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Commercial Investor's Corner Slingshot Capital Special Features

Intellectual Property Private Credit (Part 1 of 2)

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
Case Developments Consumer

Claimants in Flint Water Case Cautioned Not to Take Settlement Advance

Claimants in the Flint water crisis case have been cautioned by a judge not to seek or accept deals for a cash advance on their share of the settlement. Claimants are set to share the $641 million settlement, though the agreement has not yet been given final approval. The Detroit News details that Judge Judith Levy issued the order after becoming aware of a website targeting claimants. MC Law Funding is offering advances on the expected payouts, inviting claimants to “get paid now.” MC Law has also pursued claimants via text message, according to co-lead class counsel for plaintiffs, Michael Pitt. The claimants, many of whom were personally damaged by the lead present in the city’s tap water, are being warned against excessive, and potentially predatory contracts in order to see their payout earlier. Michigan AG Dana Nessel suggested that accepting an early advance would actually inflict further hardship on those already dealing with the fallout of poisoning. Nessel expressed disappointment that an MC Law would seek to profit from claimants in this highly publicized case. According to Nessel, there are provisions within the settlement agreement that prohibit the use of legal funding for advances on the settlement. Should this type of provision catch on, it could negatively impact legal funders like MC Law Funding.
Commercial Legal Innovation

How Both Legal and Finance Teams Can Grow with Litigation Funding

When funding leader Burford Capital took a long look at the ways legal and finance teams manage legal assets for their companies, they learned a lot. Most vitally, there are three things companies can do to make better use of their legal assets. Burford Capital details that a strong first step is to develop actionable targets for the legal department. Too many companies aren’t making use of their legal assets, which can be used to enhance liquidity and financial stability. Burford, however, believes strongly in this method, and is able to partner companies with experts that can help asses current legal assets and prioritize which should be pursued. Timing is of the essence in legal cases and financial planning. Monetizing claims can allow businesses to predict and control when money comes in, so budgeting is more stable and effective. Duration risk is a real problem, but can be circumvented with monetization. Roughly half of financial officers stated that they did not pursue judgements in 2020 due to cost. Failing to enforce a judgement because of cost might make sense, unless the option exists to shift costs and risks in order to enforce worthwhile claims.
Commercial

Are Investors Confusing Correlation with Risk?

It’s largely agreed that uncorrelated investments are in demand. Given the ongoing impact of COVID, as well as pending inflation, it makes sense to seek out uncorrelated assets. But SYZ Capital co-founder and managing partner Marc Syz, says that some investors may be confusing correlation with risk. International Adviser explains that uncorrelated assets are not impacted by instability in the markets, and are not exposed to macroeconomic volatility. But that does not make them low-risk. In fact, holding too much of the same type of uncorrelated asset can increase risk. As always, it’s safest to maintain a diverse portfolio with an array of traditional investments, as well as uncorrelated assets. Syz recommends three uncorrelated assets worth looking at. They are royalties, life settlements, and litigation finance. Litigation funding is a strong uncorrelated asset for several reasons. Investors can gain exposure to an array of legal case types, jurisdictions, and participants in the cases. Single cases and class actions are the most popular case types, though portfolio funding is increasingly common. Legal funding also increases access to justice when claimants cannot otherwise afford to take their case to court. This makes it a highly ethical investment with a potential for high returns. However, the risks are still very real.
Case Developments Commercial

Chinese Banks Found Not Liable in Nike Counterfeiting Cast

Six banks based in China have avoided liability in their role in the Nike Counterfeit case. The banks were cited for failing to freeze the assets of several hundred counterfeiters of Nike goods. Together, the banks faced sanctions of up to $150 million. Reuters reports that the entity that bought the rights to the default award from Nike, Next Investments LLC, did not abide by the asset freeze mandated by the courts. This went on for more than five years. Representatives of Quinn Emanuel Urquhart & Sullivan represented all but one of the banks, and are reportedly happy with the decision. In 2015, Nike (and their Converse Inc arm) won the default judgement against hundreds of companies and individuals for counterfeiting products. At the time, Judge Shira Scheindlin issued a restraining order freezing the assets of the defendants, and anyone acting in concert with them. Four years later, Next Investments filed to hold the banks in contempt and requested compensatory damages. The motion was rejected based on the separate entity rule. On appeal, Next Investments argued that the separate entity rule was not enacted to provide cover for illegal activity. Judges determined that ultimately, Next Investments did not establish that the Chinese banks were required to enforce the asset freeze.
Consumer Regulatory Issues

