Archive for July, 2011

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Getting out of Technology Jail

July 19, 2011

It is often said that banks can’t finance small to medium sized enterprises (SME’s) these days. Well that’s not necessarily so. True, a technology rich SME does need to get ‘Out of Jail’ first and that means doing things differently.

Let me give you an example from my own experience. I once consulted to a small company that designed and manufactured access control security systems.  This company produced relatively cost-effective security solutions and relied strongly on referrals to market and sell its products.

One day this company asked if I could I help them with their business plan, of course!

At the time of our engagement, the company was in the final stages of developing a new suite of security systems to take the company to the next level. The company estimated they needed an investment of $3 million to initiate the new plan, for which they we’re prepared to give up 33% of the company’s equity. My task was to prove to a potential investor that $3 million in new money was “worth” 33% of the company.

One look at the books and I could see they were in Technology Jail. I quickly discovered that they had been steadily re-investing every extra dollar that was available into R&D, a continuous stream of re-designed and new products. Their financial statements were (as usual) prepared solely for tax purposes, expensing everything allowable:

After an initial assessment, I decided to call in accounting specialist Joe Batty C.A. to see if the company had alternatives to an equity investment. And sure enough Joe was able to assist. The initial accounting assessment:

  •  Revenues had grown steadily over the 9-year period from less that $500,000 in Year 1 to slightly more that $14 million in Year 9.
  • According to the books, the company had shown losses in Years 1 through 8 and showed a profit in Year 9 of approximately $200,000.
  • Accumulated deficits for the 9 years were over $5 million.
  • The company had limited assets and limited liabilities.

Joe asked the simple question, “Do you know what your assets are?

They answered: “Certainly, it is our line of products.”

He then asked them: “Why don’t your financial statements show these assets?”

They had no answer.

Joe’s recommendation, they needed to treat their product line as assets. Joe told them they should re-examine their procedures for engineering, manufacturing and then capitalize the costs associated with the development of these assets. (While still taking advantage of allowable R&D tax considerations)

They asked Joe to lead them through such a process.

After about a week of analysis with their engineering staff, their accounting staff and the external accountant, we were able to adopt a series of policies that would lead to a change in their approach to accounting. The external accountant agreed to allow us to re-state their last 5 years of financial statements and show the product line as assets on these statements. The change was dramatic:

  • Stronger Balance Sheet: we added $4.5 million worth of assets on their balance sheet.
  • Improved Income Statement:  financial statements showed strong and growing profits for the last 5 years
  • Recent Performance: Year 8 showed a profit of approximately $ 1 million and Year 9 showed a profit of more that $1.5 million.
  • The accumulated deficit was almost written off.

The Result: their bank manager provided them with a line of credit for the $3 million they needed to finance their expansion.

Things to Think About:

1. If Its Not An Asset to You, its Not An Asset: there is a process to unlocking the value in intangibles. The first job is managements. Begin by identifying the underlying intellectual property “IP”, clarify what you own and determine how it delivers value. Then, if suitable, mature it into a form of intellectual capital “IC”, a revenue generating property owned by the company. If the IC has sustainability and therefore asset-like qualities capitalize it as an Intellectual Asset “IA”.

2. Most importantly: surround these valuable commodities with asset disciplines and metrics so that they fit within the traditional asset framework that covers any or all asset classes. If you do this and manage it effectively it might help your company escape from Technology Jail and avoid the leverage trap that plagues many SME’s today.

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Technology Jail #2: Wall Street Wolves

July 1, 2011

According to a recent University of Maryland study, the United States economy is generating (annually) trillions of dollars of undocumented intangible asset wealth. This wealth is literally invisible; it does not show up on company balance sheets, in GDP statistics or other national economics measures.


Interestingly this new wealth is, to a large extent, accumulating in the vast army of innovative small to medium sized businesses (SME). Unfortunately, because we don’t (at present) manage, account or securitize these sources of wealth properly or consider the assets ‘real’ we’re creating unnecessary hardship for SME’s and society at large.

Technology Jail (see last months post), handicaps knowledge-rich businesses and vastly increases their cost of capital but, also, in a real sense contributes to the relative decline of the West in global economic terms.

Many SME’s today, lacking solid bankable assets, chose to ‘Go Public’ early to gain access to the capital they so desperately need.  But going public in this way is expensive and is loaded with unexpected perils. Indeed the markets are filled to the gunnels with bright young companies essentially locked in the ‘Penny Stock’ wing of Technology Jail.

Andy Kessler, a financial journalist and writer, being interviewed on NPR recently said: “You know IPO’s are capitalism’s carrot, right, they’re hung out in front of entrepreneurs as an incentive for them to work hard, pull all-nighters, chug ‘jolt’ cola and change the world.”

But Andy also pointed out a few home truths for the audience.

What most people don’t know is that in an IPO process the management of the company fly’s around the world meeting institutional investors, meeting with the Fidelity’s, Janus’s the mutual and pension funds in a process of whipping up excitement for what they do. And then the underwriters, Goldman Sachs or Morgan Stanley go around and say ‘how many shares can we sign you up for”.

So it’s this funny kind of auction (that takes place)… You know the management of the company, the employees of the company and certainly the venture capital investors of the company do well when the company’s goes public – they can’t sell for six months by the way. But the ones who do best are the ones who get allocated shares on the deal and if it doubles in the first few minutes… you know they do quite well”.

What’s wrong with this picture Andy?

The company sweats bullets for years to get something worthwhile off the ground; the management then go around and ‘drum up demand’ for the shares. Then the guys who have done the least, the bankers and their favorites, load up on fees, divvy up the tradable shares and ride the initial demand to great profits while the company, including the guys who pulled all-nighters, are stuck.

What’s the out come of all this at the end of the day? Unfortunately not all companies are lucky enough to be a ‘Linked-In’ with huge brand recognition and earnings. Today the NASDAQ – OTC Bulletin Board and the Pink Sheet Board are littered with broken deals – public Companies with partially developed technology, trading at pennies and struggling to keep current with their SEC filings.  The SEC’s response to this is to make the filing requirements even more stringent. Unfortunately, It’s not the filing system that is broken; it’s the presence of so many un-bankable intangibles and a predatory finance industry.

The process of ‘Going Public’ is so distorted, the incentives so misplaced today that it reminds me of “Little Red Riding Hood.” You know how the story goes: an innocent little thing in her red cape is on her way to grandmothers house in the dangerous woods. When she (i.e. the high tech SME) arrives at the offices of her financial savior, she notices her ‘grandmother’ (broker dealer/investment advisor) has an odd look in his eye while he promises the little ‘darling’ cupboards filled with bread and cookies. Little Red Riding Hood then says, “But grandmother, what a big investor network you have!”. “All the better to fund your deal my dear…” This eventually culminates with Little Red Riding Hood saying, “But grandmother, what big teeth you have!”, to which the wolf (broker dealer/investment advisor) replies, “The better to eat you with my dear,” and swallows her whole.

Most truly innovative companies gain very little in real terms from going public this way; unfortunately, apart from being fleeced by their broker dealers they find themselves burdened with a host of free trading shares and absolutely the wrong (short term, opportunistic) shareholders chosen not by themselves but by underwriters.

Its a short sellers dream; welcome to Penny Stock land.

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