Government sets the stage and enterprises and banks put on the show. This is the basic model of intellectual property financing in Beijing. In this show, there is an important act – evaluation of the pledge. However, at present, an industrial standard for IP evaluation has yet to be formulated. Many evaluation authorities are perfecting their evaluation reports to gain the trust of banks. 

Beijing Liancheng Assets Appraisal Co., Ltd., is the first evaluation institution in Beijing involved in intellectual property financing. In this Special Report, we invited the general manager of the company, Mr. Liu Wutang, to elaborate on the topic and share with us his opinions.

We all know that since China’s reform and opening up, numerous small and medium -sized enterprises have sprung up and developed quickly. Their economic and social contributions have increased annually. The value of products and services created by these enterprises accounts for 58% of GDP, commodities produced by account for 59% of social sales value, and the taxes paid by these companies’ account for 50.2% of the country’s total tax revenue.

Despite these huge contributions, financing difficulties have always been a barrier that restricts the development of these small and medium-sized enterprises. According to the author, there are three factors that are generally recognized as the reasons for these financing difficulties. The first factor is the limited financial channels available to these businesses. The second is the lack of tangible assets. To avoid risks, banks impose many restrictive conditions on small and medium-sized enterprises when they apply for loans. One important requirement is that they must use their land, factories, or other tangible assets as a pledge against the loan. However, for these companies, especially for technology-based companies, land and factories are exactly what they lack. Such a requirement is equivalent to their loan application. Third, China’s guarantee system must still be improved.
 
To solve these problems, many people suggest using intellectual property as a pledge for loans. Such a practice has been put into use in Beijing and the method used to other cities. However, when intellectual property plays the pledge’s role, it raises many other problems, especially how to calculate the value of the intellectual property. Difficulty in IP evaluation has become the major barrier to the development of intellectual property financing.

As a professional organization offering intangible asset evaluation, Beijing Liancheng Assets Appraisal Co., Ltd. has accumulated a rich experience in evaluation practices, and has its own views about the problems raised by intellectual property.

Special characteristics of IP as a pledge for financing

Compared to traditional evaluation practices, the evaluation of intellectual property that serves as a pledge for a loan has special characteristics, such as transferability, cashability, and locality. Therefore, to control risks in practical works, steps must be taken to consider all of the factors that will influence intellectual property’s value, pay special attention to these three “-alities,” and consider them as special risks in IP financing.

Regarding the three risks, the author thinks that cashability is easy to understand. Transferability means that patent technology, as the mental achievement of a human being, is a technological commodity, subject to technological trade by the way of ownership transfer or use of right transfers. This is the basis for patent technology evaluation.

Locality can be understood as a reference to the fact that intellectual property law is a country’s domestic law. A patented technology confirmed and protected by one country’s law is only in effect within the region of that country. On the other hand, patent technology, as a major part of intellectual property, is only effective for a given period of time. This specific effective time frame is defined by each country’s patent law. Once the validity period expires, patent technology becomes a public wealth that everyone can have access to. (According to China’s Patent Law, the term of protection for a patent of an invention is 20 years, and 10 years for utility model and design patents.)

Three factors influencing IP evaluation

We shall pay attention to three factors that will influence the value of intellectual property as the pledge of loan:

1. Legal factors

In addition to an analysis of the protective range, legal status, and IP type in a conventional IP evaluation process, an evaluator must also pay attention to the influence of the following factors for IP-pledged loans: 

a. Ownership and effectiveness of the pledge on the date the pledge is made

Take patent pledging as an example. It is known that what is recorded in the patent certificate is the information known on the day the patent right is granted. It does not contain any information about subsequent changes of ownership, licensing, or changes of effectiveness. In our practice, we have also encountered the following problem: the patent right owner, due to his ignorance of the various different licensing types, licenses the use rights to the patent to be valuated by another person, and then charged this person the total licensing fee. In this case, the patent owner still enjoys ownership over the patent, yet has lost the right to seek a loan by pledging the patent as collateral.

