Financial Modelling: Advantages and Limitations
Financial models are used by corporations almost every day. These models help while making several key strategic decisions. For instance, if a company plans to enter a new country or even take over another company, it is likely that it will create a financial model first. This model is a way of generating “What-If” information […]
Do IPO’s Affect Competitive Firms?
Many tech-based companies are lined up for initial public offerings (IPOs) in 2019. Many companies such as Uber and Lyft belong to the same industry as well. Up until now, investors have not seen so many major IPOs from the same industry at the same time. The firms launching their IPOs used to be small, […]
Advantages and Disadvantages of Convertible Debt
In the previous article, we studied the concept of convertible debt and some of the common terms which are used while discussing convertible debt. In this article, we will have a closer look at some of the advantages and disadvantages of using this form of debt. Advantages of Using Convertible Debt Many companies continue to […]
What is Asset Light Business Model, Its Advantages and Disadvantages
It is common knowledge that the world’s largest cab service Uber does not own any vehicles. Similarly, one of the world’s largest boarding and lodging solution providers, Airbnb does not own any hotels either! The largest and the most profitable companies of the world such as Microsoft, Google, etc. do not own any tangible assets. […]
Fundamental Principles of Pension Fund Risk Management
Pension funds are amongst the most heavily supervised financial instruments in the world. This is because of the fact that these funds hold the retirement funds of a large number of people. This means that the risk management practices at a pension fund have to be top-notch. The inability to manage risks can cost the […]
Business and personal lending is dominated by tangible assets. The simple reason behind this is that they make good collateral. For instance when a person takes a mortgage, they pledge the very home that they buy even though the bank only loans out 80% of the value. Also banks include personal guarantees and ensure that the value of their loans is secured up to 150% of its value.
The same is not the case with intangible assets. Lending against such assets is a recent phenomenon and needs some research and development. In this article, we will learn more about lending against intangible assets.
Intangible assets are the predominant form of assets in the knowledge economy. Just have a look at some of the most valuable companies in the world today. The names that are likely to come to mind are Google, Microsoft, Facebook, Amazon and other such web based companies. Their valuation is upwards of hundreds of billions of dollars! Now, they certainly do not have the tangible assets to justify such valuations. Their offices and all the equipment also tend to be leased! In fact all the tangible assets of such companies amount to less than 10% of their valuation!
The world economy has undergone a change. We are no longer in the industrial era. Instead, we are in the knowledge economy. Herein knowledge assets are much more valuable than tangible assets. This is why the percentage of tangible assets in a company’s valuations have fallen down from 74% in the 1950’s to a mere 13% now.
Given that intangible assets dominate the balance sheets of modern corporations, any banks that lend to such corporations must also be well versed in lending out money to
As mentioned above, intangible assets are the biggest drivers of valuations in the modern world. Both mega corporations and startups have their valuation dependent on these assets. This makes it more important for the banks to create a framework which will allow them to lend against such assets.
At the present moment, all banking rules prohibit the use of such assets as collateral. They are considered to be worth only a fraction of their value when they are collateralized. Unless banks develop a way to loan money against these assets, they are going to lose business to venture capital funds and non banking financial corporations that are allowed to make such loans.
Intellectual assets of all types do not have the same value when it comes to bank lending. Some types of intellectual properties make better collateral than others.
Intangible assets do not have a liquid market. Hence the banks cannot easily recover their money even if they were to get possession of the said intangible asset. Selling this asset would be a huge hurdle. Brand valuations are often notional figures. They signify what the brand is worth to the company that has it now. It does not mean that it would be worth the same amount to another company! Selling intangible asset is a time consuming asset requiring the services of many experts. The business of banks is to lend money. They do not have the knowledge or the ability to liquidate such brands.
Therefore banks usually steer clear of lending against intangible assets. These loans are easy to make but difficult to recover.
One possible ways suggested by banks is to have a third party cover the risks of lending against intangible assets. The main problem is that intangible assets have fluctuating values. Therefore banks cannot lend against them.
If there were a third party that promised to compensate the bank with a fixed amount in the event of a default, banks would be willing to buy such a product. In return, the banks can offer the brand as collateral to this third party.
The third party will then sell the assets in the market. If they sell it for more than they brought it from the bank for, they make a profit, if not they make a loss!
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