Getting out of Technology Jail #2September 16, 2011
In the past few decades there has been a veritable explosion in innovation, accompanied by exponential growth in important technology drivers, including Internet bandwidths, the performance, the speed and RAM power of computers. As a result of these and other changes, the engine of growth in our economy has migrated from its traditional industrial base to something substantially different.
Today nontraditional assets, new ideas, patents, software and other forms of intellectual property underpin many of the most exciting businesses in our economy. Needless to say, these new sources of wealth do not appear on the company’s balance sheets, and sometimes not even on their management’s radar screens.
Despite the fact that these new assets form the largest part of our economy now-a-days, important institutions including business schools, banks, accounting professionals, securities and exchange commissions have not kept pace with these changes and as a result do not know how to interact with the new innovative businesses that have emerged from all this.
With Western economies failing rapidly, there is a desperate need to bridge this yawning gap. What’s required is a means of translating the institutional standards, management disciplines, operational processes and leverage of traditional assets into this rapidly developing knowledge driven ‘new asset’ space.
This means treating nontraditional assets like traditional assets.
Essentially the first step is for management to properly identify and capitalize the nontraditional assets on its own balance sheet on an historical cost basis – which will at least identify the important value drivers in the business. This is NOT traditionally done in the normal course of business, but does conform to a rapidly evolving GAAP (Generally Accepted Accounting Principals)
As important as this step is, its does not extract the full ‘enterprise’ value from innovation.
So… what is enterprise value? If you’re fortunate enough to own traditional assets, developable property for instance, accounting standards allow you to estimate the property’s value on a ‘best use’ enterprise basis.
Highest and best use, or highest or best use (HBU) is a concept in real estate appraisal that shows how the highest value for a property is arrived. HIGHEST AND BEST USE is calculated optimistically on the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.
This enterprise value will very often be many times the purchase price. This kind of valuation technique allows property developers to accelerate their businesses through increased financial leverage.
Translating these traditional valuation concepts into nontraditional assets assumes a ‘best use’ valuation of the intellectual property with all kinds of caveats and assumptions. Enterprise valuations tend to be larger than standard values at play in the market today because of many factors, including optimistic assumptions about:
(1) Access to capital and other resources of all kinds
(2) Management competency and skill, and not least
(3) Globalization’s impact on Market Size calculations.
So why is Enterprise Value so important? In a word… LEVERAGE
Leverage the Assets at Full Value: traditional businesses take full advantage of leveraging their assets on a best use basis. For instance owners of development property are able to use the full develop-able collateral value of their assets to attract bank finance, to establish valuations when going public, doing joint ventures etc. Enterprise valuations unleash this best use value of nontraditional assets so they can be leveraged in the same way, commercially and in the stock market.
By identifying the asset strength, bolstering the company’s balance sheet and structuring properly, it is possible to greatly increase the Net Worth of a company, preparing it for investment, increasing the bargaining power in real financial terms.
What’s the benefit of Enterprise Value: Now, it is possible to fit a substantial investment into the company without punishing dilution.
Things to Think About:
- Unfortunately it is very difficult – if not impossible - for your ordinary accountant to obtain Enterprise Value for nontraditional assets in the originating organization. Specialized GAAP accounting techniques (it really is brain surgery) are required to accomplish this goal.
- If you’re interested in more details on how to accomplish all this, write a summary of your new asset business in the comment box below and I’ll see that someone contacts you.