New York Post Maligns “Evil” Legal Funding Industry

The Southern District in New York has unsealed indictments against several doctors and attorneys accused of engaging in fraudulent conduct. The defendants have been charged with mail and wire fraud in connection with a plot to gain fraudulent insurance reimbursements. The New York Post has laid the blame for this squarely at the feet of third-party litigation funding. Claims of blackmail, preying on vulnerable claimants, and nuisance claims are ongoing, but lack basis in verifiable fact. Increasingly, funders are experiencing increased regulation both in the US and also globally. It would behoove the ILFA and other professional funding groups to more assertively combat misinformation about the industry.
Announcements Commercial Deals

Investor Group Led By Litigation Funder Drumcliffe Acquires Additional Equity Stake in Odyssey Marine Exploration, Inc. (NASDAQ:OMEX)

An investor group led by asset recovery funder Drumcliffe LLC has purchased 1,138,245 shares in Odyssey Marine Exploration, Inc. (NASDAQ:OMEX) (“Odyssey”), from Epsilon Acquisitions LLC in a private transaction exempt from the registration requirements of the Securities Act of 1933, as amended. The purchase price was not disclosed. Odyssey will not receive any proceeds from this transaction. Odyssey is a deep-ocean exploration company that discovers, validates and develops high value seafloor resources in an environmentally responsible manner. Odyssey has a diversified mineral portfolio that includes projects controlled by it and other projects in which it is a minority owner and service provider. Odyssey is currently pursuing a nearly $3 billion NAFTA arbitration claim against the Republic of Mexico. The claim relates to Mexico’s denial of an off-shore dredging license previously granted to an Odyssey subsidiary for one of the largest untapped phosphate deposits in the world. Drumcliffe has been providing financing to Odyssey to support its arbitration efforts since 2019. “In our view, Odyssey’s recently published Reply to Mexico’s Counter-Memorial in the NAFTA arbitration only reinforces the merits of Odyssey’s claim and the restitution they deserve,” said James C. Little, Drumcliffe’s CEO. Several long-term Odyssey investors and investment funds, including major Odyssey investor FourWorld Capital Management, and Greywolf Capital Management LP are also part of the investor group. About Drumcliffe LLC Drumcliffe LLC is the world’s leading provider of asset recovery finance to the victims of global fraud, corruption, and abuse of power. Additional details can be found at www.drumcliffepartners.com. Forward Looking Information This Press Release may include "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. Certain factors that could cause outcomes to differ materially from those in the forward-looking statements are set forth in "Risk Factors" in Part I, Item 1A of Odyssey’s Annual Report on Form 10-K for the year ended December 31, 2020, and Odyssey’s other filings with the Securities and Exchange Commission. The possible outcomes of the matter described herein will depend upon unpredictable future events, many of which are beyond Odyssey's or Drumcliffe’s control and, accordingly, no assurance can be given that any desirable outcome will occur.
People Moves

