From start-up to maturity, a company’s patent portfolio can serve as a valuable source of financing, such as via patent-backed loans, not only from banks, but sometimes from equity investors. This value can be realized in several ways. For example, your company’s patent portfolio can serve as collateral if the company defaults on loan repayment, can provide lenders with a recordable security interest, and sometimes can be held in escrow until the loan is repaid.
Patents can be designated as collateral for a loan through a “security agreement” that is recorded with the United States Patent and Trademark Office (USPTO), in a similar manner to recording an assignment. If the loan is not repaid, the lender gains ownership of the collateral. Upon successful repayment, the lender issues a “release” of the security interest, which is also recorded with the USPTO.
Accurately valuing a patent or a portfolio of patents used as loan collateral requires a thorough and analytical approach. Security agreements typically include conditions to preserve the value of the patents used as collateral, such as requirements to pay maintenance fees, not assign or exclusively license without consent, and report any detected infringements.
Investors and entrepreneurs should be aware of the implications of security interests, which are typically treated as a lien on the IP and granted to the lender through a clause in the lending agreement. If your company goes bankrupt, the lender can force liquidation, transferring ownership of the collateralized IP to them. The lending agreement will require your company to assist in formalizing and recording a written assignment of any transferred IP with the USPTO.
Investors should be cautious about security interests, as lenders will have senior rights over every investor. In the event of liquidation, these senior rights can wipe out an investor’s financial investment in the startup. Therefore, savvy investors often avoid investing in startups whose IP is covered by a security agreement.
Likewise, savvy entrepreneurs will avoid signing secured notes as they can deter future investments until the loan is discharged. Being aware of these dynamics can help entrepreneurs make informed decisions about leveraging their patents for financing without jeopardizing future investment opportunities.
Leveraging patents for financing can be a powerful tool for startups, but it requires careful consideration and strategic planning. By understanding the mechanisms and risks involved, both entrepreneurs and investors can navigate this complex landscape to their advantage.