Maximizing Value from Distressed Portfolio Companies

Transcription

1 Maximizing Value from Distressed Portfolio Companies By John Ciannamea, Senior Advisor, ipcapital Group John Cronin, Managing Director and Chairman, ipcapital Group ipcapital Group, Inc. Page 1

2 Introduction 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. Generally, the failed companies result in a complete loss of investment. 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 sixfigure 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. A follow-up problem is then created by the question of who would be best to help accomplish this. Is it the patent attorney, who wrote up all these cases, or is it the exiting CFO, CEO, or even the investors? Is there a business model or firm that can drive creating value on the IP that is left? The Characteristics of Distressed Companies Distressed companies are all too common today in a post-downturn economy, where investors are unable to renew their funds and companies are not able to grow their top lines. As companies close down there is more pressure for investors to find some way to get value out of their companies before, during, or even after bankruptcy. Distressed companies are not limited to a specific industry or stage; however, between each of them there are some common traits: The company has gone through a lot of cash. The management team is seeking another funding tranche to continue its plan, but the story gets harder and harder to sell. With the economy the way it is, the investors may start to realize, before the company, that raising more funds on the existing losses may not be the best plan. The management team is presenting an overly optimistic turnaround plan. Most CEO s are optimistic about their businesses, and admitting defeat is not in their psychology. The plan hasn t worked up until this point, so the question is then, What can I do differently? Bankruptcy counsel is requesting a prepaid six-figure retainer with no guarantee of success after bankruptcy. Bankruptcy lawyers and criminal defense lawyers always get paid up-front, and both are expensive. If your fund is a secured creditor, you are always asking if it is worth the cost and what you will get out it after the bankruptcy. The company has an unattractive balance sheet. Generally, distressed companies have a large net operating loss which has no way of being leveraged. The balance sheet assets consist mostly of computers and office equipment, manufacturing equipment, and inventory. These assets are generally sold for very little in a bankruptcy or liquidation. The Board is losing confidence in the management team. This was the team selected by the Board and investors, but it is also the team that was unable to deliver results. Also, ironically, the boards of most companies have no idea about the company s patents, trade secrets, know-how, etc., nor their value, or little idea of how to leverage them ipcapital Group, Inc. Page 2

3 Choices for Distressed Companies Traditionally there have been four choices for distressed companies; however, selling or licensing the IP is the option that is often overlooked. The most used options are: The first is to walk away. This option limits losses to current investments and assumes the company is shut down. Usually the intellectual property is one of the last considerations to liquidate because no one knows what to do with it. Sadly, bankruptcy judges or the bankruptcy trustee will try to liquate on a first-come, first-served basis, in a make me an offer transaction. This is so prevalent, in fact, that a number of businesses have sprung up looking for bankruptcies, making a lot of money buying the patents for pennies on the dollar and then reselling them at a large profit. 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, re-bought out of bankruptcy and then turned into a new and then-successful reinvestment. The second is to provide additional funding for the management team 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. The third is to file for bankruptcy. This option requires a significant retainer up-front to engage bankruptcy counsel. You can enter bankruptcy to reorganize, which results in a restructuring of the company, or you can liquidate. In filing for bankruptcy, the amazing thing is that most companies let their people go without first ensuring all IP agreements are signed and that all further 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 3 years old, and often there is other intellectual property that has not yet been patented. Any patent sale or license is done to get access to the technology. Therefore, it is vital to do IP extraction and document control before the bankruptcy. Although it is more difficult, there are many things that one can do to turn around this situation. The fourth is to hire a turnaround specialist. In addition to paying the retainer and success fee for the turnaround specialists, additional funding will be required to implement the plan. Usually, a turnaround specialist is not at all interested in IP and we have very rarely seen one knowledgeable in this matter. However, we have found that turnaround specialists will 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. These have been the options most often considered in a distressed company. But now, there is one additional option -- selling the intellectual property ipcapital Group, Inc. Page 3

4 Intellectual Property the Diamond in the Rough Intellectual property, as has been discussed, 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 intellectual property also exists in contracts and previous licenses that can be resold or leveraged, and sometimes there are grant-back rights in these contracts. Intellectual property 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, a 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. You know that IP is important to your business, 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 of a company because it sets the limits for damages, so it is not surprising that the intellectual property is not valued. ipcapital Group has been working with stakeholders of distressed companies (in any of the four categories above) to maximize the return from the sale or licensing of the IP portfolio or, to identify the IP and determine the value of the IP if a liquidation is imminent. The process is straightforward and takes advantage of existing ipcapital Group tools and systems to determine the strengths of the IP portfolio, identify new IP needed to bolster the portfolio, value the portfolio, develop the licensing strategy, and sell or license the portfolio. ipcapital Group is unique in that it has worked with over 140 start-up companies in precisely this way. The benefits of the ipcg program are: A short strength assessment of the value 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. An extraction of 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 demotivate everyone. A dollar appraisal of 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 from a nominal investment, helping ensure that the company s decision to shutdown is informed with regard to IP value. The company may decide to stay open for 3-6 months further in order to license or sell its IP, when the team is needed to make the sale happen. A list of target buyers and licensees for the IP. Finding buyers is a challenge for the inexperienced, and leveraging the ipcg knowledgebase can provide a qualified prospect list. The program is very a cost-effective alternative, as the ipcapital Group process is much less expensive than bankruptcy ipcapital Group, Inc. Page 4

5 A means to maximize value from the company s assets. Furniture, computers and other office or manufacturing equipment get resold at a great discount. Intellectual property portfolios in the right markets can demand a premium. Case Study In 2005 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 semiconductor company had a patent portfolio in which 2/3 of the patents were invented by the company s employees and 1/3 was 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. ipcapital Group pursued a three-phased plan for this engagement. The first phase began with an assessment and valuation of the portfolio. Each patent was evaluated for its strength and scored. Next, the total portfolio was then 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. ipcapital Group has worked with greater than 10% of the Fortune 500 companies in its consulting practice, so this friendly relationship made it very easy to get through the gatekeepers of these companies to help sell or license the IP. The result of the process was that ipcg was able to sell the IP portfolio in two transactions over twenty 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 any other option previously considered. The investors, all the shareholders, and the inventor were happy with the approach. The investors had wished, had they known this approach existed, that they could have built an even better portfolio that would have allowed them to exit the business even sooner, saving more money and making far more in the sale of the IP. Contact ipcg You can generally tell when a company is heading toward the distressed phase and possible end of its life. Before advancing the last tranche of funds or before allowing management to expend every last dollar, consider a strategy to appraise the value of the IP portfolio and understand your options to liquidate it. Consider selling or licensing the portfolio as a means to receive value. (jcronin@ipcg.com, jciannamea@ipcg.com, ipcapital Group, Inc. Page 5