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‘Nothing comes from nothing. Nothing ever could. So, somewhere...'

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Having read the header, I bet you’re now singing along with the Sound of Music, still drawing crowds after 57 years.

But yet another company has got caught with its valuation of intangible assets, so maybe the great music theatre duo Rogers & Hammerstein tried to give us a hint. Maybe, if intangible assets cause so many problems, they shouldn’t be valued on the Balance Sheet. Many finance bods think that. Let’s see why, and what we can learn from the experience of two previously-successful companies.

An asset is defined as an economic resource to generate revenue (and hopefully profit) in the future. An asset should be hard at work, increasing in capital value and/or generating revenue. 

The idea is that you should be able to sell an asset, hopefully for the value in the Balance Sheet. But look at this recent advertisement:

                        

If a company has gone into administration and is up for urgent sale, who wants to buy its brands, website or domain names? It’s in a competitive business (low margin, needs high turnover). I’ve shopped at this retailer many times but I’ve never given them my contact details. That makes me wonder about the database’s potential to generate revenue.

Let’s look at another type of company that has suddenly learnt how important intangible assets can be.

                                      

Financial results of private firms don’t hit the news but when a company lists on the stock exchange, suddenly there is a wide range of interested parties, especially the media. The same goes for Not for Profits - because most are public companies limited by guarantee. Everything is in the public domain. To be a law firm and one of a couple to list on the stock exchange is to be courageous. And soon everyone’s watching.

From the information above, are you keen to buy the shares? I see orange flashing lights: ‘opponents’ and ‘litigation’ means long and expensive court cases with lots of lawyers. ‘No Win, No Fee’ tells it – one party will lose. So how do you pay the lawyers for the time before the court case is held? There are specialist finance firms that fund law cases – obviously expecting a good return.  

What is Intellectual Property?

Intellectual property is meant to be a unique asset that will generate revenue (and hopefully profit) in the future. Unique thought. Unique expression. A unique way of doing what you do. Something different that will attract customers. A combination of these unique elements that give you a competitive edge.

Yes, it could be brand. Yes, it could be a database of long-term, profitable customers. Yes, it could be a sales licence over an area (such as a franchise). Yes, it could be a right to … the song Happy Birthday. Remember that? A few years ago we found out that someone owned the rights to it and the producers of a film in which a family sang Happy Birthday was hit was a huge bill.

So what’s IP for a law firm?

I’m thinking the nous and winning ways of the lawyers who have run these litigation cases for years and been 'successful' - I suppose law firms would budget something like 80% win, 20% lose.

Why does this matter?

If the IP is an asset, accounting theory tells us that IP should either be increasing in capital value and/or generating revenue in the future. To help build the capital value and increase revenue, S&G has bought many smaller firms throughout Australia but notably, 'went global' by buying a UK firm for $1.2 billion in 2015. So let’s look at the Balance Sheet that should detail its IP items (2). 

                                        

S+G borrowed to buy the UK firm and borrows to fund its cases, so it needs to be confident that it will win its expected percentage of cases and pay its lenders for its Work in Progress. The increase in ‘goodwill’ – the value you paid above the ‘book value’ increased significantly. (Note: S+G rebranded in 2015 $75m -that's a high investment to protect).

So what went wrong?

On November 25, 2015 the British Government ruled that there would no longer be a cash payment for ‘minor’ whiplash claims and limited the claim limit to reduce the number of court cases and the cost to consumer. There were 1,500 whiplash claims per day in the UK and these claims accounted for 70% of all post-accident insurance claims in the UK from 2008-2013[1].

So the UK business that S+G had just bought had its business (what it sells) and its IP (that is how S+G it generates revenue) wiped out by a government announcement. Given that the cost of these small claims was argued to add about £50 to each insurance policy, this change surely would have been mooted for some time.

Why does it matter?

S+G bought the UK business in 2015 for $1.2billion, causing its net debt to rise to $741but, as you can see from the table, the level of its asset values also rose. Suddenly those values are not justifiable because the UK business has just disappeared. It reported an ‘Impairment of Intellectual Property’ - a writedown of $876m in the value of the assets in the Balance Sheet (814m from its UK purchase) that means a higher-than-expected expense charge in the Income Statement, reducing profit. In Feb 2016 S+G reported a loss of $958m and an increase in debtors (possibly bad debts) of 21% after the adoption of a new Australian Accounting Standard.

S+G is now at risk of becoming insolvent and the financiers and trying to work out how to get their money back. S+G’s main competitor may even run a class action on behalf of shareholders. How quickly things can change from great to nightmare. If it had just stayed a law firm in the partnership structure …

What’s in this for those who don’t work in the business of law?


FOR YOUR BUSINESS OR PROJECT:

Two issues to consider

1. What’s your uniqueness?

Being unique is more than thinking that you are different or better. What you are trying to do is design your offer so that it reduces the likelihood of having your product or service replicated.

I remember interviewing the operations manager of a national menswear chain. While he was showing me their new sales flow system, he noticed me looking a bit too intently (I had a uni assignment on this topic). He said, ‘I’ve printed out the screens for you. Our business is 8 months ahead of the market but there are three features that no other company can replicate’. See, I still remember that.

Uniqueness is not business-as-usual or being the same. It has to be something that customers will value, generating loyalty so that they buy from you, again and again, and hopefully pay more for.

It sounds easy but it takes a lot of thinking and robust discussion. I’m developing a concept for a new set of courses and another player (not competitor) just launched one… Drat! Someone else is first to market. This gave me the chance to study the course information and develop a list of 10 features of our program that will be very difficult to replicate. Hint: the value add is that the course is designed not just ‘run’.

2. How do you protect your real IP?

We're used to looking after tangible assets, so we also need to look after our intangible assets.  If IP is to be your revenue generator for the future, you have to protect it by having rules about how your business is presented; what other businesses you work with; on what terms you engage and so on. 

Two questions to ask

  • In what ways is our work of more value than [name your closest competitor]? Therefore, what is our intellectual property?
  • Are we focused on that value by listening to our customers?

I know that sounds boring and ‘yes we know that’ but I’ve just tried to get answers from customer support in travel and commercial IT systems. Companies seem to be good at automatically generating happy emails but not answering a potential customer’s questions. I wonder if anyone reads the emails or chat box entries. 



Apart from the fact that everyone should go to a ‘Sing-a-long with the Sound of Music’ at least once in their lives (if you haven’t been in a production or seen the film), maybe Rogers & Hammerstein did get Business IP 101 right: Nothing comes from Nothing …. Something comes from something (unique). Sound of Music powers on, generating performance fees and royalties 57 years after its debut as a stage show, then there's the rights of the film, amateur theatre productions...  


[1] Battersby, L: The car crash that is Slater & Gordon SMH March 5-6, 2016

[2]  S+G has now adopted the AASG15 that requires companies who generate revenue on a 'No win/No Fee' basis to be very confident that the values are robust 

Financial information is taken from S&G's investor relations site. 


For education purposes only

                          

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