The period of recovery following the Great Recession sparked a shift in consumer product distribution and retail strategy. Merchants further increased investment in intangible assets such as CRM systems and ecommerce platforms, while at the same time migrating to “asset-light” models by reducing retail footprints and pushing working capital investments back to their vendors and third-party affiliates. During this cycle, commercial lenders became more willing to utilize retail and consumer brand-related intellectual property (IP) assets as acceptable forms of collateral. Beginning in the fourth quarter of 2019, the rate of default and workouts for loans with IP assets as collateral began to increase, reaching a crescendo as we entered the third quarter of 2020. In the discussion that follows, we will assess the current market for IP assets and the relevance of that market for lenders to consumer and retail companies. We will examine the near-term implications for workouts and liquidations where IP assets are expected to provide a meaningful source of lender recovery, and its longer-term implications for commercial lending to retailers and consumer brand companies.

During the previous cycle, lenders gained a greater comfort level in underwriting to IP collateral. The market for IP assets generally became more liquid with the development of public and privately funded brand management and licensing platforms. Many of these platforms were financed by agented ABL facilities and ABS structures tied to the income generating characteristics and projected recovery value of the underlying IP. Underwriters became more comfortable with IP appraisal models and underwriting fundamentals as they 1) Provided seasonal overadvance lines secured by IP collateral; 2) Agented FILO and split lien deals where IP was encumbered and; 3) Participated in workouts where IP recoveries closed gaps between the borrowing base collateral and outstandings. Additionally, during this period greater numbers of new private investment funds entered the commercial lending markets, providing term loans utilizing various forms of IP collateral. Along the way, we began to see 1) BDCs and leveraged finance lenders justifying notably higher leverage multiples by taking into account projected IP recovery values and; 2) brand licensing platforms increasingly seeking access to the commercial finance market in an effort to generate additional acquisition financing.

Heading into the fourth quarter of 2019, there were already telltale signs of stress in both the retail and consumer markets. The onset of the COVID-19 pandemic in North America starting in late March/early April 2020 led to a sizable, subsequent wave of retail and consumer workouts and bankruptcies in the U.S. with over 3,600 companies filing for Chapter 11 bankruptcy protection in the first half of 2020 alone, according to the American Bankruptcy Institute. In the initial stages of the correction, we saw depressed IP recovery levels. These results were driven by reduced liquidity in the IP asset market, largely the result of a pullback from the market by strategic buyers (e.g., traditional brick & mortar retailers) who had no choice but to focus their attention on managing their own P&Ls and balance sheets during that period. At the same time, publicly traded brand management platforms had, by and large, withdrawn from active participation in the market for IP assets.

In the post-Great Recession recovery, publicly traded brand management platforms such as Iconix, Cherokee, and Sequential Brands created large consumer brand portfolios based on a direct-to-retail brand licensing model. That model had generated significant market value through much of the last cycle via the acquisition of brands that were then licensed to retailers such as Target, Walmart, Amazon among others, who agreed to pay guaranteed minimum royalties to the licensing companies in return for the exclusive use of the licensed brand. Over time, however, the direct-to-retail model came under pressure as large retailers sought to enhance margins by developing or acquiring their own private label brands. Retailers became unwilling to pay guaranteed minimum royalties for brands that they were largely responsible for developing. Today many of these public brand management platforms have become sellers rather than buyers.

The impact on liquidity in the IP asset market from the pullback by brick & mortar retailers and the public brand management platforms has proven to be short-lived, as those market participants have been replaced by privately owned platforms financed through private equity and institutional fund investors. Going into the third quarter of 2020, we observed an emerging trend of increasing liquidity in the IP asset market driven by a significantly expanded stream of capital being made available to privately held brand management platforms such as Authentic Brands Group, Wave Hill Partners, Marquee Brands, and Spotlight Brands, among others, seeking to capitalize on market conditions to strategically expand their brand portfolios. These privately owned brand management platforms practice a much more vertical model of brand management and active engagement with their licensees. Often, this includes being more involved in the operation of specific channels, such as the direct-to-consumer channel, which provides the brand manager greater control over the development of its brands and provides increased value to licensees.

Increased liquidity in the IP acquisition market is also being fueled by technology advances in cloud-based ecommerce software applications such as Shopify, Squarespace, Volusion, and others with large, embedded-user bases. This has enabled the increasing number of digital marketing platforms to seamlessly connect to both the front- and back-end of the ecommerce ecosphere without the level of significant capital investment previously required. The improvement in cloud-based ecommerce infrastructure solutions has occurred at a moment in time when digital marketing and social media advertising costs utilizing Google and Facebook remain somewhat below their pre-pandemic levels, with many traditional advertisers having retreated from auctions.

Digital marketing platforms have been quick to adjust to these developments. These platforms represent highly scalable investments. A distressed IP sale provides a digital marketing platform the opportunity to acquire brands coupled with an engaged customer database. The exclusive opportunity to market to that customer, coupled with a wealth of transaction data, provides the digital marketer the opportunity to connect with the customer directly. This reduces customer acquisition costs and increases the return on investment in digital marketing and social media advertising. These digital marketers understand that brands provide one of the only moats to competition in the digital marketplace.

The development of large ecommerce marketplaces like Amazon, Wal-Mart/Jet, Rakuten, Wayfair and others has led to increased efficiencies in 3PL warehousing, logistics and drop shipment capabilities. Leveraging these developments, digital marketers have migrated brands with high customer awareness and acceptance into “asset- light” ecommerce models, efficiently expanding the breadth and scope of the brand through affiliate programs and the creation of their own marketplace environments.

The combination of increased investment in privately held brand-management platforms, and acquisitive digital-marketing platforms has led to increased liquidity in the IP asset market, and increased recovery values for IP assets in distressed sales. A host of recent high-profile distressed IP sales illustrate the pervasiveness of these increased values in the current market climate:

• Pier 1 acquired for $31 million by a digital marketing platform
• Sur La Table acquired for $35 million by partnership between a digital marketing platform and privately held brand management platform
• NY & Co. and Fashion To Figure acquired for $23.5 million by partnership of digital marketing platform and plus size retailer

In addition, other recent high-profile brand sales have drawn meaningful interest resulting in exceptional recoveries through acquisitions by privately owned brand management platform and digital marketing platforms. These include Brooks Brothers, Catherines, and John Varvatos.

For commercial lenders, these developments have a number of implications. In the near-term, given the liquidity in the market for consumer and retail brand assets, opportunities exist for lenders to enhance recoveries in troubled credits with IP collateral. Longer-term, as borrower balance sheets continue to get skewed more and more to their intangibles and away from traditional working capital assets, the proliferation of asset-light models will require lenders to become more comfortable with the value of IP as collateral. As the recovery progresses, the secondary market for IP assets possesses sufficient liquidity to support consumer brands that are driven by licensing and digital marketers seeking expansion into both new product channels and customer categories. It is likely that the growth in commitments secured by high-quality intellectual property assets will continue, and the importance of partnerships between lenders and IP valuation experts tied into the dynamics of the IP asset market will increase.