A practical financing approach for startups in Nigeria: Utilising IP as security

The pivotal role of funding in any project is cannot be over emphasized. In fact, whether you are a country, a fledgling company or a SME, determines in a long way the actualization or limitation of one’s goal. This is the major reason why business take loans in order to get the business going.

For some businesses, raising loans may be seamless because of abundance of assets that can serve as collateral. However, this may be a different scenario for startups and small businesses, because most startup often lack real or tangible property which lenders granting these facilities often require. Given this disposition by lenders, for many IP-rich but cash constrained small businesses and Startups, the traditional financing options like real property or tangible assets may be unavailable or too expensive. It is against this background that article aims to consider Intellectual Property as security for financing startups in Nigeria as well as the legal considerations, benefits and challenges while proffering recommendations.

WHAT IS INTELLECTUAL PROPERTY FINANCING?

The concept of Intellectual Property Law is predicated on the notion that certain products of human intellect should be afforded the same protective rights that apply to tangible assets. This refers to using intellectual property assets as collateral when borrowing money. With the rising importance of Intellectual Property, companies are now utilizing how to use IP for revenue generation and how to leverage their IP to secure funding.

THE PROVISION OF THE STARTUP ACT FOR IP AS A FORM OF A SECURITY

With the rising importance of Intellectual Property, companies are now considering how to use IP for revenue generation and how to leverage their IP to secure funding. Section 28 of the Startup Act makes provision for Startup Investment Fund and specifically, the Credit Guarantee Scheme allows credit to be extended to startups in the country secured by the IP materials of these startups.

FORMS OF IP FINANCING

The financing of a loan by Intellectual Property can occur in several ways. These are;

1. IP-backed loans: This follows the patterns of regular loans, where you offer your assets as collateral to the bank. The organization values the assets and conducts due diligence to ensure your asset meet its liquidity and grants the loan. Security will usually be taken either in the following ways:

a) Legal Mortgage: This is probably the safest form of security transaction where the IP right is registered. It would require that the IP be assigned to the lender, while a license is granted back to the debtor. License-back must contain an obligation on the borrower not to do anything that may damage or reduce the value of the goodwill in the IP. The borrower will retain a beneficial equitable interest in the mortgaged IP with the equity of redemption. The intention here is not to transfer the debtor’s IP to the lender but rather use the IP only as security for the repayment of debt. When IP is used as collateral, ownership usually remains with the borrower. However, a lender may put certain conditions on how the IP can be used in the future. This could affect the ability to transfer to license the IP or transfer it to others.

Lenders will often file notice of their rights – known as a security interest – to the IP in the case of a borrower’s default on a loan. Depending on a country’s laws, a security interest may be filed through a local IP office or a movable collateral registry. If a lender uses IP as collateral that is held in multiple countries, this process may need to be completed multiple times.

b) Charge: This charge created could either be fixed or floating over the debt. A fixed charge is created over specific property of a debtor and attaches to the property from the time of its creation. The charge restricts the rights of the debtor to deal with the charged property, without the consent of the party in whose favor the charge is created. A floating charge is a security over the assets of the company for the time being, i.e. over all or some parts of its present and future property as a going concern. Title and maintenance of the IP secured by the fixed charge will remain vested in the debtor.

Floating charges can be created over the same IP rights as a fixed charge, though usually a floating charge is purported to be taken over IP rights that cannot be identified individually such as unregistered IPs. Unregistered IPs do not often make for good security. Section 3 Trademarks Act (TA), Cap. T13, LFN 2004 for instance provides that no person shall be entitled to institute any proceeding to prevent, or to recover damages for the infringement of an unregistered trademark. However, this is different in the case of copyright as a work, once created, becomes automatically copyrighted.

c) Securitization: Asset securitization is the practice that allows a company, called the originator, to pool assets with a predictable stream of income, and repackage or convert them into interest-bearing and marketable security to raise financing for its business. The pooled assets will be sold to an issuer, which is usually a special purpose vehicle (spv) that will then issue them as security to investors.

Therefore, IP securitization is the practice of pooling IPRs and assigning the royalties due on the IPRs to an SPV in exchange for capital. To protect the interest of the lender or creditor in the securitization of IP rights, the lender must conduct proper due diligence to ascertain the quality of the IPRs assigned, since the lender may not have recourse to other assets of the borrower. Thus, the quality of IPRs, whether they are performing, or non-performing would assist the lender in making its final decision.

CHALLENGES OF SECURITIZING LOANS WITH IP IN NIGERIA

1. Valuation: This is the major problem of securitizing loans with IP assets. IP assets are intangible in nature, and it can be challenging to value IP assets, especially for newly registered assets. Additionally, there is also the problem of uncertainty, as IP assets may prove to be inadequate security when the company doesn’t get going or lacks liquidity. For IP assets to qualify as a security, they must be income-generating or show the potential to bring in money. However, not all IPRs, even when registered, can pass the liquidity test.

2. Registration: Most times, to enjoy the full benefits that accrues under IP, IP rights require registration before the owner can fully monetize or prevent their use. For instance, the Nigerian Trademarks Act 2004 prevents any person from instituting proceedings to prevent or recover damages for the infringement of an unregistered trademark. For this reason, lenders are wary of accepting unregistered IP assets as security.

3. Piracy and Infringement: Protection of IPR remains a huge problem, particularly in developing countries like Nigeria, where the awareness and enforcement of IP laws are low. Pirated copies of copyrighted works flood the market, and IP owners have to fight infringers of their rights to secure any chance of profiting from their own work. Lenders are unwilling to take on this responsibility as combating IP infringements requires much effort and capital.

