Intangible but not Insubstantial
Intangible assets are nothing new. In the United Kingdom there are many long established brands that are far more responsible for the success of their owner’s business than the physical assets necessary to produce the products. However, the march of technology now means that intangibles are the predominant cash generating assets for more and more businesses. It is therefore becoming an anomaly that even if investors can find these assets on a company’s balance sheet, their true value is very unlikely to be revealed. Why is this?
Accounting rules are partly the reason. International Financial Reporting Standards (IFRS) do require non-monetary assets without physical substance to be recognised on balance sheets providing they meet certain criteria. However, only in limited circumstances, eg immediately following a takeover, are those assets carried at a current value. In most cases intangible assets, if recorded, are carried at the historic cost of creation or acquisition, less amortisation and impairment. This can be contrasted with the requirements for tangible or monetary assets and liabilities which are mostly either required or permitted to be carried at current value.
In an age when five of largest companies in the world by market capitalisation, Apple, Alphabet (Google), Microsoft, and Facebook have all created value mainly by integrating design and software to create brands that generate huge cash flows with relatively few tangible assets, is this treatment of intangibles sustainable? While there is currently little sign that the accounting standard setters are moving to address this, in parts of the financial world others are recognising the potential benefits for capital markets in promoting the reliable valuation of intangibles.
In Asia, both Hong Kong and Singapore are seeking to establish trading hubs for intellectual property (IP) by creating a conducive legal frameworks and sponsoring skills development, with the latter amending banking regulations to permit IP to be used as collateral for lending. In the UK the Big Innovation Centre (BIC), a partnership between government agencies, leading universities and major businesses to promote business innovation, published a thought leadership article in July 2017. This recommended the establishment of an Intangible Asset Charter that sets out the rules, norms and protocols across the totality of Britain’s intangible infrastructure, better to take advantage of the enormous opportunities for business development.
The BIC paper identifies shortcomings in the current recognition of the role of intangible assets and the constraints on developing a market for them. Among the problems identified is that currently such valuations that exist of intangible assets are “individualised and subjective” and do not allow for comparison or independent validation. It recommends that the Government should publicly set a target of making the UK a world leader in IP services, including IP valuation.
More recently the UK Intellectual Property Office (IPO), a Government Agency, issued "Hidden Value", a study of the UK IP market. This also highlighted concern at the lack of a credible valuation infrastructure around intangible assets. It stated that the volumes of IP valuations have fallen “below what might be expected”, in the context of the high level of investment in creating intangible assets and, particularly when compared with practices relating to tangible assets, “there is a prevailing view that the number of IP valuations conducted by businesses is not currently at an optimum level, considering the economic importance of intangible IP assets.”
The reasons why this is so may be gleaned from some of the comments made by those interviewed for the IPO study and included in the report. They make uncomfortable reading:
"Non-experts are offering valuation services as an interesting diversion from a main professional activity which gives a complex valuation area a bad name. Too few have a recognised IP valuation accreditation and are not regulated."
"Most IP valuers are not competent."
"A market served by cowboys who pretend to have a scientific basis for their guesses."
While the UK has a world class professional infrastructure for the valuation of tangible assets, government and regulators have previously paid little attention to the regulation of intangible asset valuation. Given the amount of regulation around financial services generally, the lack of any recognised credentials or regulation for intangible asset valuation is both surprising and concerning.
The Institute of Chartered Accountants in England and Wales (ICAEW) has over 140,000 members but there are fewer than 1,000 in its Valuation Special Interest Group and they are not permitted a supplementary designation that enables prospective clients to know that a particular chartered accountant has a recognised specialisation in this area. The RICS, best known for property valuation, has started to expand into the world of intangible asset valuation and offers a qualification pathway for those wishing to specialise in this area. However, it is thought that less than 100 have taken advantage of this route. The latest published list of over 700 new RICS members in the UK and Ireland contains none who have undertaken this qualification pathway.
The lack of a clearly defined professional identity for the professionals who provide intangible asset valuations leads to confusion as to who is competent to conduct such valuations. In turn, this can lead to mistrust of the numbers that are produced and a negative image for intangible asset valuation in general. The risk is also present that with no recognised common benchmark for becoming a professional valuer of intangible assets, individuals or firms with no formal training or credentials can describe themselves as such.
With intangible assets becoming increasingly vital to corporations, and with the global stage set for competition to be largely based on intangibles, these assets become a critical resource for firms and countries keen to build competitive advantage. But without an effective and trustworthy valuation environment, financial markets fail to understand and incorporate the value of intangibles and companies fail to build successful revenue strategies on their intangible assets.
The UK IPO recently issued a "Call for Views" on IP as part or the governments wider industrial strategy. It asked for comments on interventions that could be made to maximise the benefits of the UK‘s IP system. In our response we echoed the recommendations in the BIC paper on the need for a government agency or approved regulator to act as a catalyst to bring together the various disparate organisations with a stake in improving the reliability of IP valuations with a view to building a recognised professional infrastructure. This will build trust in the valuation profession and establish a system that will strengthen the confidence of the markets in the quality of the valuation so that the greater good – the public interest – is served.
