The Viability of Ugandan SMEs Using Intellectual Property as Security for Debt Financing

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In a country that perceives property as something in a tangible form, appreciating and harnessing the value of intellectual property still remains a challenge.

With such a background, financing has evolved around allowing companies and persons to borrow against assets like land, motor vehicles, houses and machinery since ways of determining value of such assets have been established overtime and ways of realising that value should it be required to repay the loan are much more certain.

This has meant that entities that have such assets can easily access credit. SMEs that are substantially dependent on intellectual property with a potential of growth consequently face challenges in securing financing and are denied access to wider sources of finance and beneficial financing terms compared to SMEs with conventional assets.

The Value of Intellectual Property
In today’s economy, intellectual property has become paramount in contributing to the generation of value and revenue of various companies.

Unique designs have improved user experience especially in the smart phone market, reputation of brands has provided reassurance around quality and research and development has enhanced innovation hence resulting into new goods and services on the market.

As much as intellectual property has an impact on the emergence and growth of leading products in the market, SMEs have not appreciated the value of these intangible assets. On the other hand, financial service providers and private equity firms have not explored options of leveraging intellectual property to finance entities that primarily rely on intellectual property for their growth.


Does the law provide for the Use of Intellectual Property as Security for Debt Financing?

While intellectual property law has been majorly used as a tool to protect creations of the mind such as artistic works, designs, invention and symbols; the emergence of intellectual property-based financing creates an opportunity for accessing credit that SMEs ought to explore.

The Companies Act 2012 under Section 105 requires companies registered in Uganda to register every charge created and among the charges referred to, includes a charge on goodwill, on a patent or a licence under a patent, on a trade mark or on a copyright or a licence under a copyright.

It is important to note that under the definition section of the Companies Act 2012, a charge means a form of security for the payment of a debt or performance of an obligation consisting of the right of a creditor to receive payment out of some specific fund or out of the proceeds of the realization of specific property.

In respect of the provisions of the Companies Act 2012 referred to, companies can now pledge their intellectual property in form of rights associated or future revenues from their intellectual property to secure funding.

The Security Interest in Movable Property Act 2019 defines intangible assets to include intellectual property. Under the Act, intellectual property means literary, scientific and artistic works protected under the Copyright and Neighbouring Rights Act, 2006, industrial property rights protected the Industrial Property Act, 2014, trademarks as protected in the Trademarks Act, 2010 and any other related rights that may include a trade secret as protected under the Trade Secrets Protection Act, 2009.


The Security Interest in Movable Property Act 2019 further provides for perfection and enforcement of the security interest although the Act and the Regulations thereunder do not sufficiently address the aspects of perfection and enforcement of the security interests in respect to the unique nature of intellectual property.

Hence the general provisions of the Security Interest in Movable Property Act 2019 apply to the perfection and enforcement of security interest in intellectual property.

It is commendable that Uganda’s legal framework is progressive in enhancing the value of intellectual property as means of helping SMEs access credit to spur growth of their businesses.

Challenges Ahead
Financial products that enable SMEs to get financing backed by their intellectual property assets are a potential solution to the SMEs’ problem of accessing finance to support their growth.

Although this is a progressive effort towards helping SMEs access credit, there may be challenges ahead that need to addressed to make this form of financing viable for all the stakeholders.

The regulation of banks in some aspects may be an obstacle to realising intellectual property backed financing. When Uganda became part of the risk management framework in 2009, Bank of Uganda implemented Basel III.

This was implemented by the passing of the Financial Institutions (Revision of Minimum Capital Requirements) Instrument No. 43 of 2010 in accordance with section 26(5) of the Financial Institutions Act 2004.

As a result, banks were required to hold a minimum of Uganda Shillings 25 billion in capital. By enactment of the Financial Institutions (Capital Adequacy) Regulations 2018, Bank of Uganda further raised the minimum statutory capital adequacy ratios to 10% (from 8%) of the risk – weighted assets of the bank on top of holding a capital conservation buffer of 2.5 % of the total risk adjusted assets as required under Regulation 5 of the Financial Institutions (Capital Buffers and Leverage Ratio) Regulations 2020.

The implication of such a regulatory environment is that banks are required to hold capital for the risks they take.

This regulatory environment has influenced the eligibility criteria for use of physical, intangible and financial assets as collateral when offering loans. Assets like land easily meet this eligibility criteria and in the event of default there are lower levels of losses hence require less capital.

On the other hand, the unique nature of intellectual property may not meet this eligibility criteria hence making it hard for SMEs to obtain loans while collateralising their intellectual property since banks cannot derive any capital benefit for the use of intellectual property as security for loans.

This means that if banks take intellectual property as collateral, they will have to price the loan as if it were unsecured in which case doesn’t favour the SMEs and the banks since they will have to meet the required regulatory capital.

Another challenge is valuation of intellectual property. The uncertainty of the value of intellectual property is a challenge to lenders to know how much they may recover in the event of default.

There is also a scarcity of intellectual property valuers which creates a further cost of determining the value of the intellectual property. In addition to that, insolvency practitioners that may aid in valuation of intellectual property and recovery are scarce hence making intellectual property less attractive as collateral.

The lack of liquid secondary markets for intellectual property aggravates the challenge of the value and price discovery of the intellectual property. This creates a challenge on part of the lender as they risk taking intellectual property as collateral and get stuck with an asset that that they cannot sell easily and has no immediate liquidity value.

What Should be Done?

In a bid to overcome the aforementioned challenges, it is important for SMEs to appreciate the importance and value of registering and valuing their intellectual property to secure their rights in their intellectual property.

This creates reassurance in the lenders and it would accelerate finding solution to the other challenges.

The Securities in Movable Property Act 2019 needs to be amended to clearly cater for the unique nature of collateralising intellectual property and how to enforce the security interest in the security.

The UNCITRAL Legislative Guide: Supplement on Security Rights in Intellectual Property has progressive recommendations on using intellectual property as security that Uganda could consider adopting or benchmarking.

For instance, paragraph 243 of the Guide provides that where the encumbered asset is the right to receive payments of royalties and other fees under a license agreement, the secured creditor should be entitled to enforce the security right by simply collecting royalties and other license fees upon default and notification to the person that owes the royalties or fees.

Financial service providers need to engage with other stakeholders like lawyers and insurers to structure an approach to intellectual property backed financing. Since insurers may have more latitude to access risks arising from giving out intellectual property backed loans, transferring such risks to an insurance balance sheet from a banking balance sheet may help in giving banks some kind of security to offer intellectual property backed loans at a lower capital cost.

In addition to that, there needs to be certainty in the valuation of intellectual property assets to help in recognising the value of intellectual property.

In today’s world where intellectual property has greatly accelerated growth of various leading products and services, the finance market risks becoming ineffective as SMEs with potential for growth are largely rich in intellectual pr
operty.

As much as appreciating the value of intellectual property is a work in progress, its high time the relevant stake holders started working out strategies of harnessing intellectual property and normalise intellectual backed financing. This will give SMEs a new alternative of financing hence spurring their growth.

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