Development

Having concluded as to the product or idea's potential, the development stage will involve advancing it to the point at which it is ready for market. The time covered by this stage can vary substantially, depending upon the ultimate product. At one extreme, the clinical trial process for new pharmaceutical products will take several years; at the other, new publishing ideas may be converted into titles within a matter of months. This development stage is relatively investment-intensive. The product will not be generating revenue, yet the development process itself will require considerable cash resources.

The owner's perspective
As in the seed stage, owners of intellectual property look for funding which minimises their current financial obligations. Without revenues, they are unable to make the regular cost of debt service. This requirement points to a continuing preference for equity funding; co-investors who are prepared to take the same long term view of the product. A potential benefit of equity funding is that the investor may well bring skills and experience which are of value to the original innovator's owneship (and thereby rights to the future potential profit stream). This advantage is, however, considerably outweighed by the advantages otlined above. The innovator will recognise that its product will be unlikely to come to market without substantial additional funding.

The investor's perspective
The investor's perspective is largely unchanged from the seed stage. Equity finance is regarded as the appropriate basis of funding.

Early growth

By this stage, the development of the product is completed and the revenue stream will have begun. It is likely, however, that the business will continue to have further funding requirements. The cost of market penetration will be substantial relative to the level of sales being made. In addition, the business will require working capital funding, as the volume of sales expands.

The owner's perspective
Once a product is launched on the market, the attitude of intellectual property owners to funding options is likely to change. They will regard the exposure to development risk as having been extinguished, and the product as demonstrating a proven and growing market potential. At this stage, there may be a perception that further equity injections are not desirable, because much of the risk inherent within the business has been reduced. Existing investors will therefore look to protect their holdings from further dilution. At the same time, the business will be beginning to be able to meet the regular servicing charges of debt finance. Its ability to meet debt servicing costs, although improving, will nonetheless be limited. There will be a need for relatively low costs of finance and long repayment terms to reflect the timescale for the intellectual property to reach its full potential.
At this stage in the development process, intellectual property-based businesses are often significantly different from other businesses in the character of the asset base. For other businesses, equity capital is converted in a relatively short time scale into saleable assets, for example, buildings and machinery, raw materials and trading stocks. In contrast, intellectual property-based businesses will have invested much of their equity funding in the development of the intellectual property.
Intellectual property-based businesses may vary significantly in the nature of their funding requirements at this stage. Products, once lauched, will require ongoing marketing expenditure to enhance and maintain their positioning. In pharmaceutical companies, for example, this expenditure may well exceed the cash flows generated from sales. The funding requirements of such businesses are therefore for new projects, which have their own lifecycle. In other sectors, however, significantly higher expenditure may be required to maintain position. For example, in certain electronics and technology sectors, without constant development expenditure an innovation will only give short-lived market leadership. Unless and until longer term market dominance is achieved, much of the cash flow generated by sales may be absorbed by this expenditure.

The investor's perspective
The implication is that investors may at this stage in the business' lifecycle have a preference for debt, but only that which is geared to the business' long term potential. However, in these situations, the assets available, and their prospective value, are intrinsically lonked to the future performance of the business. They do not, therefore, meet the characteristics of security which lenders conventionally seek.
The indication is that investors' preferred funding route for intellectual property-based businesses in the early growth stage remains equity. While businesses moving through this stage may well be experiencing relative success, the investors' attitude is that the businesses remain high risk, long term and sustainable profitability are unproven, and their cash flow record to date is insufficient to service the levels of debt funding their require for future growth. The difficulty remains that funding requirements run well in advance of cash returns. Venture capital investors may go through a series of financing rounds with a successful, growing intellectual property-based business before significant returns are achieved. From the perspective of potential investors, debt financing is unlikely to appeal.
In the United States, debt has been raised by intellectual property-based businesses, through the NASDAQ market in particular. A number of these debt issues have been unsecured, high yielding and deep discounted, with no cash interest being payable for equity. They bring high risk but offer substantial returns in the event that the issuer is able to achieve sustained growth.
The key factor which investors would consider in relation to possible debt financing for businesses such as this is the available cash flow both for servicing the debt and for achieving ultimate capital repayment.

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