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Commercial Slingshot Capital Special Features

Intellectual Property Private Credit (Part 1 of 2)

By John Freund |

The following article is part of an ongoing column titled ‘Investor Insights.’ 

Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance. 

Executive Summary

  • Despite its size, the Intellectual property (“IP”) asset class has eluded the attention of most asset managers due to its underlying legal complexities
  • The litigation finance industry understands the opportunity, but is solely focused on litigation involving IP
  • A void exists in the financing market, which IP-focused Private Credit managers have begun to fill via credit-oriented strategies designed to drive value maximization

Slingshot Insights:

  • Secular shifts in the economy have allowed IP to assume an increasing share of corporate value
  • IP is an emerging asset class that has begun to garner the attention of asset managers and insurers
  • There are various IP-centric investment strategies that do not involve litigation.
  • IP-focused Private Credit funds approach IP in a holistic fashion, leveraging numerous ways that IP creates value
  • Investors need to be aware that investing in IP presents unique risks that warrant input from operational and legal IP specialists
  • IP Credit provides a different risk/reward profile for investors as compared to commercial litigation finance, which tends to have more binary risk

When I started reviewing and assessing managers for potential investment in the commercial litigation finance asset class five years ago, there were a small number of managers that would consider the most complex area of intellectual property litigation, namely patent infringement.  Oh, how things have changed!  Today, there are many litigation finance managers who will at least consider making an investment in IP litigation, although still relatively few that will follow through on providing a commitment.

One of the areas in which I am intrigued is the application of credit to intellectual property (“IP”) and using the value of patents (amongst other forms of intellectual property) as security for the loan, the so-called Intellectual Property Private Credit (“IP Credit”) asset class.  While this is, strictly speaking, a credit asset class (as you will see from this article), it sits adjacent to, and sometimes intersects with, commercial litigation finance.  Nevertheless, I do think it is a subset of the broader intangible finance market, and since value is inherently derived from intellectual property, and on occasion, litigation, it often gets lumped in within the legal finance category.

In an effort to assess the IP Credit asset class, I reached out to an established manager, Soryn IP Capital (“Soryn”), to obtain a better understanding of how the sector operates and why investors should be interested in this asset class.  Soryn is co-founded by two well-known investors in the IP space, Michael Gulliford and Phil Hartstein, who have a combined four decades of IP experience.

Background

Despite a major shift in corporate balance sheet asset composition from tangible to intangible in recent decades, stemming largely from the secular shift to a knowledge based (i.e. technology) economy, there has been surprisingly little growth in the number of alternative asset managers with IP-focused investment strategies.  What growth has occurred with respect to IP-specific strategies has largely been confined to the IP litigation finance space.  There, non-recourse capital is advanced from a litigation funder to a claim holder to pursue what is often single event IP litigation, featuring a binary outcome set.

The result has been an mis-allocation of risk-adjusted capital to companies and academic institutions in IP-intensive sectors that either do not plan to litigate, or that will be litigating, but only as part of a holistic and diversified business and/or IP licensing strategy.  While these IP owners may seek capital to finance objectives such as non-dilutive growth, technology licensing or royalty audits and monetization, often the IP owner must choose between a litigation funder that does not specialize in broader financial solutions, or a financing source that is not specialized in IP.  Neither option threads the needle to provide what these entities are looking for: an appropriately-structured and priced capital structure solution.

Recently, IP-focused managers with credit-oriented strategies have come into focus, as they are targeting this gap in the market.  In addition to Soryn, the hedge fund manager Fortress has an existing IP Credit fund, and Aon is currently raising capital for a debut IP Credit fund (which may have ulterior motives rooted in intellectual property insurance, which is not to say the two can’t co-exist and complement one another).

In many ways, these funds resemble a hybrid of private debt and specialty finance, as they have the flexibility to invest across the capital structure through highly-structured debt, preferred, equity, and other bespoke financial contracts.

