Technology as Collateral

When a company wants to secure financing using its technology as collateral, banks are typically reluctant to accept this asset as a surety. In order for an asset to be acceptable collateral to a lending institution, the asset must be identifiable and transferable. Other difficult conditions must also be met in order for intellectual property, such as software, to qualify as a basis for debt financing. There must be a market for the technology with an ongoing revenue base of existing clients. The software must be functionally maintained at an acceptable competitive level. In addition, the rights necessary to complete ownership transfer, and the proper materials for use in ongoing maintenance and development, must be readily retrievable and transferable.

A technology escrow account set up with an intellectual property trust company provides the bank with access to the physical asset as collateral against a loan default. The escrow deposit contains the source code, documentation, firmware, schematics and any other pertinent information that the lender needs to secure the technology as collateral. Technology escrow eliminates any ambiguity about what the bank really owns if there is a default on the loan.

To assure the lender of its position, the escrow agreement should include the ability to execute a TX Copyright transfer document. This document will allow the lending institution to take ownership of the technology under default conditions. This is the same process that applies when a bank repossesses a car if the buyer defaults on a loan.

To ensure the completeness and validity of the deposit materials, the escrow agent should technically verify the deposit. Technical verification involves three levels of analysis. First, the agent documents a description of the computer environment necessary to maintain and compile the source code. Second, it will perform an analysis of the hardware and software environments to ensure that the computer media is readable. Third, the agent will use the deposited hardware and software materials to create an object code version of the software.

After the deposit verification is complete, the escrow agent will request and receive periodic updates to the collateral deposit. In order to continually assure the lender that the deposit will have value if the loan is defaulted, the escrow agent will document and report all update activity on the account to the lender.

Leverage Your Assets
Iron Mountain has worked with many technology companies to establish and administer these types of escrow accounts. For example, Iron Mountain helped a handful of private investors purchase a company that developed the technology for hand-held computer terminals, commonly used by delivery personnel to keep track of sales.

The company, Norand Corp., based in Cedar Rapids, Iowa, was acquired in 1988 by investors who completed a leveraged buyout and acquired Norand from a large biotech firm. Norand, which had a substantial portfolio of patents and copyrights for software, was strong enough to entice First Bank in Minneapolis to lend money to the investors. But critical to the deal was Norand's ability to convince First Bank that its technology could be used as collateral. 

Attract Capital Infusion
In another case, a small software development firm in Burlington, Mass., called Object Design Inc., caught the attention of IBM, which wanted to license ODI's product in large volumes. But to meet IBM's needs, a huge infusion of capital was required. 

In 1993, IBM chose to invest in ODI, eventually pumping about $12 million into the company, an innovative developer of a new object-oriented database that is well suited to handle the majority of Internet applications. IBM confidently moved forward with the relationship -- asking that ODI's source code be kept in escrow so that IBM would have access to it if ODI went bankrupt or failed to fulfill its contract. 

"The IBM transaction was vital to establishing ODI as a mainstream software vendor, and a carefully structured source code escrow was a cornerstone to the IBM transaction," said Jon Bain, a Boston-based intellectual property consultant who advised ODI on the IBM deal.

Strengthen Your Market Position
ODI's relationship with IBM not only led to a much-needed capital investment in the firm, but it strengthened ODI's position in the market. IBM, which integrated ODI's technology with its own systems and purchased from 1993 to 1996 nearly $16 million worth of ODI's products, gave the young company instant credibility. Due to the association with IBM at a critical juncture in its development, ODI saw product sales climb.

ODI is now a publicly traded company which had $32 million in revenues in 1996, thanks to the unique opportunities presented to it by leveraging its technology to secure investment.

Iron Mountain has assisted many borrowers and lenders in using technology escrow to turn an intangible asset into a transferable product with commercial viability. This allows technology companies to secure financing using their most valuable asset while providing banks with the necessary collateral for a loan.