The following article is part of an ongoing column titled ‘Investor Insights.’  Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance.  Executive Summary

• Despite its size, the Intellectual property (“IP”) asset class has eluded the attention of most asset managers due to its underlying legal complexities
• The litigation finance industry understands the opportunity, but is solely focused on litigation involving IP
• A void exists in the financing market, which IP-focused Private Credit managers have begun to fill via credit-oriented strategies designed to drive value maximization

Slingshot Insights:

• Secular shifts in the economy have allowed IP to assume an increasing share of corporate value
• IP is an emerging asset class that has begun to garner the attention of asset managers and insurers
• There are various IP-centric investment strategies that do not involve litigation.
• IP-focused Private Credit funds approach IP in a holistic fashion, leveraging numerous ways that IP creates value
• Investors need to be aware that investing in IP presents unique risks that warrant input from operational and legal IP specialists
• IP Credit provides a different risk/reward profile for investors as compared to commercial litigation finance, which tends to have more binary risk

When I started reviewing and assessing managers for potential investment in the commercial litigation finance asset class five years ago, there were a small number of managers that would consider the most complex area of intellectual property litigation, namely patent infringement.  Oh, how things have changed!  Today, there are many litigation finance managers who will at least consider making an investment in IP litigation, although still relatively few that will follow through on providing a commitment. One of the areas in which I am intrigued is the application of credit to intellectual property (“IP”) and using the value of patents (amongst other forms of intellectual property) as security for the loan, the so-called Intellectual Property Private Credit (“IP Credit”) asset class.  While this is, strictly speaking, a credit asset class (as you will see from this article), it sits adjacent to, and sometimes intersects with, commercial litigation finance.  Nevertheless, I do think it is a subset of the broader intangible finance market, and since value is inherently derived from intellectual property, and on occasion, litigation, it often gets lumped in within the legal finance category. In an effort to assess the IP Credit asset class, I reached out to an established manager, Soryn IP Capital (“Soryn”), to obtain a better understanding of how the sector operates and why investors should be interested in this asset class.  Soryn is co-founded by two well-known investors in the IP space, Michael Gulliford and Phil Hartstein, who have a combined four decades of IP experience. Background Despite a major shift in corporate balance sheet asset composition from tangible to intangible in recent decades, stemming largely from the secular shift to a knowledge based (i.e. technology) economy, there has been surprisingly little growth in the number of alternative asset managers with IP-focused investment strategies.  What growth has occurred with respect to IP-specific strategies has largely been confined to the IP litigation finance space.  There, non-recourse capital is advanced from a litigation funder to a claim holder to pursue what is often single event IP litigation, featuring a binary outcome set. The result has been an mis-allocation of risk-adjusted capital to companies and academic institutions in IP-intensive sectors that either do not plan to litigate, or that will be litigating, but only as part of a holistic and diversified business and/or IP licensing strategy.  While these IP owners may seek capital to finance objectives such as non-dilutive growth, technology licensing or royalty audits and monetization, often the IP owner must choose between a litigation funder that does not specialize in broader financial solutions, or a financing source that is not specialized in IP.  Neither option threads the needle to provide what these entities are looking for: an appropriately-structured and priced capital structure solution. Recently, IP-focused managers with credit-oriented strategies have come into focus, as they are targeting this gap in the market.  In addition to Soryn, the hedge fund manager Fortress has an existing IP Credit fund, and Aon is currently raising capital for a debut IP Credit fund (which may have ulterior motives rooted in intellectual property insurance, which is not to say the two can’t co-exist and complement one another). In many ways, these funds resemble a hybrid of private debt and specialty finance, as they have the flexibility to invest across the capital structure through highly-structured debt, preferred, equity, and other bespoke financial contracts. Reflecting their specialization, however, these funds’ management possess an interdisciplinary expertise in IP, and are concentrated on opportunities where the underlying asset value supporting the investment is intellectual property.  Given the flexibility within these strategies, and the skillset of those managing the capital, this new genre of IP-focused investor will likely be an important source of strategic capital available in IP-intensive sectors. IP VALUE PROPOSITION According to recent reports, intangible assets represent ~90% of the S&P 500 market value compared to ~30% in 1985.  Other studies estimate that intellectual property — a subset of the intangible asset class — represents more than a third of the market value of US publicly traded companies. Intellectual property refers to creations of the mind, such as inventions, literary/artistic works, designs and symbols/names/images used in commerce.  The primary forms of intellectual property are:

• Patents: protect inventions and discoveries
• Trade Secrets: protect valuable information that is intentionally kept secret
• Copyright: protect artistic works in a fixed medium of expression
• Trademarks: protect “signs” associating products and services to an owner

