Getting creative with capital

Powering Innovation and Recovery With IP and Parametric Models

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July 7, 2021


Overview

Capital is the lifeblood of businesses, allowing them to grow, invest, embrace new market opportunities and rebound in times of crisis. The economic downturn caused by the COVID-19 pandemic strained many companies’ financial positions and shrunk their working capital.

At the same time, the pandemic made raising capital more difficult, as many banks and investors grew wary of a rise in defaults and bankruptcies.

One survey of private equity investors conducted during the pandemic showed that only 27 percent of respondents expected investment activity to remain flat or increase in the months ahead. Meanwhile, the U.S. government stepped in to offer forgivable and low-interest loans to businesses in certain segments, and many banks enacted tougher terms for new loans while the pandemic environment put pressure on corporate debt markets.

Throughout the pandemic, however, many businesses have started looking for opportunities in new markets, innovation or business transformation. Meanwhile, financial institutions are examining new sources of capital to invest.

“Many financial institutions and businesses are exploring new pathways to sourcing capital,” says Joel Sulkes, managing director, Global Financial Institutions Practice leader at Aon. “Banks globally are becoming more comfortable with the reinsurance markets to manage credit risk and free up capital or internal credit limits to then redeploy to clients. Lenders are also getting more comfortable valuing intangible assets as a way to provide nondilutive financing to their clients.”

In this series, we’ll take a closer look at creative ways businesses are freeing up capital, whether to innovate or rebound from crisis. This week — intellectual property (IP) and parametric insurance programs.

In Depth

In the past 30 years, intellectual property has become a significant asset for many organizations.

In 1975 IP represented 17 percent of S&P 500 balance sheets. By 2019 IP’s share had grown to 85 percent. Currently, the U.S. is issuing patents at a rate of about one million every three years while China is issuing patents at a rate of about one million every 12 to 18 months.

“As we’ve transitioned to a global innovation-driven economy, we’ve witnessed a historic value rotation from tangible to intangible assets,” says Lewis Lee, CEO and global head of Aon IP Solutions. “Every business today views innovation as critical. So now the question for companies is, how do you optimize conversion of that innovation into an IP asset class that can then be leveraged to make companies more valuable?”

In order to tap IP into their capital-raising efforts, businesses need to fully understand their IP and its value. New analytics tools, along with artificial intelligence and machine learning, are making it possible to assess IP assets at scale.

Intangibles as Collateral

Beyond traditional monetization approaches, such as licensing IP to third parties, most companies don’t fully understand the importance of their IP assets to their overall enterprise value, Lee says.

“There are a lot of mid-market companies that don’t truly appreciate the value of their IP assets,” says Nick Chmielewski, chief broking officer for Aon IP Solutions. “They look at it from a legal perspective or as a cost center, but not as something that has value that can drive the business.”

And historically, businesses have not been able to adequately leverage IP assets as collateral in borrowing. That has changed.

Chmielewski says the value afforded to IP assets is more frequently being tapped for financing opportunities. For instance, fast-growing companies can use their IP portfolios to collateralize loans for growth capital. The benefit — these types of loans offer a nondilutive, competitively priced source of capital compared to traditional equity financing, Chmielewski says.

“We are seeing significant expansion in lending capacity for this market and increasing demand from borrowers for this option,” says Chmielewski.

Predefined Events, Predefined Recovery

Although IP may be new to the capital toolkit, insurance has long been an important part. But its applications are evolving.

Take the “if-then” coverage model of parametric insurance, says Michael Gruetzmacher, managing director at Aon: If a predefined event happens, as defined by an independent index, then there’s a recovery available. This alternative way to think about matching capital to risk is ideal for creating flexibility during a business interruption event.

“Companies are finding this to be a powerful problem-solving tool. With parametric insurance, if you can predefine an event of concern, you can transform more of the economic exposure around that event to be insurable,” says Gruetzmacher. “Plus, the claims process is fast, with payouts within days or weeks of the event. In a crisis, liquidity matters most. This strategy helps pay quickly and support other sources of capital.”

Ensuring Liquidity in a Crisis

On a recent webinar, risk leaders at Microsoft shared their views on the opportunity parametric programs provided as a capital option to offset Microsoft’s exposure to natural catastrophes.

Microsoft has experience with natural disasters. The company and its employees faced the Chennai floods, Hurricanes Harvey, Irma and Maria, and Superstorm Sandy. Ensuring the wellbeing of Microsoft’s employees during those crises meant providing generators and helping employees get their homes cleaned up if they didn’t have insurance coverage.

Many of Microsoft’s 156,000 global employees and much of their $60 billion in property and equipment are located in areas of earthquake risk, such as the San Francisco Bay area, Seattle and Washington. The company’s campuses are designed for resilience. But Microsoft’s leaders recognized that they had less control of the surrounding areas. In the event of an earthquake, while company buildings might remain safe, there might be no safe way to get there.

“In the event of an earthquake, could adjusters even get out to our facilities to adjust a claim in a reasonable amount of time? Could contractors get out there to start repairing facilities? Those are big questions,” says Marc Shea, senior risk manager at Microsoft. “The liquidity aspect is important. We could use the cash we’d get from a parametric program to supplement costs to repair infrastructure and ensure there’s good internet access to enable people to work from home. That’s all an option when you’re figuring out how to get things back up and running.”

Shea says the pandemic has been a sort of “dress rehearsal” for other gray swan risk events, such as an earthquake scenario: everyone working from home, no one can get to campus.

“Look at all the expenses we’ve incurred from the pandemic that we’d never thought of, like hand sanitizer and face masks,” he says. “We could see the same in an earthquake scenario — things we didn’t plan for until the event is upon us. The parametric structure gives us the ability to use the cash in a way that’s appropriate to what we’re responding to: to take care of our employees and help them to be safe and productive in the wake of a catastrophic event.”

Plus, Shea says this balance sheet protection allows Microsoft to keep investing in growth areas, such as building Azure cloud data centers around the world.

The Value of Capital Options

A major element of resilience is having risk and capital management strategies in place so they’re available in times of stress and opportunity, Sulkes says.

“In times of crisis, organizations that are dedicated participants in the reinsurance markets, not perceived as behaving opportunistically, can be positioned not just to navigate a crisis but to thrive,” says Sulkes. “New valuation tools and innovative risk mitigants can enable financial institutions to manage risk and deliver for their clients when they need it most.”