset collateral for capital adequacy requirements, unlike commercial banks. While the total market size for IP-backed loans is hard to ascertain due to the lack of disclosure requirements for non-bank institutions, research found that the proportion of loans backed by intangible assets, especially IP, in a sample of 1,415 US-originated syndicated loans, rose from 11% in 1996 to 24% in 2005.
The table below highlights several transactions where companies utilised IP as key collateral during periods of financial distress:
Source: “IP-Backed Financing: Using Intellectual Property as Collateral”
The Indian Context
In India, the potential for IP-backed lending is immense, given the country's burgeoning startup ecosystem and a strong emphasis on innovation. A real-world example from India is the collaboration between the Indian Bank and the Indian Institute of Technology (IIT) Madras. They have created a framework where startups incubated at IIT Madras can use their patents and IP to secure loans. This initiative has helped numerous tech startups obtain funding that would have been challenging to secure through traditional means. Additionally, Biocon Limited, a major biopharmaceutical business in Bangalore, has successfully raised ₹ 1,125 crore for research and development activities using its substantial patent portfolio as collateral.
The Indian Patents Act of 1970 governs the issuance, protection, and enforcement of patents in India. While it doesn't specifically address using patents as collateral, it does not restrict it either. The Act grants patentees the exclusive right to manufacture, use, sell, or import the patented invention. These rights can be transferred or licensed to others, including as security for loans (Section 68). Section 68 allows for the transfer of patents, including the creation of security interests or mortgages.
Benefits
For lenders, IP-backed lending offers a unique opportunity to diversify their portfolios and engage with high-growth sectors. Unlike traditional collateral, the value of IP can appreciate over time, driven by successful commercialisation and market demand. This potential for increased value makes IP-backed loans an attractive proposition. However, it also requires lenders to develop expertise in valuing and managing intellectual property, which can be complex and requires specialised knowledge.
The benefits of this lending approach extend beyond immediate financial relief. For the broader economy, it can drive job creation, technological advancement, and competitive markets. By providing an alternative financing route, we can empower innovative companies to pursue bold ideas that might otherwise languish due to funding constraints. Moreover, it encourages a culture of IP creation and protection, which is crucial for sustaining long-term economic growth and maintaining a competitive edge on the global stage.
The Challenges
Implementing IP-backed lending on a wider scale does pose challenges. Accurate valuation of IP is critical yet challenging, as it involves assessing not just the legal standing of a patent or trademark but also its market potential and the competitive landscape. Legal and regulatory frameworks will also need to adapt to support IP as collateral, ensuring clarity in enforcement and protection of rights for both lenders and borrowers. Not all patents are suitable for use as collateral though. Lenders might show little interest in patents with limited services or commercial potential, which can restrict financing options for companies.
Financial institutions and policymakers have key roles to play in this evolution. Banks and other lenders need to invest in developing their capabilities to evaluate and manage IP assets. They can collaborate with IP valuation experts and create dedicated teams to handle these specialised loans.
What can policymakers do?
Policymakers should create explicit legal frameworks recognising patents and IP assets as valid collateral, outlining rights and obligations for lenders and borrowers. Standardising valuation processes for IP assets can reduce uncertainty, requiring guidelines and methodologies for accurate assessment.
Creating public registries for IP collateral increases transparency and security, aiding in ownership verification and risk mitigation. Governments can offer tax breaks or subsidies to encourage IP-backed lending, stimulating investment in innovation.
Investing in education programs for financial institutions and businesses enhances understanding and confidence in IP-backed lending. Policymakers should foster collaborations between government agencies, financial institutions, and innovation hubs to promote IP financing. They should also encourage international cooperation and harmonisation of IP laws to facilitate cross-border lending and simplify funding processes for businesses globally.
Not entirely unrelated to this is the concept of Advance Market Commitments (AMCs). This enables us to purchase products that have not yet been created, providing innovators with an incentive to develop and expand new products. In 2007, a coalition of governments and philanthropists committed $1.5 billion to expedite the development of pneumococcal vaccines targeting Streptococcus pneumoniae infections, a leading cause of child mortality in low-income countries. Another AMC was initiated under Operation Warp Speed in 2020, featuring US-guaranteed purchase orders for 900 million doses of Covid-19 vaccines.
While AMCs don’t directly deal with intellectual property rights, they underscore the need to explore new financing methods to spur innovation.
In conclusion, utilising patents and IP as collateral for lending is a promising strategy to unlock the potential of innovation-driven companies. By bridging the gap between intangible assets and financial capital, we can create a more dynamic and inclusive economic landscape.
The examples from the United States, Europe, China, and India demonstrate the viability and benefits of IP-backed lending. It is a call to action for financial institutions, innovators, and policymakers to work together in fostering an environment where intellectual property is recognised and leveraged as a powerful catalyst for growth and development.
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Antariksh Matters: What on Earth is Space Power?
— Aditya Ramanathan
The Indian Air Force (IAF) appears to have a sweeping vision for space. In 2023, it announced its vision to transform into the Indian Air and Space Force. In December 2023, we learnt that it has a “Space Vision 2047” and plans, within a decade, to operate more than 100 satellites offering intelligence, surveillance and reconnaissance (ISR), position, navigation and timing (PNT), space traffic management, and space situational awareness. Simultaneously, there are ambitions to eventually turn the tri-services Defence Space Agency into a full-fledged space command. How an Indian Air and Space Force is supposed to divide responsibilities with a fully operational space command remains unclear.
