Monetising IP: Making sense of the variable factors involved Monetising IP: Making sense of the variable factors involved

When banks want to build a strategy to monetise their IP, commercial objectives come first. Banks might want to create or enter a particular market and access relationships with other banking clients. Or they might want to create a separate entity primed for external private investment or formal partnerships with technology firms or other FS market participants.

Once the commercial and strategic objectives are in place, detailed work begins. One of the greatest challenges that banks face in monetising their IP is in bringing together the different factors at play in the various parts of the group in order to get the best result for the overall business.

Banks and their advisers have to carefully examine the different variables at play, always with one eye on the strategic design principles. Timing issues, details of implementation and deciphering trade-offs between the variables will be vital. This article highlights seven variable factors which drive the optimal model for banks looking to monetise group IP.
 

IP monetization, in many cases, is pursued outside of core regulated entities within the group. This then raises the question as to how to fund this business; related to this funding question is what impact will the setting up and operation of this business have on the group’s capital requirements?

Prudential regulatory issues will then come into play. Given that intangible assets are (in the UK) fully deducted from regulatory capital, efficiencies might potentially be achieved in structuring a new business outside of the core regulated banking entities (resulting in solo capital benefits) or even outside of the regulatory consolidation group altogether. The result can be a better utilisation of capital in the banking group and a more flexible financing structure for IP development going forward.
 

Corporate tax, transfer pricing and VAT form a crucial part of constructing an optimal IP monetisation plan. Their combined impact needs to be understood as they can trade-off against each other – one can work against the other.

Much of the effect of both direct and indirect taxes revolves around a clear characterisation or role definition of individual group companies, as well as the nature of the transactions between group entities. Questions such as how best transactions should be articulated based on the nature of the services being supplied, and which entity should bear investment costs and risk in ongoing development of technology are important to tackle early on.

The questions that need to be posed in assessing tax are often the same for various elements of the tax system but the optimal model can vary depending on specific circumstances. An optimal model must also consider the potential access to tax incentives as well, technology IP can benefit from R&D credits and also innovation box benefits in some cases.

The bank has to make certain decisions about people. Which existing people within the group will take a leadership role in monetizing the IP and executing the IP strategy; who will be developing the IP or creating new IP; and which parts of the group are they currently employed by?

Some groups chose to locate their IP teams virtually. In this model colleagues are employed by one part of the group and then seconded into a new entity that has been created specifically for IP monetisation. The alternative model which is designed to achieve a “one firm” mentality is for a separate entity to employ the relevant colleagues with harmonised teams operating across the business. FinTechs/ TechFins focus on rewards being tied to business performance, which could lead to conflicts in the virtual-entity solution. Using legal mechanisms to move people into a single entity could resolve these issues as it could support with creating one culture with one type of reward system around that individual business, provided that this can be structured, as necessary, in compliance with the UK remuneration rules. The locations of people in the group will also have a significant impact on tax outcomes.

Any banking group pursuing a new line of business needs to consider whether that new business line will fall within the regulatory perimeter. This generally depends on the activities being carried out and whether those activities fall within the regulatory perimeter in the relevant jurisdiction.

If the new business line is conducting a regulated activity and this is not covered by the group’s existing permissions or authorisations, structuring the new business line in a new or an existing unregulated entity will require new permissions with the relevant regulator to cover this additional entity. In these circumstances operating the business from the existing core regulated group entities might be easier.

Conversely if the new business line does not require any regulatory permissions or authorisations but it is operated out of the core regulated group entities, the activities of that business will fall within the regulatory perimeter. A further question is whether the incumbent banking group has an ongoing dependency on the IP that will be monetized in the new business line. If the new business line is being pursued outside of the core regulated entities but such a dependency exists with the regulated entities, the new business will be subject to its existing banking group’s operational requirements which are derived from regulation, notwithstanding the fact that the new business is not carrying out any regulated activity. Different regulatory rules – including the PRA’s operational resilience rules and its outsourcing and third-party risk management rules – will apply to the intra-group relationship.

Groups which use a new entity to exploit their IP will typically transfer that IP into the new business, which will trigger a requirement for a valuation of that IP. And if external investment into the new business by way of equity capital is sought, a further valuation of the IP will be required.

Depending on the stage of the business, the valuation can be quite subjective until the business is a bit more mature and has a more predictable stream of revenue and cash flow. Ultimately, it is the potential cash flow that determines the value of a start-up, and there’s various methods used to try to determine this along with the potential ROI. At the early stage of valuation, its more an art form than science based on judgement over such things as vision, market size, competition, technological advancement, and the credibility of the management team.

The holding and value of IP can have accounting implications as well that will need to be factored in.
 

Banking groups need strong processes and controls to enable them to protect their IP. If external investment is the aim, due diligence exercises will include close scrutiny over this protection.

Outside of patents, other important components of banking groups’ IP are trade secrets and knowhow. These may not always be recorded in writing, so this creates a key person dependency. It is important to clarify: the people responsible; who within the organisation holds this information; how will the group protect this information for the new business; options for remediating any key gaps in recording this information.

Typically banks aim to group the relevant people into a new organisation as this helps keep direct control (and hence protection) over the use of the IP.

The best laid plans can run to chaos without a properly managed transition.

In many IP monetisation scenarios, the banking group is spinning off assets into a new part of the business and running them down in another part. How best can this happen, particularly if the incumbent bank needs to stand up their own assets in order to continue to operate?

Tax for the transitional period has to be considered; the process of transitioning people to a new organisation needs to be managed with timelines rigidly adhered to for legal reasons. And as with any major project general change management processes must be put in place for before, during and after.

When these and other relevant variables have been thought through the focus then turns to having a structure – a legal framework from which the new business can be built. Many of the variables listed above, tax, legal, regulatory and accounting, crystalise into this legal framework. This will enable the business to stand on its own and meet its commercial and strategic objectives.

All the legal agreements and contracts have to be properly documented including asset transfer agreements, registration of IP within a new business, harmonisation of terms of employment of people moving into a new business, contracts for internal and external IP income generation, and the regulatory status of the new business.

Many strands come together under the legal framework and it is crucial that all agreements are properly executed.

The variables at play in IP monetisation can be complex and require many different specialists to combine forces to get the best result for each situation.

KPMG has the multi-disciplinary model that can make this work. The firm’s FS Business Optimisation Advisory Group brings together relevant experts from many specialist areas from legal and regulatory to tax, accounting, people consulting, capital finance and intellectual property, who work as a team to bring the different strategic strands together to reach the optimal outcomes for our clients. This dedicated group of specialists have optimised IP and banking group businesses on client assignments and are ready to bring their expertise to play in your organisation.

Thank you to the following members of the Advisory Group for sharing their expertise with us on this blog:  Charlotte Lo, Dorothée Giret, Dai Duong, Jonathan Tam, Kennedy Masterton-Smith, Mark Wrafter, Nick Mead and Terri Costello.

If you would like to discuss any of the points raised in more detail, please get in touch with the authors.