Collateral Salvage

The collateralization of intellectual property has emerged as a new credit-enhancement tool for asset-based lenders. Will it catch on with corporate finance chiefs?

Asset-based lenders are in a tight spot, and CFOs looking for bigger loans for their employers are in a position to benefit from the lenders’ predicament.

With corporate cash balances bulging, a general oversupply of capital-market liquidity, and hedge funds and other new entrants taking bites out of the asset-based lending (ABL) business, traditional lenders are competing fiercely for the attention of finance chiefs.

Lenders are groping for ways to stand out. One way for ABLs to distinguish themselves is to boost “borrowing-base availability,” says David Peress, an ABL expert and principal at XRoads Solutions Group, a turnaround firm. Borrowing-base availability is the amount of money a lender determines it can make available to a company based on the value of the borrower’s collateral and its risk profile. If lenders offer more money at the same borrowing rates, they’ll win business, adds Peress.

And one way of stretching availability is by using intellectual property (IP) as collateral for a piece of the loan. Although it’s a relatively new idea, IP collateralization has already increased available credit in a few cases over the last several years.

Typically, asset-based loans are secured with hard assets, including such collateral as inventory, receivables, real estate, and equipment. In an IP collateralization deal, however, the borrower pledges its intangible assets — such as patents, trademarks, and copyrights — along with its tangibles. As a result, the value of the collateral pool is increased. A more valuable collateral pool means greater availability and thus the potential for a bigger loan.

The problem, however, is that lenders tend to be wary of using intangibles as collateral because of the difficulty in placing a value on such assets. The trick in some of the new deals has been to treat intellectual property as a “credit enhancer,” rather than the bulk of the collateral.

Consider last year’s deal between Wise Foods Inc. and GMAC Commercial Finance. In October 2004, Wise, the maker of Wise Potato Chips and Cheez Doodles, closed a five-year, $43 million asset-based facility underwritten by GMAC. Included in that amount was $7 million in credit-enhancement backing by IP Innovations Financial Services Inc.

The deal separated the loan into two tranches: $36 million collateralized by the hard assets and $7 million using the IP as backing. The borrowing rates were the same for both tranches.

Charlotte-based IP Innovations, a four-year-old spin-off of the Principal Financial Group, worked with GMAC and Wise to increase the value of the snack company’s collateral pool by adding IP assets to the mix, without forcing GMAC to take on more risk then it was comfortable underwriting.

For its $7 million guarantee, IP Innovations accepted a portion of Wise’s IP as collateral. In general, IP Innovations takes a small percentage of the interest payments to the lender. Wise officials declined to discuss what percentage of the company’s IP collateral was used in the deal.

In the event of a bankruptcy, IP Innovations would pay GMAC what’s owed on the $7 million tranche and could foreclose on the IP collateral Wise pledged in the deal. Once IP Innovations foreclosed on the IP, it could liquidate the intangible assets to recoup its investments. Currently, none of the borrowers involved in the IP Innovations deals have filed for bankruptcy.

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