Tech Lending: Due Diligence Issues
This article is
the third in a series providing an overview of critical considerations for
commercial lenders contemplating whether to finance a tech company and how such
loans can be secured.
Adequate due diligence is an essential component of every tech
lending deal. As previously discussed in this series, tech companies differ
from traditional businesses in that most have very few, if any, tangible or
hard assets. The majority of tech companies’ assets are intangible IP assets,
which makes the borrower’s business difficult to value, increasing the
importance of due diligence before entering into financial arrangements.
As a first step, lenders should ensure the company has legal
ownership of the IP it purports to own and determine the jurisdictions in which
any IP rights are registered and where the IP rights, whether or not
registered, are used. Different searches will need to be conducted in each
jurisdiction to verify the asset and ownership.
Lenders must identify the entity that owns the IP, not just the
entity that uses it. Many companies use entities other than their operating
entities to hold IP assets. In those instances, the operating entity may only have
licence rights. In an enforcement scenario, a judgment against the operating
entity may not be enforceable against the IP holding company. In the case of related
party licences, lenders need to determine to what extent there is protection of
a borrower’s use of the IP and whether the licensor affiliate should be made an
obligor under the financing arrangement.
If the licence is material, a lender should determine if the
licensee has unilateral extension rights. Under the Bankruptcy and
Insolvency Act and the Companies’ Creditors Arrangement Act, an IP licensee
is protected if the licensor enters formal insolvency or restructuring
proceedings, or if the licence is disclaimed or the IP is sold in such
proceedings, whether by the licensor or its trustee or receiver. As long as the
licensee continues to perform its obligations under the licence, it will have a
continuing right to use the IP for the remainder of the term of the licence and
for any further period by which the licensee is entitled to extend the term. That
continuing right may be exclusive or non-exclusive, depending on the grant in
the licence. Such an extension right mitigates risks for a lender as there is
greater protection for both the IP and the ongoing business operations of a
licensee borrower. A lender will have comfort knowing the borrower will not
suddenly lose its IP rights if the IP holding company faces insolvency, which
would otherwise impact the viability of the borrower’s business and its ability
to repay the loan.
This due diligence can be time-consuming and challenging to
complete. However, it is crucial to understand the value and ownership of the
borrower’s assets to ensure sufficient security in the collateral.
If you require assistance with any matter or question related to tech lending, please reach out to a member of our Financial Services Group.
More articles in this series:
- Tech Lending: Why Are Tech Companies So Hard to Value? (airdberlis.com)
- Tech Lending: What Are IP Assets? (airdberlis.com)
- Tech Lending: Software as a Service (airdberlis.com)
- Tech Lending: How to Register Security Interests in IP (airdberlis.com)
- Tech Lending: Types of Debt for SaaS Providers (airdberlis.com)
