Financing Strategies of Startups and Role of IPRs

For startups, success in financing is a crucial step for succeeding in their business. When focusing on debt financing among startup’s financing, intellectual property-backed financing focusing on intellectual property right (IPR) value seems promising.

However, IPRs as intangible fixed assets have the lower liquidity. Thus, IPRs are very difficult to be converted to cash. In addition, IPRs themselves do not generate cash flow unless licenses are set on them.

Therefore, setting collaterals as well as financing solely based on IPRs would have difficulties. For these reasons, the collaterals are often set on IPRs together with manufacturing equipment as tangible assets.

This means that IT startups such as SaaS typed companies would have difficulties in financing using IPRs as collaterals. It is because that such IT startups do not have enough tangible assets. On the other hand, it has been pointed out that IPRs can improve the profitability of startups and promote financing even for startups that do not own enough such tangible assets.

For example, according to reports from the UK Intellectual Property Office and the UK Business Bank, companies holding IPRs have lower tendency of defaults of their debts. In addition, according to this report, such tendency can also be seen for companies without enough tangible assets. Therefore, it is inferred that IPRs play a certain role in the financing of startups including IT startups and service-based startups.

In addition, according to a report issued by the Japan Patent Office, SMEs that own / utilize IPRs tend to improve their operating margins and return on assets (ROA). The reason of these improvements is inferred to be the nature of monopoly rights of IPRs. In other words, IPRs have a function of preventing competitors from launching products that are exactly the same as the IPR owner’s product. Thus, IPR owners can avoid price competition to set the higher prices and margins. Such a nature as monopoly rights seems to contribute to the improvement of the SME’s business as well as the avoidance of default when receiving a loan.

  • Amazon’s Business Strategy and IPRs

Then, how do IPRs play roles, especially in IT companies? We can study this issue while exemplifying Amazon’s case by referring to their financial reports.

Generally, the valuation of IPRs is often conducted with the income approach. That is, the valuation of the business / company is conducted by accumulating cash flow. The value of IPRs is calculated by determining the contribution of the IPRs in the value of the business / company.

The amount of cash flow or that of operating income usually tends to grow as gross assets of the company increase. A ratio of operating income in a certain business having a certain amount of gross assets is called as return of asset (ROA; [Operating Income]/[Gross Assets]).

Generally, this ROA indicates an earning yield in the business. It is often said that business model being able to increase the operating margin ([Operating Income]/[Sales]) and the total asset turnover ([Sales]/[Gross Asserts]) often increases ROA. Thus, operating income and cash flow will be increased under such circumstances.

Regarding Amazon’s business strategy, they deem Cash Conversion Cycle (CCC) to be important in their business. For example, Amazon Prime’s subscription fee is charged a fixed amount every month. Therefore, even without any transactions, a certain amount of cash will always be deposited on Amazon.

In addition, the subscription fee basically has the features as advance payments. Thus, payments are always conducted prior to the purchase of stock as well as the subsequent payment of accounts payable. Accordingly, it enables to dramatically improve Amazon’s financial condition due to significant improvements in cash flow. In addition, Amazon’s IP strategy also seems to be focusing on cash flow.

The most prominent example of Amazon’s IP strategy is the “One-Click Buying Patent” (U.S. Patent No. 5960411; filed on September 12, 1997, registered on September 28, 1999). It enables purchasing products with only “one click” on their EC platform. Credit card information and shipping information are registered in advance. This patent relates to a technology developed for the purpose of reducing the shopping-cart abandonment rate. The rate indicates the percentage of events not leading to check out after the goods have been put into the cart.

The patent had shortened process required for payment on Amazon’s EC platform. Thus, it had improved the deposit cycle. In addition, it had demonstrated customer attraction thanks to improved convenience. Accordingly, the total asset turnover was dramatically improved to greatly improve their cash flow. In fact, Amazon’s revenues as well as their total asset turnover had been on a rapid growth trend since 1999.

