With the economy increasingly turning digital, what does this mean for the world of finance? Lenders are taking note and finding new and innovative ways of lending to companies in the technology, media and telecoms (TMT) sectors. TMT finance has become a specialised area.
Senior lenders in the TMT sector, as they do in all sectors, focus on cash flows and lending multiples of earnings. In other words, a company needs to be operational and, more importantly, profitable before it can look to get senior debt finance. The issue with this for lenders is that by the time a company is successful there will be a crowd of lenders beating at the door. On the one hand, the big question is how to get a foot in the door with these companies before they become the next big thing. On the other hand, there is an obvious reluctance to provide debt to an un-established company, with all the accompanying risks. Early stage FinTech companies have added another incentive; banks want to lend to these businesses, not only as a business proposition but also so that they have early access to new technologies they can use in their own businesses.
A number of lenders, namely debt funds, alternative lenders and, increasingly, traditional banks, now provide finance to innovative early stage companies. This is described in a number of ways, be it venture debt, growth finance or other. Effectively this is lending to companies which are up and running and which have revenues but may still be unprofitable. Lenders look at different factors in making a decision to lend where historical cash flows alone do not justify the lend. Some will look at management – is there a team of trusted individuals behind the helm who have previously had success in taking a product to market? Some will look at the equity investment – is there serious investment from a venture capital (VC) firm or well-known angel investor? Some will look at intellectual property (IP) – is there valuable IP, such as patents, in the business, which could generate value if the loan goes bad? Many look at a combination of these factors and more. And, of course, with more risk comes higher pricing.
At a senior debt level there is a great emphasis on expertise, with a number of banks having specialist TMT teams lending to companies in the sector. This gives borrowers comfort that their business will be understood and lending structured in a way that means they can continue to function and grow. It is stating the obvious that a loan to a company with tangible assets, such as buildings, plant and machinery and so on, will have different provisions to that of a loan to, say, a company owning music catalogues, which would require a thorough knowledge of collecting societies and how royalties are paid.
Across all levels of debt, lenders can look to protect themselves by a proper understanding of the business and the market in which it operates, whether it is in the TMT sector, or the myriad sub-sectors which exist. Where a lender does not have that understanding in-house, it can buy in that expertise. Good due diligence on the borrowing company, both from a commercial and legal perspective, is key. This is the case even in the more established companies with good cash flows. For example, a company with a great piece of software (and good history of cash flow) could quickly become worthless if it turns out that it is infringing somebody else’s IP. Lawyers who understand intangible assets can help with IP diligence, for example there are also IP advisory firms which can health check the IP or provide a valuation. Both legal and commercial advisers can help with understanding the market and identifying credit risk.
There is some debate as to whether IP valuations are useful for lenders. Often, the majority of lenders do not currently ask for an IP valuation. This may be an area which will evolve over the next few years as the market looks for new solutions and the possibility of valuations being supported by insurance.
When it comes to documenting the loan, it is important to have legal advisers who understand the sectors and can advise accordingly. Lenders need protection for their loan on the one hand, for example effective security being taken over intangible assets, whether that be copyright in software, a domain name or a trademark. On the other hand, however, the documents have got to work with the business and not prevent it from operating as normal. For example, a lender may require an assignment by way of security of the IP in a business. However, the business will need that IP to be able to operate. There are legal solutions to this sort of problem which need to be added to the documents.
The future for TMT finance looks bright. New technologies are emerging and existing technologies are becoming more relevant to a range of different industries, with lots of buzz around artificial intelligence (AI), blockchain, data analytics and augmented reality in particular. The government is keen to promote TMT in general, with different focus groups looking at, for example, the creative industries and AI, among others. Accelerators and incubators throughout the UK (some of which are backed by the banks) are also encouraging start-ups and are improving the ecosystem. Even more traditional companies, such as real estate businesses, are becoming more digital and are looking at ways in which new technologies can help them stay ahead of the competition. Encouraging lending to companies with intangible assets is also a focus; for example, a few years ago, the UK Intellectual Property Office produced its report ‘Banking on IP? The role of intellectual property and intangible assets in facilitating business finance’. Over the next few years, lenders and borrowers will continue to evolve and become more sophisticated in their understanding of this area.
Ruth Marken and Charles Kerrigan are partners at CMS London. Ms Marken can be contacted on +44 (0)20 7067 3416 or by email: firstname.lastname@example.org. Mr Kerrigan can be contacted on +44 (0)20 7067 3437 or by email: email@example.com.
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Ruth Marken and Charles Kerrigan