Reflecting their specialization, however, these funds’ management possess an interdisciplinary expertise in IP, and are concentrated on opportunities where the underlying asset value supporting the investment is intellectual property.  Given the flexibility within these strategies, and the skillset of those managing the capital, this new genre of IP-focused investor will likely be an important source of strategic capital available in IP-intensive sectors.

IP VALUE PROPOSITION

According to recent reports, intangible assets represent ~90% of the S&P 500 market value compared to ~30% in 1985.  Other studies estimate that intellectual property — a subset of the intangible asset class — represents more than a third of the market value of US publicly traded companies.

Intellectual property refers to creations of the mind, such as inventions, literary/artistic works, designs and symbols/names/images used in commerce.  The primary forms of intellectual property are:

  • Patents: protect inventions and discoveries
  • Trade Secrets: protect valuable information that is intentionally kept secret
  • Copyright: protect artistic works in a fixed medium of expression
  • Trademarks: protect “signs” associating products and services to an owner

While each form of IP offers different protections, the value of each lies in its legally proscribed, exclusionary right that prohibits third parties from practicing or “infringing” the IP without permission.  It is this exclusionary right that promotes a healthy competition and innovation ecosystem by, for instance, incentivizing R&D, encouraging investment, protecting market share, and allowing the licensing of these rights to either a) promote synergistic business relationships or b) stop unauthorized copying.

Several data points highlight the value attributable to IP licenses that are struck to promote synergistic business relationships, or to resolve enforcement scenarios. The following statistics help contextualize the significance of the IP value proposition.

IP VALUE CREATION

IP gains sufficient value to form the foundation for a financial transaction, when third party commercial actors have either begun to use the IP or desire to use it in the future.  When this situation occurs, IP rights can create value in several ways, including:

  • IP rights can be licensed to third parties that wish to practice or produce the technology associated with the underlying IP;
  • IP rights can be exploited to negotiate cross-licenses that allow IP owners access to sought-after technologies;
  • IP rights can be sold to third parties that wish to practice or produce the technology associated with the underlying IP;
  • IP rights can be enforced against third parties that are practicing the underlying IP without a license;
  • IP rights can serve as the basis for significant insurance policies;
  • IP rights can be the principal basis for an M&A transaction, and are a key driver of M&A activity;
  • IP rights can be central to value creation following a business separation or spin-off transaction;
  • IP rights can facilitate the formations of JVs for co-development of new technologies, which increase enterprise value;
  • IP rights can be monetized through the sale of all or part of contracted royalty payments associated with particular IP

In turn, IP owners and managers (e.g.  companies, academic and research institutions, and law firms), can leverage these sources of IP value to raise debt and equity capital in several ways, including:

Although IP offers a unique and significant source of value, many owners and managers of IP experience difficulty when attempting to leverage their IP to achieve an appropriate risk-adjusted cost of capital due to the lack of IP expertise, and/or transactional flexibility among the investing community. As such, the new genre of IP Private Credit funds may prove to be an important source of strategic capital available in IP-intensive sectors. 

IP CREDIT

IP Credit generally involve highly structured, privately negotiated financial contracts of varying types.  Counterparties are often companies possessing valuable IP portfolios, which are underserved by the capital markets. The strategy seeks to provide these IP owners with differentiated financing solutions through flexible and creative structures that offer attractive risk-adjusted returns. Just as private debt funds take different shapes and sizes, so too does an IP Credit fund.  Portfolio composition, while manager or mandate-specific, focuses on financing opportunities across the capital structure wherein IP forms a material component of a transaction’s value proposition.  Where the underlying IP, and/or associated rights or income streams can be assigned predictable licensing, monetization, and/or sale value, various transactions can be structured to leverage or maximize the value of the associated IP.

Investment Types

Investment types in the Private Credit strategy include senior loans, loans secured by IP, loans secured by legal judgments, loans secured by insurance policies, convertible debt instruments, highly structured preferred equity, common equity, and warrants. The types of credit products involved in an IP Credit strategy are generally not limited.

Deal Structuring

The duration of Private Credit investments is generally one to five years, and expected returns on these investments will vary based on the existence of negotiated downside protections.

