The importance of intellectual property (IP) rights in steering India to its ambitious developed economy status cannot be overstated. With greater acknowledgement of IP assets as growth engines, it is an opportune time for India to capitalise on its unique position as a knowledge and innovation-driven economy.

IP assets are broadly segregated into two major categories: industrial property (which includes patents, trademarks, industrial designs, and geographical indications); and copyright ( associated with literary works, films, music, artistic works, and architectural design).

India is currently the world’s second-largest start-up hub (second only to the US). Per the World Intellectual Property Organization, a large proportion of Indian start-ups possess at least one IP asset. India now ranks fifth in trademark registration, sixth in patent registration, and eleventh in industrial design registration globally.

As innovation-driven firms grow in the domestic economy, their need for monetising their IP assets for business growth and expansion rises. Unlike industrialised economies, where IP is recognised as an asset class, this is not the case in India due to absence of IP-related advanced infrastructure, and market inefficiencies. Debt funding for start-ups has not been popular in India due to limited tangible assets (as collateral) of these innovation-driven firms.

The current geopolitical situation has worsened the funding crunch of Indian start-ups, pushing businesses to seek alternative funding sources. While start-ups prefer debt financing over equity as the former allows firms to obtain capital without diluting their ownership interest, the debt financing avenues are limited in India.

According to Inc42’s ‘Startup Funding Report H1 2023’, debt finance accounts for just 4.8 per cent of start-up funding in India. Several Indian banks have begun supporting start-ups through their venture capital divisions, which are primarily equity-based.

IP-based debt financing is an untapped source of funding for start-ups in India. It offers tremendous scope for Indian banks to expand their balance sheet and adds to their interest income. Venturing into this relatively new area of financing would boost market confidence and help the Indian economy reach new heights.

Several schemes

The government has initiated several schemes to promote start-ups. India’s first IPR policy in May 2016 proposed securitisation of innovation rights, allowing them to be used as collateral to raise funds for their commercial development. The Indian IP policy complies with WTO’s agreement on TRIPS (Trade-Related Aspects of IPRs).

Startup India is a welcome step towards the development of IPR-based firms by improving their access to finance.

Additionally, the government has set up a panel of facilitators to help file patents and IP applications and raise finance for further innovation and research. Also, a strategic blueprint and action plan is being formulated by the Department for Promotion of Industry and Internal Trade (DPIIT), which will foster and institutionalise intellectual property funding in India.

Acceptance of IP as collateral by banks was recognised way back in 2002. Section 2(1)(t) of the SARFAESI Act 2002 defines the expression ‘property’, and it specifically includes intangible assets such as knowhow, trademark, copyright, licence and franchise. Further, Section 2(1)(zf) defines ‘security interest’ as a right, title or interest of any kind upon property created in favour of the secured creditor and includes such rights as title or interest in intangible assets.

Despite the existing provisions and initiatives, banks develop cold feet when it comes to IP-based debt financing as they lack IP valuation expertise. With valuation mechanism still at a nascent stage and in the absence of a centralised valuation mechanism, lenders in India are risk-averse.

Further, the lenders face the following constraints:

IP-based debt financing requires a number of essential infrastructure, including creation, maintenance, and proper valuation of IPs. This is lacking, at present.

The bitter experiences of the past still hound Indian banks.

The absence of a central valuation agency is stifling the development of the market. The lenders are shying away due to the risk of the overvaluation of IPs. Without proper valuation, banks cannot use the IP-based collaterals in their regulatory capital calculations.

The absence of a liquid secondary market for IPs is making price discovery and asset disposal challenging.

The inseparability of IP assets is another issue. Since IPs are embedded in the business, companies do not consider the possibility of using IPs in a different setting.

These constraints suggest the need for India to develop a value-enhancer instrument (insurance) for IPs. This will offer the lender with an insured value for the borrower’s intangible asset collateral with the agreement that the title of ownership gets transferred to the insurer in case the borrower’s loan goes into foreclosure.

The lender will be guaranteed no less than the insured value while maintaining any upside, should the assets be worth more than the insured value. This would ultimately reduce credit risk, making IPs more marketable and grants an option to the borrower to bargain for a better rate.

Insurance will provide the lender and regulator with a creditworthy floor value to determine lendable IPR advance rates.

Building up the necessary valuation, and other required infrastructure will address the market failure by creating a win-win situation for commercial banks and innovative start-ups.

Panda is AGM-Economist at State Bank of India, and Joy is Economist with India EXIM Bank. Views are personal