Ensuring Positive Outcomes with Negative Pledges in Venture Lending

Background

Intellectual property is often the primary asset for emerging growth companies, be it the source code underlying a SaaS developer’s software platform or a biopharmaceutical company’s patented gene therapy.

Given its role in the business, many companies seek to carve out their intellectual property from the general requirement that borrowers under senior secured credit facilities grant their lenders a security interest in all of their assets.

Rather than granting the lender a security interest in its intellectual property, a borrower under a so-called negative pledge arrangement instead agrees not to grant a security interest in its intellectual property to anyone else.

The intellectual property is thus excluded from the lender’s collateral package, effectively rendering the lender an unsecured creditor vis-à-vis the borrower’s intellectual property without the streamlined remedies of Article 9 of the Uniform Commercial Code.

From the borrower’s perspective, the negative pledge is likely preferable to an outright grant of a security interest in intellectual property because it shields the company’s “crown jewels”from the reach of its secured creditors.

Venture lenders, for their part, may find the negative pledge provides sufficient protection against interference from other creditors in a workout or enforcement situation, or that the forgone security interest provides only minimal credit enhancement ( ie, a borrower’s intellectual property is unlikely to provide for a significant recovery in post-default enforcement proceedings).

In situations where a stronger credit is considering multiple financing proposals, lenders might feel compelled to concede a security interest in intellectual property to remain competitive with other financing sources.