The underlying investments in an IP-focused Private Credit Strategy can feature a plurality of terms and structures designed to solve for an appropriate risk-adjusted cost of capital, including:

  • Delayed draw funding schedules and performance-based milestone provisions
  • Events of default / material adverse event scenarios
  • Minimum cash / treasury requirements
  • Prepayment protection (make-wholes, yield maintenance, non-call provisions)
  • Structural and / or contractual seniority over IP or other assets
  • Affirmative and negative covenants / financial covenants
  • Warrants or other instruments with equity-like kickers
  • IP-backed securitizations
  • Credit enhancements via IP-related insurance policies

Industry Focus

While the strategy is generally industry agnostic, investments are often placed in IP-intensive industry groups, including technology, life sciences, materials sciences, automotive, semiconductors, telecommunications, biotechnology, and pharmaceuticals.  The hallmark of foundational IP that may serve as the basis for an IP-focused investment are assets protecting key innovations in a field, which an entrant will need to license to practice the technology.

Investment Team

Managers of IP-focused funds often possess a multidisciplinary IP expertise, with additional expertise in credit or distressed strategies.  Such expertise allows management teams focused on IP-specific strategies to not only appropriately measure risk and value potential, but to appropriately structure such transactions to capture value and mitigate downside.  Management’s IP experience also serves as an advantage when sourcing deals from among counterparties seeking a value-add financial partner with a deep understanding of IP.  In Soryn’s case, for example, co-founders Michael and Phil possess investment, legal and executive experience which allows them to assist counterparties with their legal, operational, and financial strategy planning with the goal of improving the risk-reward profile of the underlying investments.

Deal Sourcing

Because multidisciplinary IP expertise is a prerequisite for managers in the IP space, barriers to entry remain high and competition for deals is less severe than that of other asset classes.  Typical counterparties involve operating companies (both private and public) and universities that own foundational IP or revenue streams associated with such IP, as well as law firms representing such entities.

Use of Proceeds

IP-focused Private Credit transaction proceeds may be used for general business purposes and IP-related expenses or investments.  This is an important distinction between IP Litigation Finance and an IP-focused Private Credit, with the latter allowing for significantly greater flexibility in terms of the use of proceeds.

Insurability

Demonstrating the quantifiable value of intellectual property, the insurance industry has recently introduced products aimed at insuring various aspects of intellectual property.  Such products include:

  • Collateral protection insurance for credit deals where IP serves as the collateral package;
  • Judgement preservation insurance, to insure against an adverse appellate result following an IP owner trial win; and
  • IP litigation insurance, to insure against the associated costs and expenses of being sued for patent infringement.

Not only do such products demonstrate the insurance industry’s growing comfort with IP as an asset class, they also present downside protection scenarios for a variety of IP-centric financings.

In the next part of our 2-part series, we will be applying the theory above into practice by reviewing a case study of two financings by a public entity.

Slingshot Insights

Secular shifts in the economy should be forcing investors to think about value in different ways.  It’s indisputable that intellectual property is clearly the basis for technology company valuations, and therefore value must be attributable to IP when considering financing alternatives.  While understanding the value inherent in intellectual property can be difficult, fund managers with specific expertise exist to allow investors to allocate capital in an appropriate risk adjusted manner.

The fact that the insurance industry is now providing insurance products geared toward intellectual property is a testament to how far the industry has come, and how significant the opportunity is, and perhaps much less risky than one would think, if approached prudently.

I believe the IP Credit asset class has a bright future ahead, as existing players have had great success producing consistent returns in a sector that one might otherwise believe to be volatile.

As always, I welcome your comments and counter-points to those raised in this article.

 Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.  Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, investing with and alongside institutional investors.

Soryn IP Capital Management LLC (“Soryn”) is an investment management firm focused on providing flexible financing solutions to companies, law firms and universities that own and manage valuable intellectual property (“IP”) assets.  Soryn’s approach employs strategies, including private credit, legal finance, and specialty IP finance, which enable it to invest across a diversity of unique IP-centric opportunities via investments structured as debt, equity, derivatives, and other financial contracts.  The Soryn team is comprised of seasoned IP and investment professionals, allowing the firm to directly source opportunities less travelled by traditional alternative asset managers.

