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NOVEMBER/DECEMBER 2008
VOLUME 5, NUMBER 6
Is Issuing IP Bonds a
Good Move forYour
Company?
By Scott Slavick
TRADITIONALLY, INTELLECTUAL PROPERTY management has been considered
one of the most important responsibilities of a corporate officer. More recently,
pressures have increased to the point where old notions about managing the
company’s intellectual property are no longer enough, and
corporate officers are being asked to do more to increase
profitability.
One way some companies are trying to increase value is
by issuing bonds based on their most valuable intellectual
property. These “IP bonds” could be instrumental in unlocking corporate fortunes and significantly changing the way
financial analysts view and value companies.
Singer David Bowie is credited by many with initiating
the IP bond craze when he issued $55 million worth of IP
bonds in 1997. The interest on Bowie’s IP bonds was backed
by royalty payments from over 300 song titles.
Since then, a number of other IP bonds have been issued
using similar methodology, i.e., relying on outside income
streams. Issuers have included film studios issuing IP bonds
backed by future revenue streams; clothing designers and retailers issuing IP bonds backed by outside licensing fees; and restaurant chains issuing IP bonds backed by franchising fees.
Recently, Sears may have raised the issuing of IP bonds
to the next level by creating income without relying on outside income streams. It did so by potentially creating over
$1.8 billion dollars worth of securities based on three of its
key brands: Kenmore, Craftsman and Diehard.
How did Sears do this? It began by incorporating a separate, wholly owned bankruptcy-remote subsidiary, called
KCD IP (for Kenmore, Craftsman, DieHard Intellectual
Property). Sears then assigned ownership of the Kenmore,
Craftsman and Diehard brands to KCD IP. Now, KCD IP
charges Sears royalty fees to license those three brands and
uses the royalties to pay interest on $1.8 billion worth of IP
bonds. KCD IP sold the IP bonds to Sears’ insurance subsidiary, where, like any other security on an insurer’s books,
the IP bonds serve as protection against future loss.
In addition, the insurance subsidiary protects Sears from
financial trouble – and because it is a subsidiary, it insures
Sears at much lower cost than Sears would have received
from an outside insurer. In the end, from Sears’s standpoint,
Sears’ payments net out to zero because Sears owns KCD IP
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and the insurance subsidiary.
It’s important to note that Sears’ IP bonds take things
one step further than previous IP bond issuances. Unlike
Bowie’s IP bonds, Sears’s bonds do not involve outside preexisting royalty payments or other outside revenue streams.
Instead, Sears flipped the script and created internal payments to itself, through its subsidiary, in order to issue its IP
bonds. In essence, Sears created value, i.e., money, from
within, as opposed to value from the outside.
Other entities are also getting in on the act. For example,
NexCen Brands is attempting to build an entire business model
around a similar method of securitizing intellectual property.
Using debt and proceeds from a public offering, NexCen
Additional potential benefits to issuing IP bonds include
allowing the issuer to shift some of the brand owner’s risk
associated with licensing its intellectual property. Assuming
the financing is non-recourse, the IP bond issuer’s risk of not
receiving royalty payments from a licensee is transferred to
the investors through issuing the IP bonds.
Also, some of the risk associated with intellectual property infringement would also be shifted by the IP bond issuer
to the IP bondholders. Moreover, any upside potential residing in the intellectual property would be retained by the IP
bond issuer for use in future financing or sales.
Proper valuation of the subject IP is crucial. Without
accurate valuation, proper investment decisions and, perhaps
Proper Valuation of the IP is crucial. Without it
successful marketing of the bonds is not possible.
acquired the Athlete’s Foot chain, Bill Blass apparel and the Maggie Moo’s and Marble Slab Creamery ice-cream stores. NexCen
then created an entity to hold the brands and issue IP bonds.
It should be noted, however, that issuing IP bonds is not
without risk to the IP bond issuer. For example, if the IP
bond issuer were to declare bankruptcy, it could be putting
the ownership of its key brands beyond its reach because,
remember, the IP bond issuer is issuing the IP bonds to itself.
Thus, instead of going to the IP bond issuer, in bankruptcy,
the brands covered by the IP bonds would go to an outside
third party insurer. However, many IP bond issuing companies may be willing to take that risk to create such lucrative
additional revenues from pre-existing resources without the
need for outside revenue streams.
There are a number of things that a company issuing IP
bonds could do with its newly created source of capital,
including: (1) sell the IP bonds and use the proceeds to fund
acquisitions or pay down previously incurred debts, (2) trade
the IP bonds for the debt of another company to obtain ongoing revenue streams, (3) hold the IP bonds and allow them
to grow in value, and (4) license the brands covered by the
IP bonds to third parties.
Allowing outside manufacturers to create products
using the licensed brands in return for royalty payments, for
example, could potentially increase the issuer’s profits without any additional expense. In fact, these payments would be
almost entirely profit for the IP bond issuer.
more importantly, successful marketing of the IP bonds to
third parties once issued, is impossible. Whether a company
chooses any of the currently most popular IP valuation techniques – that is cost, income, market or options-based valuation – the bottom line is that any company considering
issuing IP bonds must spend the time and money needed to
accurately value its IP and the potential for its IP bonds
before issuing them.
Doing so will help any subsequently issued IP bonds
withstand the inevitable scrutiny from potential third party
investors. As noted, outside investors of IP bonds bear a
great deal of risk, and they may be inclined to bear such risk
only if they are thoroughly convinced of the underlying IP’s
agreed-upon value. Indeed, as IP bonds become more commonplace, proper and accurate IP valuation will only
become more important.
Any company with intellectual property could be in a
position to unlock value by issuing IP bonds. Even with the
risks, determining whether issuing IP bonds is the right move
for your company appears to be a step worth taking.
Scott J. Slavick is a shareholder at the intellectual property firm Brinks Hofer Gilson &
Lione. His practice focuses primarily on trademark prosecution and litigation. He is co-chair
of the firm’s Transactions Department and
chair of the firm’s U.S. Trademark Prosecution Committee.
Reprinted with permission from Executive Counsel, November/December 2008. On the Web at www.executivecounsel.info.
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