While each form of IP offers different protections, the value of each lies in its legally proscribed, exclusionary right that prohibits third parties from practicing or “infringing” the IP without permission.  It is this exclusionary right that promotes a healthy competition and innovation ecosystem by, for instance, incentivizing R&D, encouraging investment, protecting market share, and allowing the licensing of these rights to either a) promote synergistic business relationships or b) stop unauthorized copying. Several data points highlight the value attributable to IP licenses that are struck to promote synergistic business relationships, or to resolve enforcement scenarios. The following statistics help contextualize the significance of the IP value proposition. IP VALUE CREATION IP gains sufficient value to form the foundation for a financial transaction, when third party commercial actors have either begun to use the IP or desire to use it in the future.  When this situation occurs, IP rights can create value in several ways, including:

• IP rights can be licensed to third parties that wish to practice or produce the technology associated with the underlying IP;
• IP rights can be exploited to negotiate cross-licenses that allow IP owners access to sought-after technologies;
• IP rights can be sold to third parties that wish to practice or produce the technology associated with the underlying IP;
• IP rights can be enforced against third parties that are practicing the underlying IP without a license;
• IP rights can serve as the basis for significant insurance policies;
• IP rights can be the principal basis for an M&A transaction, and are a key driver of M&A activity;
• IP rights can be central to value creation following a business separation or spin-off transaction;
• IP rights can facilitate the formations of JVs for co-development of new technologies, which increase enterprise value;
• IP rights can be monetized through the sale of all or part of contracted royalty payments associated with particular IP

In turn, IP owners and managers (e.g.  companies, academic and research institutions, and law firms), can leverage these sources of IP value to raise debt and equity capital in several ways, including: Although IP offers a unique and significant source of value, many owners and managers of IP experience difficulty when attempting to leverage their IP to achieve an appropriate risk-adjusted cost of capital due to the lack of IP expertise, and/or transactional flexibility among the investing community. As such, the new genre of IP Private Credit funds may prove to be an important source of strategic capital available in IP-intensive sectors.  IP CREDIT IP Credit generally involve highly structured, privately negotiated financial contracts of varying types.  Counterparties are often companies possessing valuable IP portfolios, which are underserved by the capital markets. The strategy seeks to provide these IP owners with differentiated financing solutions through flexible and creative structures that offer attractive risk-adjusted returns. Just as private debt funds take different shapes and sizes, so too does an IP Credit fund.  Portfolio composition, while manager or mandate-specific, focuses on financing opportunities across the capital structure wherein IP forms a material component of a transaction’s value proposition.  Where the underlying IP, and/or associated rights or income streams can be assigned predictable licensing, monetization, and/or sale value, various transactions can be structured to leverage or maximize the value of the associated IP. Investment Types Investment types in the Private Credit strategy include senior loans, loans secured by IP, loans secured by legal judgments, loans secured by insurance policies, convertible debt instruments, highly structured preferred equity, common equity, and warrants. The types of credit products involved in an IP Credit strategy are generally not limited. Deal Structuring The duration of Private Credit investments is generally one to five years, and expected returns on these investments will vary based on the existence of negotiated downside protections. The underlying investments in an IP-focused Private Credit Strategy can feature a plurality of terms and structures designed to solve for an appropriate risk-adjusted cost of capital, including:

• Delayed draw funding schedules and performance-based milestone provisions
• Events of default / material adverse event scenarios
• Minimum cash / treasury requirements
• Prepayment protection (make-wholes, yield maintenance, non-call provisions)
• Structural and / or contractual seniority over IP or other assets
• Affirmative and negative covenants / financial covenants
• Warrants or other instruments with equity-like kickers
• IP-backed securitizations
• Credit enhancements via IP-related insurance policies

Industry Focus While the strategy is generally industry agnostic, investments are often placed in IP-intensive industry groups, including technology, life sciences, materials sciences, automotive, semiconductors, telecommunications, biotechnology, and pharmaceuticals.  The hallmark of foundational IP that may serve as the basis for an IP-focused investment are assets protecting key innovations in a field, which an entrant will need to license to practice the technology. Investment Team Managers of IP-focused funds often possess a multidisciplinary IP expertise, with additional expertise in credit or distressed strategies.  Such expertise allows management teams focused on IP-specific strategies to not only appropriately measure risk and value potential, but to appropriately structure such transactions to capture value and mitigate downside.  Management’s IP experience also serves as an advantage when sourcing deals from among counterparties seeking a value-add financial partner with a deep understanding of IP.  In Soryn’s case, for example, co-founders Michael and Phil possess investment, legal and executive experience which allows them to assist counterparties with their legal, operational, and financial strategy planning with the goal of improving the risk-reward profile of the underlying investments. Deal Sourcing Because multidisciplinary IP expertise is a prerequisite for managers in the IP space, barriers to entry remain high and competition for deals is less severe than that of other asset classes.  Typical counterparties involve operating companies (both private and public) and universities that own foundational IP or revenue streams associated with such IP, as well as law firms representing such entities. Use of Proceeds IP-focused Private Credit transaction proceeds may be used for general business purposes and IP-related expenses or investments.  This is an important distinction between IP Litigation Finance and an IP-focused Private Credit, with the latter allowing for significantly greater flexibility in terms of the use of proceeds. Insurability Demonstrating the quantifiable value of intellectual property, the insurance industry has recently introduced products aimed at insuring various aspects of intellectual property.  Such products include:

• Collateral protection insurance for credit deals where IP serves as the collateral package;
• Judgement preservation insurance, to insure against an adverse appellate result following an IP owner trial win; and
• IP litigation insurance, to insure against the associated costs and expenses of being sued for patent infringement.