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Commercial Special Features

Key Highlights from the Inaugural LF Dealmakers European Edition

By John Freund |

Last week, the LFJ team attended the inaugural LF Dealmakers European Edition, held across two days at the Royal Lancaster in London. Building on the longstanding success of Dealmakers’ New York event, the first edition of the European conference brought together an impressive selection of leaders from across the industry.

Spread across two days, LF Dealmakers featured an agenda packed with insightful conversations between some of the most prominent thought leaders in the European litigation finance market. An array of panel discussions covered everything from the looming potential of regulation to the increasing corporate adoption of third-party funding, with these sessions bolstered by a keynote interview between two of the key figures in the Post Office Horizon litigation.

A long road to justice for the postmasters

In a conference that managed to fill every single panel discussion with speakers engaged in some of the largest and most influential funded disputes taking place in Europe, the standout session of the two days provided unparalleled insight into one of the most famous cases of recent years. The keynote interview on ‘The Future of Litigation Funding in the Wake of the Post Office Horizon Scandal’ saw James Hartley, Partner and National Head of Dispute Resolution Freeths, and Neil Purslow, Founder & CIO, Therium, offer up a behind-the-scenes tale of the sub-postmasters campaign for justice.

Going back to their first involvement with the case, James Hartley reminded attendees that whilst those looking at the case post-judgement “might think it was a slam dunk”, this was not the viewpoint of the lawyers and funders who first agreed to lead the fight against the Post Office. As Hartley described it, this was a situation where you had “a government owned entity who would fight to the end”, with a multitude of potential issues facing the claimants, including the existence of criminal convictions, the limited amounts of documented evidence, and the fact that the Post Office was the party that had ninety percent of the data, documents, and evidence.

Hartley also offered his own perspective on the legal strategy adopted by the Post Office and its lawyers, noting that at every stage of the litigation, “every single issue was fought hard.” He went on to explain that whilst he was “not critical” of the defendant’s strategy in principle, there remains the underlying issue that “the arguments they made were not consistent with the evidence we were seeing.” Hartley used this particular point to illuminate the issues around defendant strategies in the face of meritorious litigation that is being funded. He summarised the core issue by saying: “There is nothing wrong with fighting hard, but it’s got to be within the rules, and in a way that helps the court get to a just outcome.”

Offering praise for the support provided by Purslow and the team at Therium to finance the case, Hartley stated plainly that “without Therium’s funding it would not have gone anywhere, it would not have even got off the ground.” Both Purslow and Hartley also used the case to highlight problems around the lack of recoverability for funding costs and how that incentivises defendants such as the Post Office to prolong litigation and inflate legal costs. Hartley said that he would welcome a change to rules that would allow such recoverability, arguing that in this case “it would have neutralised the Post Office’s strategy to just keep driving up costs on the claimants side.”

What problem is regulation solving?

It was unsurprising to find that questions around the future of regulation for the litigation funding industry were a regular occurrence at LF Dealmakers, with the event taking place only a few days on from the House of Lords’ debate on the Litigation Funding Agreements (Enforceability) bill. From the opening panel to conversations held in networking breaks between sessions, speakers and attendees alike discussed the mounting pressure from government and corporate opponents of third-party funding.

The view from the majority of executives at the event seemed to revolve around one question, which was succinctly put by Ben Moss from Orchard Global: “What are the specific issues that require regulation, and what is the evidence to support those issues?”

This question became somewhat of a rallying cry throughout the conference, with suggestions of increased scrutiny and oversight being turned back on the industry’s critics who make claims of impropriety without citing evidence to back up these claims. Whilst several speakers referenced the recent LFJ poll that found a broad majority are open to the potential for new regulation, Ben Knowles from Clyde & Co described a lot of the discourse around the issue as “a fairly partisan debate.”

