Archive for the ‘Technology Jail’ Category

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Euro Debt Crisis: No Strategy for Growth

January 13, 2012

Angela Merkel emerged from the European Summit last month with lofty visions, speaking to reporters in flowery terms like ‘European family’, ‘running a marathon’ and preparing Europe for… who knows what? A Prussian dominated European Federal State perhaps?

Missing was a coherent plan to reduce the levels of sovereign debt and, more importantly, a strategy to restore growth to European economies.

Fiscal Policy Integration

Yes there was the “fiscal compact”; a Plan for centrally ‘approved’ national budgets and greater fiscal discipline; all good news to Euro federalists. Meanwhile budget deficits continue to exceed revenues in all European countries.

The Plan, if actually implemented, would place Europe in a death spiral of ever-greater austerity, slowing economic growth and rising debt servicing costs. Europe will simply die on the Bond Market rack.

Addicted to Debt

Meanwhile the debt burden rolls on, and the Euro-Zone nations, like alcoholics on a binge, have, with this Plan, simply stepped to the bar and ordered a couple of cool ones in the morning: ‘hair of the dog’ so to speak.

True to form the IMF seems more than willing to play the role of bootlegger.  There are plans for the International Monetary Fund (“IMF”), to essentially recycle boomerang loans; i.e. IMF is to borrow money from member states and lent it back to Greece, Ireland and other troubled economies. The IMF involvement it seems is necessary for Treaty reasons, but also to lend an air of legitimacy to the process.

The Brits refused to contribute to the Plan and many other member states are hedging their bets. Germany, for instance, has placed its commitment on hold awaiting the formal commitment of others; who indeed are waiting for Germany to commit. The international community (read USA) is also hedging its bets and if they don’t fulfill their commitments soon the Plan could unravel quickly.

Priorities are Twisted

Europe (like the US) is living in a Bond Market induced coma; just more evidence that the ‘financial sector’ has hoodwinked the politicians into believing they’re the center of the economic universe.

According to the ‘gods of finance’, recovery is assured. We need only rescue the banks and embrace the Miracle of Austerity: the wacky idea that you can CUT your way to recovery.

Unfortunately this thinking is dangerous, delusional. This crisis will not be solved by austarity. The cold reality is this: post-industrial economies, including the US, UK and Europe, have changed their ‘engines of growth’. Recovery in the 21st century requires deliberate, informed capital direction, which is not happening.

Direct Capital (immediately) to the Productive Heart of European Economies

According the Organisation for Economic Co-operation and Development (OECD), postindustrial economies (i.e. Western developed economies) are now solidly ‘service’ oriented. The proportion of traditional (i.e. bankable) assets presently being generated in European economies is somewhere in the region of 20% of GDP. In industrializing China the proportion of hard, tangible assets runs about 80% of GDP; similar numbers to J.P. Morgan’s industrializing America a century ago.

According to studies, intangible (asset) investment by U.S. businesses has now risen to $3 trillion per year (2010) dwarfing investment in capital assets.  The new ‘intangible’ economy dominates but is concentrated in small to medium sized businesses that are massively undercapitalized.

Unfortunately, this sector alone is capable of driving growth and employment in the West.

IMF boomerang loans will buy time, but not solve the underlying problem. Hang on to your hats, 2012 could be rough ride.

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Getting out of Technology Jail #2

September 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:

  1. 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.
  2. 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.
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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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Technology Jail

June 14, 2011

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:

  1. Identification of the assets: What exactly is the asset, how does it deliver value to the company?
  2. The current state of the assets: What does the company ‘own’ and what is its condition?
  3. 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?
  4. Life of the asset determinations: How long will this asset continue to deliver value?
  5. 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

  1. 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.
  2. 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.
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