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This article was first published in the March 2016 international edition of Accounting and Business magazine.

Investment in intangibles has now overtaken investment in tangible assets, but companies, particularly SMEs, struggle to measure this investment and the returns it offers. As a result, they are not investing in the right things, fail to maximise the returns and struggle to raise finance for growth against that investment.

Intellectual property (IP) is no longer a niche subject – it is recognised as a core asset in many businesses. Yet mainstream finance has been slow to allow SMEs to use their intellectual assets to raise finance.

This market failure has been explicitly recognised in Malaysia, where the country’s innovation agency AIM (Agensi Inovasi Malaysia) has been working with its UK counterpart Nesta to develop tools to help companies identify and manage their intellectual assets.

‘Industry doesn’t see the return on innovation clearly,’ says AIM’s CEO Mark Rozario. ‘There’s a perception that innovation requires large investments – in fact, innovation happens at all levels. And it’s not just R&D – it’s much broader than that.’

AIM worked with a bank in a pilot study to assess what an SME had to offer based on intellectual property rather than any other form of collateral they have.

‘The question is, how do I get finance from a bank if I don’t have tangible assets to offer?’ says Rozario. ‘Can we use IP as an additional credit risk factor? If you can clearly segregate the return from tangible assets, then the difference is your returns on intangible assets.’

The agency has developed a toolkit, the National Corporate Innovation Index (NCII), to help companies identify their intellectual assets and their return on investment in IP. The toolkit tracks their investment in six core areas (see box) derived from 2009 research by Nesta in the UK investment industry.

‘We used them as a model to work with individual businesses,’ says Benjamin Reid, principal researcher in international innovation at Nesta. ‘If you take these six areas, then you can imagine that different businesses have a different mix of intellectual investments they are making and the intellectual assets they are creating.’ Companies can then compare their investments with the average for their industry.

‘It’s not that more is better, but whether you have got the balance correct,’ says Reid. NCII uses a number of different measures of RoI (return on investment): Reid says there’s no ‘magic bullet’, but companies do need to be able to say what scale of return they are getting.

‘These kinds of outputs were things they could use with other stakeholders, with senior management, with boards and potentially with the investor community,’ he says. ‘It can help them make the case for why they need to invest in intangible assets and innovation.’

Nesta and AIM found that large companies needed quite a lot of support using NCII to identify IP investments. So they were keen to understand how the tool might work with smaller businesses that face different challenges.

‘We thought there must be a role for finance professionals to potentially help small businesses,’ says Reid. ‘It could be a new area that they can support businesses in by going through this kind of tool.’

Working with ACCA’s member network in Malaysia, they developed and trialled a version of the tool for SMEs. ‘We knew that with quite a bit of assistance larger companies can do reasonably well, but what about SMEs with a smaller level of intervention?’ says Martin Brassell FRSA, co-founder and chief executive of IP specialist Inngot, and co-author with Reid of the resulting report, Innovation, intangibles and integrated reporting: a pilot study of Malaysian SMEs.

The simplified version was modified to make it easier to complete from existing accounting records – separating internal from external expenditure, for example; it also asked firms how easy it was to find the information.

Brassell says the study led to several conclusions about the overall level of awareness, and about professional development requirements for accountants. ‘It was much easier to say what innovation wasn’t than what it was: innovation is not doing more of the same thing,’ he says. ‘The forms of investment and expenditure that companies generally recognise through their standards and accounting systems are geared around existing business models, but those business models are changing quite rapidly.’

Portfolio of investments

Brassell says it’s not just about how companies find these assets and recognise these areas of expenditure, it’s about how they can be encouraged to see it as investment for the future. ‘We encouraged companies to think about the anticipated lifespan of each category and apply that to their portfolio,’ he says.

‘It may feel like this year you’ve spent x amount on innovation. But if you were to represent that like you would an investment in tangible assets, over the expected period of benefit of that investment it was actually x minus y. Depending on the portfolio of investments, that could be a very substantial difference. It proved a very interesting conversation starter.’

The study also explores the link between accounting for IP investment and integrated reporting. ‘We wanted to think about what a detailed examination of your intangible assets means if you are going to take on a different way of reporting like IR, where you are looking at the flows of capitals within your business,’ says Brassell. ‘Yes, your financial capital is being depleted when you’re investing in R&D, but you’d expect your intellectual capital, and probably your human capital, to be developed further as a consequence. It’s the notion that things are not lost in this process, that capital is being transformed rather than costs being sunk.’

There is a very high degree of compatibility between IR and the NCII tool. ‘If you were going through this kind of process you would find it much easier to articulate what the numbers were at different stages of the process, and I think there are some similar disciplines involved,’ says Brassell. ‘Frankly, if a company found it difficult to work with the NCII methodology, they might struggle with IR as well.’

He believes that the growth of IR will get finance professionals more interested in highlighting both the value of intangibles and the role they play in creating value. The trial will now be extended to a wider sample of UK SMEs and will ask how this information on intangible assets could help companies with funding strategies.

‘It’s evident that companies are investing in very different things,’ says Brassell. ‘Finance has to find ways to support that transition.’

Even if companies succeed in identifying intellectual assets, that may not mean they are exploiting or protecting them properly. According to Rosa Wilkinson, innovation director at the UK government’s Intellectual Property Office (IPO), companies are ‘wide-eyed and witless’ about managing these assets.

‘They don’t tend to think about them until something happens,’ she says. ‘Until the advent of things like [TV programme] Dragons’ Den, an awful lot of businesses never drew IP into mainstream conversations – it’s not on the balance sheet, it’s not physical, why would I think about it?’

To help firms communicate the value of their IP to potential funders, the IPO has worked with the financial services industry to put together the IP Finance Toolkit.

‘Financiers and companies are talking completely different languages,’ she says. ‘The toolkit helps take businesses through the process of documenting their IP assets and pinning a value to them in a way which will be understood and credible for the financial services industry.’

The IPO is also keen to encourage the market in intellectual assets: often firms develop IP assets they cannot exploit themselves.

‘Any trade in IP tends to go on between people who already know each other – people aren’t sure where to find a marketplace for their IP,’ she says. Business insurance also needs to develop to include IP. As trusted advisers, financial professionals can help clients talk about these new additions to the balance sheet. ‘They can raise all sorts of issues with them and the issues they raise can radically alter their client’s potential for growth,’ she says. ‘IP can feel terribly scary, it feels technical, but the basic principles are very straightforward – you’ve created something and it’s yours.’

Mick James, journalist