Among the few speakers in attendance who offered a contrasting view on regulation, Linklaters’ Harriet Ellis argued that “regulation done right would be good for the industry.” However, even Ellis acknowledged that any rules would have to be carefully crafted to provide a framework that would work across the wide variety of funded disputes, saying that a “one size fits all approach does raise issues.”

Regarding the government’s own approach to the issue through the draft legislation making its way through parliament, all of the executives in attendance praised lawmakers’ attempts to find a solution quickly. Alongside these government-led efforts, there was also a feeling among legal industry leaders that funders and law firms have to be part of the solution by promoting more education and understanding about how litigation finance works in practice. Richard Healey from Gately emphasised the need for firms to engage in “hearts and minds work” to change wider perceptions, whilst Harbour’s Maurice MacSweeney emphasised the need to “create the environment where law firms and funders can flourish.”

Innovation through collaboration

Outside of the narrow debate around legislation and regulation, much of the conference was focused on the speed at which litigation finance continues to evolve and create new solutions to meet complex demands from the legal industry. This was perhaps best represented in the way speakers from a variety of organisations discussed the need for a collaborative approach, with executives from funders, insurers, law firms, investors and brokers, all discussing how the industry can foster best working practices.

The interplay between the insurance and funding industry was one area that offered plenty of opportunity for insightful discussions around innovation. Andrew Mutter from CAC Speciality noted that even though “insurers are not known for being the fastest and moving the most nimbly,” within the world of litigation risk “the insurance markets are surprisingly innovative.” This idea of an agile and responsive insurance market was backed up by the variety of off the shelf and bespoke products that were discussed during the conference, from the staples of After-The-Event and Judgement Preservation Insurance to niche solutions like Arbitration Default Insurance.

Delving into the increasingly bespoke and tailored approach that insurers can take when working with funders and law firms, Jamie Molloy from Ignite Speciality Risk, described how there are now “very few limits on what can be done by litigation insurers to de-risk.” Whilst there is sometimes a perception that insurers are competing with funders and lawyers for client business, Tamar Katamade at Mosaic Insurance offered the view that it is “more like collaboration and synergy” where all these parties can work together “to help the claimant and improve their cost of capital and reduce duration risk.”

Class action fervour across Europe

Throughout both days of the LF Dealmakers conference, the volume and variety of class actions taking place across the European continent was another hot topic. However, in contrast to an event focused on the American litigation finance market, the common theme at last week’s forum was the wideranging differences between large group claims across individual European jurisdictions. In one of the most insightful panels, the audience were treated to an array of perspectives from thought leaders practicing across the UK, Spain, and the Netherlands.

The example of Spanish class actions provided an incredibly useful view into the nuances of European claims, as a country that is still in the process of implementing legislation to comply with the EU’s collective actions directive, but has already evolved routes for these types of actions over the last decade. Paul Hitchings of Hitchings & Co. described how the initiative to innovate has come “more from the private sector than the legislature”, with domestic law firms having become “experienced with running massive numbers of parallel claims” as an inefficient, yet workable solution. Hitchings contrasted Spain’s situation with its neighbouring jurisdiction of Portugal, which he argued has been comparatively forward thinking due to the country’s popular action law.

Speaking to the Dutch class actions environment, Quirijn Bongaerts from Birkway, argued that the “biggest game changer” in the country was the introduction of a real class actions regime in 2020. Bongaerts explained that the introduction of this system allowed for “one procedure that fits all types of claims”, which allows not only claims for damages, “but also works for more idealistic cases such as environmental cases and ESG cases.”

LFJ would like to extend our thanks to the entire Dealmakers team for hosting such an engaging and insightful event, which not only offered attendees a view into the latest developments in litigation finance, but also created a plethora of networking opportunities throughout both days. LFJ has no doubt that after the success of the inaugural LF Dealmakers European edition, a return to London in 2025 will cement the conference as a must-attend feature in the litigation funding events calendar.