4. IP protection in Nigeria: As mentioned above, protecting IPRs in Nigeria is tedious. While several laws recognize the right of creators and inventors to exclusively reproduce and monetize their works, implementing these laws remains a major challenge. For instance, the now-repealed Copyright Act of 2004 made no provision for digital works. There is also the problem of awareness, as large sections of the population need help understanding why IP laws exist or how they work. This makes it difficult for registered and unregistered IP owners to secure rewards for their innovation as provided by law.

PRECAUTIONARY MEASURES FOR IP FINANCING

1. Due Diligence: The investors willing to use the startups intellectual property right should carry out the necessary due diligence. Some important issues that the Due Diligence should cover include:

Are the IP rights legally owned by the debtor (as opposed to being used under a license from the owner)?

Have all cost related to registered IPs been paid to protect their registration status

Are there any pending liens, foreclosures, or other types of claims against the IP rights?

Is the remaining term (with renewals if applicable), subject to expiration (like patents and trademarks) adequate for the security transaction?

2. Valuation of the IP: This is probably the most significant precautionary measure to be utilized in using IP as security. A poor valuation (overvaluation or undervaluation) of an IP might have a detrimental effect on the entire arrangement. Factors relevant to the value of any IP right will include the type of right, its strength, the number, and the value of the similar products on the market, the cost of maintaining and policing the right, and the potential to license or sell the right to others in the market. It is worth noting that a considerable gap often exists between the value of IP assets examined for collateralization and the value of IP assets following a default

STEPS TO INTEGRATE IP FINANCING FOR STARTUPS IN NIGERIA

1. IP Registration: In order to secure funding, registering your IP rights should be the first step. IP rights cannot be granted over ideas, and these ideas only become assets when you take reasonable steps to register them as applicable. The possibility of generating revenue from licensing and other commercialization strategies makes it appealing to lenders as IP constitutes a potential source of income that might be used to pay back the loan. Registration also allows you to bring actions against infringers and grants you exclusive rights, which you can subsequently use as security for loans.

2. Insurance: Insuring your IP assets also shores up their valuations. You can insure your IP assets against loss, infringements, and risks like tangible assets. IP insurance firms also allow you to secure the valuations of your securitized IP assets.

3. Awareness: One major challenge inhibiting the growth of Intellectual Property is lack of awareness among the general populace in Nigeria. This can be achieved using legislation, awareness drives, and sensitization. The utilization of IP assets as security and protection of IP rights is relatively lower in Nigeria than in other advanced parts of the world due to several factors, including illiteracy and low-income earning capacity. Regulatory bodies like the National Copyright Commission, the Trademarks Registry and Patent Offices, and other stakeholders in the IP industry can do more to raise awareness and knowledge of IP laws in the country.

4. Legal recognition/framework of IP securitization: Legally recognizing IP assets as collateral will also go a long way in increasing the adoption of IP Financing in Nigeria. While the current IP framework recognizes the assignment and licensing of IPRs, more must be done to facilitate IP Financing. Nigeria needs to take cue from other country. An example is the Kenyan Movable

Property Security Rights Act of 2017 which provides for the securitization of intellectual property assets, allowing startups and businesses to access funding using their intellectual property.

Although, Nigeria has a law on security of asset, it is only limited to tangible assets, that is the Secured Transactions in Movable Assets Act. Nigeria could model a law that extends to intangible asset using the Singaporean Government IP Financing Scheme. This law stemmed from a collaboration between the Singaporean government and the Institute of Valuers and Appraisers (IVAS) which developed a guideline for the valuation of IP assets.

5. IP Exchanges: This follows the stock exchange modus. The creation and licensing of IP exchanges may also allow businesses to raise capital. IP exchanges list intellectual property assets in units, granting the IP owners to a vast pool of investors. Existing models include the Hong Kong Intellectual Property Exchange (HKIPEX) and Asia IP Exchange (AIPEX), which make IP valuations and offer verified assets to the public while charging commissions on trades.

BENEFITS OF INTELLECTUAL PROPERTY AS SECURITY

1. There is an increased appetite for repayment by startups because IP assets are essential to the company’s business operations. This favors the lender as the borrowing company would love to keep its most treasured assets.
2. IP assets, unlike tangible assets which require periodic maintenance, offer future marketability and appreciation
3. Securitizing loans with IP financing allows a company to raise capital without creating excess interest on its physical assets.
4. IP assets also offer the benefit of being calculated on future projections, especially for patents or copyrights in movies and music. For instance, a producer could raise money for a new movie using his copyright in the yet-to-be-produced movie as collateral.
5. IP financing also allows companies to raise more capital than their fixed assets would typically secure.
6. By using IP as collateral, business can avoid giving up equity in exchange for funding. This can help maintain ownership and control over the company’s trajectory

CONCLUSION

Securitizing IP in Nigeria as a financing mode will remain a theoretical concept unless we become intentional towards actualizing it. Nigeria is estimated to have one of the highest number of startups in Africa, a creative force that led to $2 billion in funding between 2015 and 2022. However, till date there is no mention of creating a charge IP on the website of the Trademarks, Patents and Designs Registry – the office that should ‘theoretically’ receive charges that have been created over IP.

The judiciary also has a role to play in order to fully leverage the securitization of IP. Due to its intangible nature, its infringement may go on without the knowledge of the alleged owner – but who upon becoming aware should be able to bring a claim, and which should be decided timeously. Thus, the timely and adequate intervention by our courts can protect the use of IP as security. Where awareness is created by the judiciary and where it is being swift to act in cases of IP breach, more people would begin to see the potential for securitization in IP

Article written by Deborah Dada. Deborah is an associate in the Fiscal and Finance Practice group at the Trusted Advisors