One of the more unintended consequences of the knowledge asset ‘revolution’ has been to increase the cost of capital for small to medium sized businesses (SME) in our economy.
Sadly, this is not a small problem. Consider that in a developed economy like Canada’s, SMEs deliver 60% of the nation’s economic output and generate 80% of all employment; importantly SMEs are Canada’s future, responsible for 85% of all new jobs.
According the CIBC World Markets report, SMEs are the major systemic source of growth in all post industrial ‘developed’ economies but suffer from some predictable problems including poor management, lack of economies of scale and inadequate capitalization.
The reality is structural flaws in our system today trap many innovative businesses in Technology Jail. Technology Jail is terrible for business but also has negative implications for GDP growth, the job market, and ultimately the material well being of citizens in the developed world.
So, what is Technology Jail?
Technology jail: a lethal combination of institutional inertia, ignorance and lack of balance sheet strength that produces strategic weaknesses in knowledge-rich SMEs.
The problem naturally begins (but does not end) with management. Executives today, whether in SMEs or larger more established companies have been trained to operate in an ‘industrial’ economy, which officially sanctions only the more traditional assets, like land, financial assets, plant and equipment, and inventory – to name a few of the more obvious industrial era assets.
But as everyone knows, we’re generating economic value in different ways today than our grandfathers. Most businesses today are underpinned by new and exciting technologies or copyright protected software, many are re-inventing our workplaces and our lives with novel business processes, systems and (increasingly today) network applications that deliver real value.
But these ‘soft’ assets don’t get much attention from management, certainly not the disciplined treatment that is showered on traditional assets.
Asset management is a normal part of traditional management practice. One of its most attractive attributes is its formal disciplined process, which standardizes the treatment of assets in the following discrete stages:
- Identification of the assets: What exactly is the asset, how does it deliver value to the company?
- The current state of the assets: What does the company ‘own’ and what is its condition?
- Performance criteria: What levels of performance or service are required, how is performance measured, what factors strengthen or impair the asset, how do these asset fail?
- Life of the asset determinations: How long will this asset continue to deliver value?
- What is the strategic ‘best use’ of the asset, are there alternative uses of this asset?
Very few managers today can answer these questions in regard to their nontraditional value drivers; fewer value their asset on a ‘best use’ basis, which would capture the full global market potential of their innovations.
Where this is being done successfully quantitative valuations of intangibles (software, patents, trademarks etc.) are beginning to show up on financial statements, strengthening corporate balance sheets. But this rosy picture is definitely the exception; in business today it is commonplace to prepare the financial statements for tax purposes, and therefore expense the costs associated with new asset development and ignore the nontraditional asset(s) on the balance sheet.
If you review the financial statements of almost any emerging technology company trapped in Technology Jail you may be surprised to find there will be literally no assets listed on the balance sheet and (by not capitalizing expenses) years of accumulated accounting losses. Furthermore, according to established valuation techniques, which measure assets – liabilities, the companies have little (or negative) ‘net worth’ and therefore little recognizable value.
If you then go on to ask the obvious question: How do you ‘fit’ the large scale investments needed to properly commercialize these business into a company with NO legitimate assets? The Answer is you don’t, or if you do, it’s at a very high cost!
Things to Think About
- Getting out of Technology Jail requires specialized skills. It requires the ability to clearly identify and quantify new, often unfamiliar assets and then the guts to stand up to almost everyone. The standard operating procedures of business schools, technology specialists, as well as accountants, lawyers and securities regulators needs to be faced head on and beaten. This is a non-trivial exercise. There is no escape without knowledge and courageous action.
- Going public to avoid this financing trap, often breeds more problems. In the absence of proper structuring and a strong balance sheet, the world of broker dealers, IPO’s and public company strategists will drive you into Penny Stock land, fighting another kind of uphill financing battle.