Building your business’ Intellectual Capital is the way to increase the value of the business because it’s the intangible assets that account for most of the value of corporates nowadays – as much as 70-80% - rather than the tangible machines, buildings and other hard assets.
I’ll be coming back to this theme again and again in future blogs because I see some entrepreneurs dealing with their IP registrations and compliance with a minimal understanding of Intellectual Property, and its role in bolstering these intangible assets.
I often wonder if those same people would deal with their own physical property transactions with so little background understanding of the transaction.
It’s important to note that intellectual property is PROPERTY and therefore needs careful handling. There are courses like Legally Branded Academy which is suitable for established businesses and startups. So, if you haven’t already taken the time to understand Intellectual Property, I recommend signing up to that program as it’s a business course suitable for a worldwide audience. By this, I mean that it’s a practical course, not one that’s focused on legal minutiae.
The intangible assets are what comprise a company’s intellectual capital. Pay attention to the various components of intellectual capital if you want to increase the value of your business because focusing on turnover is not necessarily the way to increase the multiple your business might achieve on exit.
You see, contrary to popular belief, the traditional method of valuing a business used by accountants, namely earnings before interest, taxes, depreciation, and amortisation – EBITDA – with its focus on increasing revenues, is not always the yardstick by which your business will be valued.
In reality, there is no single formula to valuing a company on exit that can be used to precisely value every private business.
The seller will want to drive the price up, and potential buyers will want the opposite. Although there are relatively easy ways to value certain parts of the business – such as stock, fixed assets (land, machinery, equipment etc.), there will very probably be a sizeable intangible element to the value of a business.
Intangible elements would include “goodwill” that is, the brand. This would comprise trademarks, and other intellectual property as well as elements like the reputation of the company. Such assets are notoriously difficult to value, and in many cases, the value will come down to how keen a potential buyer is to acquire your business.
If there is a strategic fit, and a little competition from another potential buyer in the wings, a buyer may well be willing to pay a significant premium to acquire your business.
I would recommend planning your exit strategy carefully.
Start by getting the nuts and bolts of your business sorted. Here I’m referring to your Intellectual Property. This is sensible to address sooner rather than later so that there is plenty of time to iron out any issues that may arise. What you don’t want is for such issues to spoil your negotiations during a potential sale. Bear in mind that some IP issues can take a few years to resolve so do an IP audit and begin your intellectual property protection very early on.
Whatever stage your business is at – and particularly if you are at a growth stage or thinking about exit – you will be focused on adding value to your business, and so should address IP straight away. Don’t postpone it. You can’t look at IP soon enough.
Examples of Sales
Instagram is an example of a company which was acquired for a sum well beyond its “market value” at the time. Facebook reportedly acquired Instagram in April 2012 for $1 billion because Instagram already had a built-in user base, which Facebook’s own planned photo sharing app lacked. By purchasing Instagram, Facebook acquired a foothold in the photo-sharing market, and at the same time squashed a threat to its own dominance in photo sharing. Essentially, the valuation was based on Instagram’s intangible assets, namely goodwill and intellectual property, and its strategic fit for Facebook.
Similarly, Facebook’s acquisition of Whatsapp for $21.8 billion was largely driven by the large user base WhatsApp enjoyed. The purchase price achieved was also a high one as Facebook was competing with Google to purchase the company.
These examples demonstrate that synergies within businesses can result in a valuation which is far higher than the company turnover or traditional methods of valuation might suggest. There is an element of the qualitative, rather than the quantitative when assessing a company’s sale prospects, and if there is a competitive bid (as in the Whatsapp scenario) this tends to push the valuation even higher.
Strategic protection of your intellectual property and goodwill is fundamentally important whatever the basis of the valuation. It is best to secure your IP protection sooner rather than later, as IP is foundational. It can make the difference between a successful sale and a potential buyer or investor walking away.
Your IP Real Estate
Maybe you are a local business serving a loyal customer base, or you are not in the technology space but rather selling goods and services. Whilst the above examples of a strong valuation, not based on turnover, involve technology companies, most companies now interface with technology at some point.
We are living at a time when any company, even your small business, could increase its value by focusing on team, knowledge, processes, and systems. Be savvy about how to increase its value.
Perhaps yours is a business where the online dimension if correctly dealt with, can lead to a huge valuation.
For example, Skyscanner, which is a global online metasearch engine that enables people to find comparisons for flights. It was founded in Scotland in 2001 by three IT professionals. Following various rounds of investment and expansion over the years, and with 50 million monthly users, it has recently been sold to Chinese travel giant Ctrip for £1.4 billion. A large portion of its valuation on exit will have been attributable to its intangible assets, namely its brand, goodwill and effective algorithms. That is why the website has become so successful.