Who’s Who Legal’s Thought Leaders in Third-Party Funding

Who’s Who Legal recently assembled a list of movers and shakers in the third-party legal finance industry. They represent a global community of stakeholders advancing the acceptance and adaptability of the industry. Who's Who Legal's highlighted professionals include Julia Gewolb, Director of Underwriting at Validity Finance. Gewolb relies on her extensive legal experience to create an environment where clients can expect a speedy answer on funding compatibility. She emphasizes that legal funding isn’t just for those who struggle financially—it’s also a valued tool for companies looking to mitigate risk.  Co-founder of Profile Investments, Iain McKenny, enjoyed a lengthy career in international disputes before launching PI. He explains that many potential clients are unaware of the differences between legal funding and bank loans—to their detriment. McKenny seeks to educate the public on the benefits of the practice and to increase access to justice.  Alain Grec is also a co-founder of Profile Investments. He emphasizes the flexibility of portfolio funding as a means of money management. Grec is deeply involved in the growth and expansion of PI, as well as the debate between those who support external regulation and those who feel self-regulation is sufficient. Investment Manager and head of the Houston office for Validity Finance, Laina Hammond, is seeing increased demand for funding in oil and gas cases—largely arising from turbulence in the industry. She emphasizes building goodwill by establishing trust. The team at Validity is made up of experienced trial lawyers who put client needs first. Drumcliffe, a fund facilitating recovery of assets for victims of international corruption or fraud, is led by James Little. Little enjoys being a go-to source for fighting fraud. He is impressed by how well the legal industry has adapted to the challenges of COVID, and claims that this allowed Drumcliffe's funds to flourish despite tragedy.  David Kerstein is the Chief Risk Officer of Validity. In fewer than three years, Kerstein helped grow the company from a startup funder with few employees to having $100 million in committed capital, and over $400 million in raised capital. He welcomes the trend of funding being used by companies as a means of mitigating risks, in addition to more traditional funding applications. Validity Finance CEO and Founder, Ralph Sutton, is considered a pioneer in the funding industry. Sutton has lectured on civil justice at Stanford and Harvard Law, among others. He believes that the funding industry is not in need of increased regulation—and that regulation will hinder access to justice, rather than increase it. Ben Moss is a new addition to the team at Orchard Global Asset Management. His background in law and finance have combined to make him a valued asset to Orchard. He points out that the legal and financial merits of a case are equally important factors when determining which cases should receive funding.  In the UK, thought leaders represent the biggest names in litigation funding, including Burford Capital, Litigation Capital Management, Augusta Ventures, Omni Bridgeway, and Harbour. While in France, Profile Investment and Vannin Capital are the sole firms represented.  Globally, Omni Bridgeway has the strongest presence on this list. Burford Capital, Therium, Vannin Capital, and LCM also featured prominently. Unsurprisingly, Australian representation on this list of thought leaders focuses on Omni Bridgeway, Vannin Capital, LCM, and Therium.
Announcements People Moves

Lauren J.Harrison Joins Law Finance Group as Vice President/Investment Counselor

Law Finance Group, a leading commercial litigation finance company, today announced that Lauren J. Harrison has joined the firm as Vice President/Investment Counselor, based in Houston, Texas. Ms. Harrison will work with Law Finance Group’s underwriting and business development teams, where she will focus on evaluating the merits of proposed investments while also identifying and managing growth opportunities in the civil litigation space. “Lauren’s deep expertise in antitrust, intellectual property, and commercial litigation, in addition to her long-standing relationships across the AmLaw 200, will be tremendous assets as we continue to grow our business,” said Kevin McCaffrey, Law Finance Group’s CEO. “We are thrilled to welcome Lauren to our team as we add scale to our platform to take further advantage of the exciting opportunities in the litigation finance markets.” Ms.Harrison joins Law Finance Group after practicing for more than 30 years as a civil litigator for leading law firms int he Houston area. Most recently, she was a Partner in the Litigation Practice Group of Jones Walker LLP, where she represented clients active in the areas of alternative energy development, traditional oil exploration and production, energy infrastructure, chemical and mechanical engineering, software development, entertainment, media distribution, and manufacturing. Earlier in her career, Ms. Harrison worked as a Partner in the litigation departments of Conner & Winters and Vinson & Elkins LLP, and before practicing, served as a judicial clerk to the Honorable Thomas S. Zilly in the U.S. District Court for the Western District of Washington and the late Honorable Eugene A. Wright in the U.S. Court of Appeals for the Ninth Circuit. She received her J.D.fromCornell UniversityLawSchool, where she graduated magna cum laude and was elected into the Order of the Coif, and earned her B.A. degree from Dartmouth College, where she graduated magna cum laude as a member of Phi Beta Kappa. AboutLaw FinanceGroup Founded in 1994, Law Finance Group is a leading litigation funding firm focused on investing in high-value civil litigation opportunities.LawFinance Group partners with law firms and their clients to mitigate risk, improve cashflows, and leverage existing assets in the face of litigation risk. The firm has offices in Mill Valley, New York, and Austin. For more information, visit www.lawfinance.com.