Asset-light companies are transforming the landscape of private credit by prompting lenders to utilize intellectual property (IP) as collateral, despite various challenges related to valuation, legal risks, and concerns regarding potential obsolescence driven by artificial intelligence (AI).
These businesses differ from traditional enterprises that utilize tangible assets such as equipment, inventory, and real estate for private direct lending. Instead, they rely on illiquid and challenging-to-value IP as their security.
“Investment is increasingly aligning with asset-based finance (ABF) strategies, but we are still in the early stages of its growth within private credit markets,” stated Brian Armstrong, managing director at Benefit Street Partners. “We anticipate that ABF could emerge as one of the fastest-growing asset classes in the next five years.”
According to Moody’s 2026 Global Private Credit Outlook, private credit assets under management are projected to surpass $2 trillion this year and approach $4 trillion by 2030. “Although corporate lending currently dominates the private credit landscape, there is a shift towards ABF,” the report noted. “While more difficult to measure, ABF has the potential to surpass traditional corporate lending.”
The use of IP as collateral is not unprecedented; for instance, specialty retailer J. Crew utilized a combination of IP and other assets to secure over $540 million in payment-in-kind notes nearly a decade ago. However, accurately valuing assets like proprietary software and data sets remains complex.
Methods for valuation include discounted cash flow analyses, benchmarks against similar transactions, and assessing the asset’s replacement or reproduction costs. Businesses frequently enlist independent third-party valuation firms like Alvarez & Marsal, Holihan Lokey, or Kroll for this purpose.
A primary concern for ABF lenders is the potential for IP to be removed from the pool of pledged assets. “In many agreements, covenants allow borrowers to determine the value of assets based on their reasonable commercial discretion,” remarked Jake Mincemoyer, partner at A&O Shearman. “This has raised alarms among lenders, particularly after instances where borrowers manipulated the situation to extract key assets from collateral packages.”
A notable example is J. Crew’s 2017 decision to transfer pledged IP to a new, unrestricted subsidiary, circumventing restrictive covenants and enabling the company to secure additional funding with the same IP. This has led to the establishment of a “J. Crew Blocker” provision in debt covenants, which aims to prevent borrowers from transferring significant assets into unrestricted subsidiaries.
Despite these precautions, some borrowers are still finding innovative ways to navigate credit agreements. In February, Xerox moved IP assets tied to existing debt into a joint venture, securing an additional $450 million in funding while still owning a 49% stake, therefore preventing the joint venture from being classified as a subsidiary in relation to its debt agreements, as noted in Ropes & Gray’s Distressed Debt Legal Insight.
Regional Differences in ABF Adoption
The ease of acquiring ABF by pledging IP as collateral varies significantly by region. North America is approximately five years ahead of Europe, largely due to European Union regulations governing the use of IP as collateral.
For instance, under the European Parliament and Council’s Directive/24/EC, the original creator of software, whether an employee or a contractor, holds copyright ownership unless specified otherwise in their agreement. However, establishing the origin of software can be challenging, particularly when it includes third-party applications and open-source content.
“The market is not yet fully equipped to finance software comprehensively due to uncertainties surrounding ownership,” stated Steffen Schellschmidt, a Munich-based partner at Clifford Chance specializing in private credit. “Thorough and expensive due diligence is essential to address this issue.”
This reality has prompted many European private lenders to concentrate on registered IP, such as patents and trademarks, where ownership is clearer. Additionally, EU regulations do not allow for the inclusion of software IP under a floating charge, as Schellschmidt highlighted: “Once security is established under European law, assets can still be transferred, which diminishes their value as they remain linked to an existing pledge.” This situation creates a funding gap for businesses that lie between startups and larger, established companies in industries like pharmaceuticals.
“This explains why we lack a Silicon Valley in Europe,” Schellschmidt asserted.
In response to the funding gap, the European Union is taking steps to address the issue. As part of its Strategic Plan 2030, the European Intellectual Property Office (EUIPO) and the European Commission have created an IP-Backed Finance Steering Group to develop an IP Finance Roadmap aimed at helping European startups, scaleups, and SMEs secure financing based on their intellectual property.
Impact of AI on IP Valuation
AI is increasingly influencing ABF, particularly among businesses looking to use enterprise software as collateral.
AI-driven software development tools, such as Anthropic’s Claude Sonnet and Microsoft’s GitHub Copilot, are accelerating the pace of obsolescence for existing software solutions, thereby reducing the value of such assets used as collateral amid heightened market competition.
Nonetheless, AI should not be regarded solely as a detrimental force for the valuation of software as collateral. Mincemoyer from A&O Shearman believes that AI will yield significant advancements and innovation, enabling new business opportunities. “While there is a potential risk that a few people wielding powerful AI tools could dominate, I do not believe that it will fully transpire,” he explained.
Ultimately, the rapid advancement of software development necessitates a more active management approach for collateral. “If your IP collateral could be directly influenced by AI, you should regularly review and reassess its value to ensure your loan is adequately covered,” advised Armstrong from Benefit Street.
Despite these challenges, the willingness of ABF lenders to accept a variety of IP types as collateral is on the rise. “In the past five to ten years, I have observed a significant increase in financing involving lenders who are comfortable extending credit against intangible assets,” Mincemoyer added.