No doubt, interservice rivalries play a role in this confusion, but those always exist and can be tackled through leadership. A deeper challenge is the absence of a clear understanding of space power (or sometimes ‘spacepower’). This challenge is not unique to India. In truth, outer space is a novel strategic environment, and no one has quite figured out a coherent strategic theory for it.
The IAF seems to be pushing the idea of ‘aerospace power,’ which is based on the idea of an “air and space continuum”. As the IAF’s 2022 doctrine puts it:
“The physical contiguity of the media of air and space has transformed into operational contiguity. With the advent of new generation technologies, platforms, vehicles and weapons are now being developed which would transit seamlessly from one medium to the other; thus acquiring trans-domain character…The possibility of threat from contiguous aerospace medium demands a seamless capability of detection, identification, tracking, and neutralisation in both the layers of air and space.”
It’s certainly true that some weapons, like long-range ballistic missiles, transit between air and space, but moving between mediums is hardly uncommon. For instance, a torpedo dropped from a maritime patrol aircraft transits seamlessly between the atmosphere and the undersea environment. Long-range submarine-launched ballistic missiles (SLBMs) transit between the undersea environment, the atmosphere, and outer space. In short, the idea of an “air and space continuum” is as meaningful as an “air and sea continuum” or an “air and ground continuum”.
IAF officials also sometimes refer to outer space as ‘the ultimate high ground’, a line unfortunately borrowed from the US Air Force even though it makes little sense. As we’ve argued before in this newsletter, while orbital space is an unmatched vantage point, it lacks some of the basic characteristics of high ground, like cover and concealment.
Let’s Start with Definitions
If outer space is not a high ground or part of a seamless continuum with the Earth’s atmosphere, how do we define military space power? At Takshashila, we took a stab at this problem by first trying to define space power in the broadest sense of the term. As we put it:
“Space power is the ability of a state to leverage its space-related activities to wield influence in international politics. It encompasses commercial, military and scientific activity in space, as well as all Earth-based activities connected to the use of space.”
This is an idea of space power somewhat analogous to maritime power. To get a measure of a state’s maritime power we assess not just its navy, but also its merchant fleets, its trans-oceanic trade relationships, and its wider maritime economy, which may include everything from fisheries to shipping insurance. To measure space power as defined above, we must employ similar metrics as applicable.
However, proud as we are of this definition, we must admit it does not describe military space power. For that, I’m willing to turn to the rough-and-ready but admirably pithy definition offered by John Sheldon and the late Colin Gray way back in 1999. As they defined it, space power was “the ability in peace, crisis, and war to exert prompt and sustained influence in or from space”.
While this definition draws from strategic theory for terrestrial geographies, it is broad enough (encompassing peace, crises, and war) and also lays down two key metrics: promptness and the ability to sustain influence.
Why Military Space Power Theory is so Difficult
Even if this definition is a good place to start, how do we proceed further? In a follow-up article in 2011, the authors identified the impediments to a theory of military space power and some ways forward.
The most important impediment they identified was the novelty of outer space. Theorists of seapower have millennia of empirical evidence from which to draw, and even airpower theorists can build on a century of experience. The limited experience of the space age provides much less to the theorist.
Other impediments, according to the authors, include overly secretive governments, public emphasis on civil space exploration, popular culture (which can trivialise space-related issues), and the challenges of grasping the political meanings of orbits.
To develop a cohesive and useful strategic theory for military space power, they argue that we must respect some basic principles: recognising outer space as a strategic environment, employing ‘universal’ principles of strategy, and remaining pragmatic (in theory, we may consider how earthlings would fight aliens in space, but that would be a profound waste of time).
While these may be wise words, they do not provide us with much direction for the future of Indian space power. However, we can begin by agreeing on a military space doctrine. At the risk of engaging in excessive self-promotion, I would humbly point readers to a space doctrine we proposed for India back in early 2021. While there are peripheral elements of this document I would modify today, I believe its core propositions will continue to hold up well for many years to come.
Keep an eye on these developments in AI:
The AI industry’s energy-guzzling impact on the environment is drawing growing concerns from economists. Read more about it here and here.
Daron Acemoglu writes in NBER on the predicted economic impact of AI in the next 10 years. He predicts that AI will widen the gap between capital and labour income with no more than a 0.66% rise in total factor productivity over 10 years.
The Atlantic, alongside other publishing giants, entered into a business partnership with OpenAI, with editorial content from their publications soon to be referenced in products like ChatGPT.
Singapore announced its Model AI Governance Framework for Generative AI shortly after the draft was announced at the World Economic Forum 2024.
The structure of the EU AI Office was revealed, employing over 140 staff, including Technology Specialists, Administrative Assistants, Lawyers, Policy Specialists, and Economists.
What We're Reading (or Listening to)
[Opinion] Aadhaar, PAN, Paytm, KYC — how fintech regulation is hurting the consumer, by Arindam Goswami
[Takshashila Blog] What did the China-Japan-ROK Summit Achieve?, by Vanshika Saraf
[Podcast] Deconstructing the Indo-Pacific ft. Aditi Mukund, Anushka Saxena, and Felix Heiduk
Loved the way IP financing is introduced. Dramatic, but drives the point so well.