Not only do such products demonstrate the insurance industry’s growing comfort with IP as an asset class, they also present downside protection scenarios for a variety of IP-centric financings. In the next part of our 2-part series, we will be applying the theory above into practice by reviewing a case study of two financings by a public entity. Slingshot Insights Secular shifts in the economy should be forcing investors to think about value in different ways.  It’s indisputable that intellectual property is clearly the basis for technology company valuations, and therefore value must be attributable to IP when considering financing alternatives.  While understanding the value inherent in intellectual property can be difficult, fund managers with specific expertise exist to allow investors to allocate capital in an appropriate risk adjusted manner. The fact that the insurance industry is now providing insurance products geared toward intellectual property is a testament to how far the industry has come, and how significant the opportunity is, and perhaps much less risky than one would think, if approached prudently. I believe the IP Credit asset class has a bright future ahead, as existing players have had great success producing consistent returns in a sector that one might otherwise believe to be volatile. As always, I welcome your comments and counter-points to those raised in this article.  Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.  Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, investing with and alongside institutional investors. Soryn IP Capital Management LLC (“Soryn”) is an investment management firm focused on providing flexible financing solutions to companies, law firms and universities that own and manage valuable intellectual property (“IP”) assets.  Soryn’s approach employs strategies, including private credit, legal finance, and specialty IP finance, which enable it to invest across a diversity of unique IP-centric opportunities via investments structured as debt, equity, derivatives, and other financial contracts.  The Soryn team is comprised of seasoned IP and investment professionals, allowing the firm to directly source opportunities less travelled by traditional alternative asset managers. INFORMATION SOURCES

• IP-Based Financing of Innovative Firms (OECD)
  • https://www.oecd.org/sti/ieconomy/Chapter9-KBC2-IP.pdf
• Financial Development (World Bank)
  • https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/financial-development
• The Puzzle in Financing with Trademark Collateral
  • https://www.law.uh.edu/ipil/symposium/prior/2018/6778-the-puzzle-in-financing-with-trademark-collateral.pdf
• Patent Aversion: An Empirical Study of Patents Collateral in Bank Lending (1980-2016)
  • https://www.law.uci.edu/lawreview/vol9/Online_Nguyen.pdf
• Insurers are Credit Facilitators
  • https://www.iii.org/sites/default/files/docs/pdf/insurance-driver-econ-growth-053018.pdf
• Asset Based Lending: IP
  • https://www.appraisaleconomics.com/asset-based-lending-intellectual-property/
• The Role of Insurance in Ensuring Financial Market Liquidity
  • https://link.springer.com/content/pdf/10.1111%2F1468-0440.00120.pdf
• Maximizing Intellectual Property and Intangible Assets
  • https://www.issuelab.org/resources/3304/3304.pdf
• Private Credit Strategies (Cambridge Associates)
  • https://caia.org/sites/default/files/0._private_credit_strategies_an_introduction.pdf
• Types of Intangible Assets (ITR)
  • https://www.internationaltaxreview.com/article/b1fyg9wg61n4m9/intangible-assets-in-the-media-and-entertainment-industries-in-depth-analysis
• The Intellectual Property (IP) Audit: An Effective IP Asset Management Tool (Strook)
  • https://journals.sagepub.com/doi/pdf/10.1177/0883911503008001011
• Sanctions for Trade Secret Thieves Part of Senate-Passed Bill (Bloomberg)
  • https://news.bloomberglaw.com/ip-law/sanctions-for-trade-secret-thieves-part-of-senate-passed-bill
• Intellectual Property Theft/Piracy (FBI Website)
  • https://www.fbi.gov/investigate/white-collar-crime/piracy-ip-theft
• Financial Development (World Bank)
  • https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/financial-development
• The Decline of Secured Debt (NBER)
  • https://www.nber.org/system/files/working_papers/w26637/w26637.pdf
• A Century of Capital Structure: The leveraging of Corporate America
  • http://finance.wharton.upenn.edu/~mrrobert/resources/Publications/100YearsJFE2015.pdf
• Why Did Universities Start Patenting (Social Studies of Science, Dec 2008)
  • https://journals.sagepub.com/doi/pdf/10.1177/0306312708098605
• Intellectual Property and the US Economy (USTPO)
  • https://www.uspto.gov/learning-and-resources/ip-motion/intellectual-property-and-us-economy