Changes in Amazon’s revenues and total asset turnover from the late 1990s to the early 2000s

Furthermore, following Amazon filing an application of the one-click patent at the end of September 1997, they succeeded in financing of USD 75 million with repayment terms of 3 years, which was backed with substantially whole assets of the company. This loan is about nine times of the gross assets of USD 8 million at the end of 1996. It is also about 21 times of the operating cash flow of USD 3.5 million in 1997. These figures show that the financing institute had expected Amazon’s drastic growth.

The one-click buying patent is said to have brought huge profits to Amazon. Now, EC market will become more competitive after the expiration of the patent term.

  • Amazon’s Recent Business Development and IPR Trends

As for Amazon’s business, the those currently producing the largest revenues are the North American EC business. In this regard, Amazon is recently strengthening same-day or next-day delivery in their EC business.

According to 2019 Q4 financial results, Amazon’s same-day and next-day delivery in the U.S. had quadrupled year-over-year. Amazon’s EC platform has a system charging when products are shipped. Thus, the increase in the number of same-day and next-day deliveries will improve Amazon’s cash conversion cycle to accelerate payments.

In addition, it would also demonstrate customer attraction by improving convenience. Accordingly, their total asset turnover will be improved to contribute significantly to the increase in cash flow.

In fact, revenues of Amazon’s North American EC business in 2019 Q4 was increased by 22% year-on-year. Moreover, revenues in other regions was also increased by 14% year-on-year. Furthermore, operating cash flow was increased by 19% year-on-year. As such, the expansion of same-day or next-day delivery seems to have greatly contributed to Amazon’s business performance.

Here, based on the data available on WIPO’s PATENTSCOPE, we focused on trends of international patent applications by Amazon for the five years up to 2018. The number of international patent applications (PCT applications) filed by Amazon is about 141 to 195 per year.

However, from 2015 to 2017, the percentage of international patent applications in the field of delivery-related technology (including automatic delivery using drones) was on the rise. In other words, Amazon had been filing patent applications in the field of various technologies related to same-day or next-day delivery prior to expanding the scale of the service that will increase cash flow.

Changes in the number of Amazon’s international patent applications and percentage of delivery-related technology

Also, when focusing on the patent application trends by Amazon during the same period, cloud-related technology accounts for 57% to 69% of the total international patent application. In addition, the segment margin of AWS (Amazon Web Services) is increasing over the years.

In the cloud business, the ratio of variable costs to the cost of revenues is usually low. Moreover, the cost of revenues tends to be kept small compared to the total revenues. Therefore, by increasing the revenues of the segment, the segment margin is greatly increased, and the cash flow margin will be increased. Accordingly, the cash flow in cloud business is dramatically increased.

Amazon’s cloud-related international application percentage and AWS segment margin

Thus far, Amazon has recorded huge profits while utilizing the one-click buying technology that seems to be directly linked to an increase in cash flow. And even now, they continue to develop technologies that improve the cash conversion cycle. In other words, the company seems developing IP strategies improving cash conversion cycle or cash flow. Such IP strategies of Amazon is considered as an excellent example for drafting business strategies of other companies including startups.

Reference

  1. Koji Watanabe and Takehiro Takei, “Financing Strategies of Startups and Role of IPRs”, Patent, Vol 74, No. 1, p. 95-101, Japan Patent Attorneys Association (2021) [Link]
  2. Martin Brassell and Kris Boschmans, OECD SME and Entrepreneurship Paper, “Fostering the use of intangibles to strengthen SME access to finance” (2019)
  3. Intellectual Property Office, British Business Bank, ”Using Intellectual Property To Access Growth Funding” (2018)
  4. Japan Patent Office and Mitsubishi UFJ Research & Consulting Co., Ltd., Report of “Basic Survey on Intellectual Property Activities of SMEs “(2019)

Disclaimer & Disclosure

1. This report is provided solely for informational purpose and not intended for the purpose of soliciting investment in, or as a recommendation to purchase or sell any specific products. 

2. Any opinions or statements expressed in this report are based on the author’s personal and subjective views, and are not the official views of the organization to which the author belongs.  In addition, although we have done our best efforts in making accurate assessments on the companies’ strategies, we cannot guarantee any complete accuracy of this report. We do not guarantee either that any future forecasts referred to in this report will certainly be realized. 

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