b. Stability of ownership of the pledge

Ownership of a utility model patent is not stable, because it has not undertaken any substantive examination. The valuator must ask the loan applicant to provide a novelty search report issued by SIPO to guarantee the stability of the patent. Ownership of a trademark is relatively more stable compared to that of a utility model patent, but we must still pay attention to the variance in it. 

c. Control over several core technologies for one product by different right owners

A pledge’s cashability is seriously affected by the pledge’s inability to form a product independently and the loan applicant’s powerlessness over operating the patents owned by other economic entities under the same group. Consequently, the pledge’s value is affected. Therefore, the valuator must take the condition of “several core technologies of one product shared by different right owners” into full consideration when he evaluates a pledge.

Furthermore, the valuator must determine whether the intellectual property to be pledged is entangled in any right disputes or invalidity suspicions, or whether the use of intellectual property must be in combination with proprietary technologies, or whether the payment of the patent’s annual fee or trademark renewal fees during the pledging period will pose any risks in rights or law.

2. Factors concerning patent technology and trademark maintenance

When the intellectual property is used for the purpose of securing a  loan, only proven patent technology and trademarks can receive loans from banks. Patent technologies still under research and development (R&D), due to the associated high risks, are usually rejected by banks. However, some patent technologies in the R&D process, due to their high potential value and high predicted cashability, can also serve as the pledge after the potential risks are fully studied. The technology factor (or trademark maintenance when trademark is the case) has certain effects on the evaluation of intellectual property when it is to be pledged for a loan. 

a. Relationship between product’s profitability and the pledge

Generally speaking, the value of intellectual property is realized by profiting from relevant products and services. We have a data model to determine the qualitative relationship between the pledged IP and the associated product’s profitability after a full comprehension of the pledge’s several characteristics. Here, we have an example. A company in Xiamen specializing in the production of women’s handbags has neither factories nor a sales force. However, in as few as three years, it has amazingly increased its sales income from several million to 100 million Yuan. This company adopted the Pierre Cardin-styled brand operation model. Trademark is its most important and indispensable asset. With a full understanding of the trademark and the data model stated before, we finally determine the qualitative relationship between pledge and product’s profitability.    

b. The influence of alternative technology upon the valuated IP

When we valuate intellectual properties for secured loans, we realize that an analysis of alternative technology is a must. By using a patent map or some type of technology trend analysis software, valuators analyze the possibility of the emergence of alternative technology for the patent technology to be pledged, so as to predict the possible changes in value during the duration of the loan.  

3. Economic factors

The principle of prudence must be applied during the evaluation process. The value of the applicant’s pledge must be based on its practical use, instead of any potential use. In addition to this, the valuator must pay attention to the following aspects of the loan applicant:  

a. The division of financial data of the pledge-related product and the company’s overall financial data

A paper mill in Shandong has a patent technology, which every year saves the mill millions in the cost to dispose production related waste products. When the bank received the mill’s loan application with this patent technology as its pledge, the bank was confused by how to divide the value of the technology owned by the mill from the value of the mill, in order to make the pledge independently operable. After we studied the mill’s manufacturing technique and procedures, we determined that the value of the technology was mainly represented by lowering the mill’s operation costs. Then, we divided the technical value of this technology from the enterprise’s value and finally determined the value of the pledge.   

b. Selection of the discount rate

Another issue in loan-based IP evaluation that valuators must keep in mind is that to select the yield life, the valuator must consider the influence of the loan’s term.

Now, valuating companies can do the most of the work during the evaluation process. Regarding the legal issues of intellectual property, valuating companies will cooperate with professional IP law firms. In IP-pledged loans, lawyers from law firms provide a professional analysis and offer conclusions regarding IP-related legal issues, and offer the lending bank their legal opinions with legal effect. This is to guarantee the ability to solve legal problems related to intellectual property when it serves as a loan pledge.

About the author:
Liu Wutang is the General Manager of Liancheng Assets Appraisal Co., Ltd.

(Translated by Hu Xiaoying)