Maximizing Value from Distressed Portfolio Companies

If you have been managing venture capital or private equity investments for more than a few years, you’ve undoubtedly faced the question of what to do with a distressed company.

The rule of thumb is that approximately one-third of the companies in a venture capital portfolio will fail. The path to the decision to shut down a company is slow and agonizing, and there is a lot of debate for a solution and a means to an exit. How many times have you been at a board of directors meeting and heard management say, “If we had another $1 million we could… ”?

Or how many times have you heard management report that, “Bankruptcy counsel requires a prepaid six-figure retainer to file for bankruptcy so that we can …”?

When these conversations occur, the options aren’t very appealing, but there is one option that is often overlooked: to leverage the intellectual property (IP) in a sale or license.

The traditional approaches to dealing with distressed companies have been to:

• Walk away and limit losses. Usually the IP is one of the last considerations to liquidate because no one knows what to do with it. Often, bankruptcy judges or the bankruptcy trustee will try to liquidate on a first-come, first-served basis, in a “make me an offer” transaction. This is the point at which the most valuable intellectual assets, the key people, the trade secrets and the know-how, are either totally lost or, worse yet, purchased out of bankruptcy and then turned into a new and then-successful reinvestment.

• Provide additional funding for management to reach a specific set of objectives. This is often most risky and thought of as throwing good money after bad. The management team has not delivered up until this point and it is questionable whether it can deliver with a new plan. It would be far easier to make the additional investment if you knew that the IP could be backstopped by a patent sale or license as well as ensure that the new funds were “required” to develop further IP.

• File for bankruptcy to reorganize or liquidate. This option requires a significant retainer up front to engage bankruptcy counsel. In filing for bankruptcy, companies often let their people go without first ensuring all IP agreements are signed and that all IP is extracted and documented. Many times the company’s patents are just the tip of the iceberg in value. A patent that is issued is generally at least three years old, and there may be other IP that has not yet been patented. Any patent sale or license is done to provide “access to the technology.” Therefore, it is vital to do IP extraction and document control before the bankruptcy.

• Hire a turnaround specialist. In addition to paying the retainer and success fee for the turnaround specialist, additional funding will be required to implement the plan. Usually, a turnaround specialist is not very interested in IP and is most likely not knowledgeable in this matter. However, turnaround specialists generally welcome value-adders like IP, and because they are not emotionally attached, they can actually make clearer decisions with regard to leveraging the IP of the company (or investing a bit more in it to protect the downside). What is required here is good factual information on value and comparables.

In a distressed company, the IP portfolio may be the most valuable asset, and yet most distressed companies do not make an attempt to sell or license the portfolio.”

These have been the options most often considered in a distressed company. But there is one additional option: selling the IP.

Selling IP

Intellectual property represents the issued patents, non-issued but applied-for patents, provisional applications, inventions documented but not yet sent to the patent office, trade secrets of the key areas of the business, know-how, and key people. Sometimes IP also exists in contracts and previous licenses that can be resold or leveraged, and sometimes there are grant-back rights in these contracts.

IP is often not well-understood by the company and, therefore, gets undervalued or even lost. In a distressed company, the IP portfolio may be the most valuable asset, and yet most distressed companies do not make an attempt to sell or license the portfolio. From an investor’s standpoint, licensing of the IP is as good as a sale because the investors can collect royalty checks and not have to keep the company afloat.

It is given that IP is important to most businesses, but from an accounting standpoint it is generally shown on the balance sheet based with a value equal to the cost to acquire the patents. Most companies do not appraise their IP portfolio or consider it as an asset to generate cash. In general, IP is not valued on the balance sheet because it sets a dollar figure that can be used later in a license or litigation, which may minimize its real value. The lawyers in litigation would hate to see a patent valued in the balance sheet because it sets the limits for damages, so it is not surprising that the IP is not valued.

To extract the value from the IP, you need to:

• Assess the strength of the IP. Here it is important to do a short strength analysis before any further time or money is spent. Many times this strength check will provide an expert view on value for the investor, to help make further decisions of what to do or at least know whether the IP has value.

• Extract the existing IP, documented or not. This clearly updates the IP as well as ensures you own it before further negative actions are taken with the business which can de-motivate everyone.

• Appraise the value of the IP portfolio. This is an important step that provides much needed information to the board and management so that all options can be properly weighed. It provides an understanding of the potential upside for key stakeholders helping ensure that the company’s decision to shut down is informed with regard to IP value.

The result of the process was that the IP portfolio was sold in two transactions over 20 months, which resulted in over $8 million going to the stakeholders.”

• Target buyers and licensees for the IP. In this step, targets are qualified so that the sales cycle time is minimized.

• Sell or license the IP. The last step is convincing the buyer of the value proposition and closing the deal. Furniture, computers and other office or manufacturing equipment get resold at a great discount, while IP portfolios in the right markets can demand a premium.

Case Study

Our company, ipCapital Group, was engaged by a fabless semiconductor company to assist with the liquidation of its IP portfolio. The company’s funding was derived from several institutional investors and it had a net operating loss of $20 million. The investors did not have a clear path to an exit and the board was not satisfied with the traditional options.

The company’s IP portfolio consisted of patents invented by the company’s employees and patents licensed from a university. The institutional investors were secured creditors. The choice had been made to wind down the company and, when ipCapital Group arrived, there was only the CEO and a relationship to the inventor.

A three-phased plan was pursued for this engagement. The first phase began with an assessment and valuation of the portfolio. Each patent was evaluated for its strength and given a score. Next, the total portfolio was valued. The valuation took into account various market opportunities, products and rates for similar patents. Lastly, a licensing strategy was developed and key companies were targeted.

The result of the process was that the IP portfolio was sold in two transactions over 20 months, which resulted in over $8 million going to the stakeholders. The board of the company commented that this return was much better than could have been expected through bankruptcy reorganization or other options previously considered. The investors had wished, had they known this approach existed, that they could have built a better portfolio that would have allowed them to exit the business even sooner, saving money and making far more in the sale of the IP.

When a company is heading toward the distressed phase and possible end of its life, consider a strategy to appraise the value of the IP portfolio and understand your options to liquidate it. Consider selling or licensing the IP portfolio as a means to receive value.

John Cronin is Managing Director and Chairman of ipCapital Group. He spent over 17 years at IBM and became its top inventor with over 100 patents and 150 patent publications. Cronin may be reached at jcronin@ipcg.com. John Ciannamea is a Senior Advisor to ipCapital Group. He may be reached at jciannamea@ipcg.com.