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Lenders 360

Sometimes Your Collateral is Source Code, which is Actually Nothing

Posted in Collection, Technology Notes

We are well out of the .com bubble, but tech companies still form and fail.  For the lenders brave enough to lend to the tech companies developing software, the collateral is often the source code which is the nuts and bolts of an application or “app”.  While the source code is actually a written text written in some development code, it exists in the abstract and it thus an intangible in that sense.  However, unlike most collateral intangibles, this type often requires the original developer to make the source code worth anything more than a line item on a security agreement.

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Consider for a moment the case of Aereo, Inc., which filed bankruptcy is late 2014.  It was a company which developed a web based app which allowed users to watch TV on mobile devices or over an internet connection at home.  Basically, Aereo, Inc. received the cable/TV signal from the normal sources, e.g., cable and antenna, and then converted the signal to be routed through the internet to the subscribers.

In the course of developing this technology, Aereo raised about $250 million in equity from inventors.  So, presumably someone believed in the product.  (Admittedly, there was no secured debt).  Additionally, Aereo listed its assets as worth $20 million when it filed bankruptcy in November 2014.

So why did Aereo end up in bankruptcy? Basically all the old guard TV networks sued Aereo for providing their content to Aereo subscribers.  Much could be written about the underlying litigation in which Aereo essentially claimed it did nothing wrong by re-broadcasting the network’s programming verbatim.  However, this post is to discuss the value of the underlying source code of the app.

Putting the lawsuit aside, the technology was worth $250 million to someone.  However, in a recent decision by the bankruptcy court hearing the case the bankruptcy court approved a sale of the source code for $125,000.00.

Obviously, the sale price of what was essentially the heart and soul of Aereo seems low when considering the equity investment.  One of the main reasons is the lawsuit by the networks.  However, I would also propose that the ultimate sale price was also driven by the fact that the value of the source code is also driven by the individual developer’s involvement.  If the programmers leave, then the value drops a precipitously. Why would that be?

The simple answer is that source code is not a straight forward fait accompli, but rather it is usually a patchwork of fixes, updates, modifications and short term solutions.  It’s basically as if you are selling the rights to the sewer system of Rome – its complex, it’s been modified as the generations have progressed, and the original guy who designed it is gone.

So, if you are the secured creditor, how do you monetize the source code collateral to recover on the debt?  The short answer is that you likely won’t.  Most lenders discount the various types of collateral based on their collectability after default.  In the case of source code, the recent Aereo sale should be of some indication of the value of source code without the developers.  Understanding that the Aereo lawsuits played an impact in the sale, a lender should not ignore the total loss in value because the source code did not come with its original developers.

The take home message is this – the true value of source code is often with the developers and not with the intangible code.

In re Aereo, Inc. case no. 14-13200-shl, pending in the United States Bankruptcy Court for the Southern District of New York, Manhattan Division.