As the web and technology become more important in our lives, it means intellectual property is a critical area to upskill yourself in, so you can be sure to take the basic steps you need to take to ensure your assets are secured on an ongoing basis.
Intellectual property is closely intertwined with a company’s intellectual capital, but is narrower in scope that intellectual capital.
What is intellectual capital?
Intellectual capital is something I will discuss in future blogs. Essentially it has these components:
The human element comprises your knowledge assets. This is described in the book Wealth of Knowledge by Thomas A Stewart as follows:
“Simply put, knowledge assets are talent, skills, know-how, know-what and relationships – and the machines and networks that embody them – that can be used to create wealth.”
“Because knowledge has become the single most important factor of production, managing intellectual assets has become the simple most important task of business”
Nowadays 70% of businesses are in the services sector, so managing the knowledge of people within an organisation is a most essential focus as knowledge is potentially the most valuable asset of the business. It’s an important task.
Use IP To Increase Your Valuation
Building the brand is another most important aspect of growing the value of a business because it’s potentially one of the most valuable assets of the business.
Having a legally effective, legally available name, and then building your brand is key. So, look at the fundamentals, and if necessary rebrand now while there is still time to build up name recognition with a new brand name if there is some problem with the existing name.
By consistently promoting your values you will be able to attract the human capital which is essential to increasing value, given the importance of knowledge. Having the right human capital is the measure by which the talent of your team will be assessed.
A strong, developed talent base will help place a higher value on your business because, among other things, it will make it more likely that the business does not depend on you, and only you, to be successful. That increases its value to a buyer.
So, developing assets that can support you to be less indispensable to your business is a worthwhile activity. Part of this involves having well-considered processes in place that increase your efficiency, reduce the scope for mistakes, ensures you consistently take in the information you need at certain junctures, and so on. This will all serve to enhance the value of your business.
Getting the right people on your team before you start down the path of your growth gives you the necessary human capital to improve your direction and approach.
Customer capital is the value and strength of relationships that a business builds with its customers, and which is reflected in their loyalty to the business and/or its products and services.
Strong customer capital is a measure of the company’s brand, and how well it looks after its customers.
Nowadays the aim is to try to create deep, long-term relationships. Douglas Atkin in the Culting of Brands maintains that the aim of a really successful business is to create a cult following among its customers. One manifestation of this objective is the new trend of building a sense of community. It’s becoming common to create Facebook groups where additional value is given to customers, with the aim of building a sense of common culture and interests.
Are the relationships delivered in a consistent, reliable, recurring fashion? Are you integral to your customers’ success because the products/services you offer are unique? Most of all, are these relationships transferable should the business be bought by a new party?
The customer is of central importance as is getting a clear picture of who that customer is. How the business interacts with customers is actually more important than what it sells.
The aim is no less than to make your relationships so entangled that your customers cannot live without you!
Structural capital consists of the organisation’s infrastructure, processes and the databases that enable its human capital to function. So, it’s the tools on which the organisation is built. They support the organisation to add value to customers.
The structural capital remains with an organisation even when people leave as it includes the capabilities, routines, methods, procedures and methodologies embedded in the organisation. It’s part of its culture, its philosophy and systems for leveraging the organization’s capability.
It includes the techniques, procedures and programs that implement and enhance the delivery of goods and services. As well as its intellectual property it also includes the talents of its team, and the theory behind the organisation’s approach.
What enables your team to do the things that make them so special, allows them to meet and exceed customer expectations, and enables them to build and sustain lasting and recurring relationships needs to be documented and transferable from one employee to another, such that someone else can learn from the organisation and apply it.
If you make it part of your routine to capture this knowledge so it becomes company property you can ensure that when your talent walks out the door at night, their knowledge doesn’t walk out the door with them.
Social capital refers to what makes social groups function effectively, such as the relationships between the various players, a shared sense of identity, norms and values. It’s a complex subject so a single definition of it is difficult.
All the social networks that include people who trust and assist each other is what comprises an organisation’s social capital, and this can be a powerful asset.
Social media is a component of this insofar as it is an aspect of an organisation’s culture, its brand, the way its people function, communicate, and interact with customers.
Positive social media can go a long way, and a social media presence may also help in dealing with any negative social media.
The objective when creating a valuable business is to focus on these different forms of capital. Once you’ve built it and replaced yourself so that it’s not about you anymore; it becomes all about the business, and your business becomes the project. Focusing on your systems and processes rather than purely on increasing sales and other revenue-generating activities enables you to increase the value of your business.
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