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Commercial Regulatory Issues

The Dangers of Retrospective Legislation in Litigation Funding

By John Freund |

The debate around whether the Litigation Funding Agreements (Enforceability) Bill should be retrospective is a complex one, with valid arguments on both sides. A recent op-ed makes the case that retrospectivity poses significant dangers and unfairness.

Writing in LegalFutures, Jeremy Marshall, Chief Investment Officer of Winward UK, argues that the core issue is whether it is unfair to allow litigation funders to rely on contractual agreements that were freely entered into by both parties, even if those agreements were based on a mistake of law.

Marshall claims that the common law right to recover money paid under a mistake only applies when the mistake led to one party receiving an unintended benefit. In the case of litigation funding, the only benefit that has accrued is the one that was explicitly drafted into the contract. Allowing retrospectivity would open the door to satellite litigation and unreal counterfactuals, according to Marshall.

Claimants who have already received funding and won their cases are now arguing for the "right" to renegotiate and keep all the proceeds for themselves. But what about the funders' arguments that cases may have gone on longer or become more expensive than intended? Fairness demands that both sides' positions be considered.

Marshall insists that the true drawback in retrospectivity is the inherent danger of prejudicing one party to the exclusion of the other, or conferring an unexpected benefit to one party at the expense of the other. Ironically, this is precisely what those challenging the bill are attempting to do. So while the debate is a complex one, one can make a compelling case that retrospectivity in litigation funding poses significant dangers and unfairness.

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Commercial Regulatory Issues

The CJC’s Review of Litigation Funding Will Have Far-Reaching Effects

By John Freund |

The following is a contributed piece by Tom Webster, Chief Commercial Officer at Sentry Funding.

Reform is on its way for the UK’s litigation funding sector, with the Civil Justice Council firing the starting gun on its review of litigation funding on 23 April.

The advisory body set out the terms of reference for its review, commissioned by lord chancellor Alex Chalk, and revealed the members of its core working group.

The review is working to an ambitious timetable with the aim of publishing an interim report by this summer, and a full report by summer 2025. It will be based on the CJC’s function of making civil justice ‘more accessible, fair and efficient’.

The CJC said it will set out ‘clear recommendations’ for reform in some areas. This includes consideration of a number of issues that could prove very significant for funders and clients. These include:

  • Whether the sector should be regulated, and if so, how and by whom;
  • Whether funders’ returns should be subject to a cap; and if so, to what extent;
  • The relationship between third party funding and litigation costs;
  • The court’s role in controlling the conduct of funded litigation, including the protection of claimants and ‘the interaction between pre-action and post-commencement funding of disputes’;
  • Duties relating to the provision of funding, including potential conflicts of interest between funders, lawyers and clients;
  • Whether funding encourages ‘specific litigation behaviour’ such as collective action.

The review’s core working group will be co-chaired by CJC members Mr Justice Simon Picken, a Commercial Court judge, and barrister Dr John Sorabji. The four other members are:

  • High Court judge Mrs Justice Sara Cockerill, who was judge in charge of the commercial court 2020 – 2022, and who is currently involved in a project on third party funding for the European Law Institute;
  • Academic and former City lawyer Prof Chris Hodges, chair of independent body the Regulatory Horizons Council which was set up to ensure that UK regulation keeps pace with innovation;
  • Lucy Castledine, Director of Consumer Investments at the Financial Conduct Authority; and
  • Nick Bacon KC, a prominent barrister and funding expert who acts for both claimants and defendants

The CJC had said that it may also bring in a consumer representative, as well as a solicitor experienced in group litigation.

In a sign that the review seeks to be informed by a wide range of views, the CJC has also extended an invitation for experts to join a broader consultation group, which will directly inform the work of the review and provide a larger forum for expert discussion. Meanwhile the advisory body has said there will also be further chance ‘for all to engage formally with this review’ later this year.

Given the broad remit of the review and significant impact that its recommendations may have on the litigation funding industry, litigation funders, lawyers and clients would be well advised to make the most of these opportunities to contribute to the review.

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