From the event announcement:

Did you know that a balance sheet presented under U.S. generally accepted accounting principles can only explain 20% of the value of the average company? The rest is lumped together as “intangible.” Very little is known or understood about this hidden 80% of value, yet this information gap affects the ability of management teams everywhere to make the right decisions and drive growth performance, as well determine the true value of their company.

These intangibles reflect the shift of companies toward greater dependence on knowledge. These “unrecognized” intangibles include a broad range of capabilities and “assets” such as data, networks and processes that together make up the fundamental infrastructure of the modern business.

Management accountants have a unique opportunity to unlock the secrets of this hidden 80% of corporate value. This presentation will explain how you, as a management accountant, can be a valued partner to your fellow managers and peers in identifying, measuring and monetizing these critical intangibles. We will draw from the recent IMA Statement on Management Accounting entitled Unrecognized Intangibles: Identification, Management and Reporting and the book Intangible Capital: Putting Knowledge to Work in the 21st Century Organization, both co-authored by our speakers, Mary Adams and Michael Oleksak.

More information and registration

The Future Drivers of Performance and Value: Understanding the intangible infrastructure of your business

The Conference Board has done great macroeconomic research on intangibles and we are excited to talk with their members about the huge opportunities in intangible capital management.  More information

Last month we attended The Conference Board’s two-day program on Job Growth and Intangibles: New Building Blocks for Jobs and Economic Growth: Intangible Assets as Sources of Increased Productivity and Enterprise Value.  The conference had two themes: policy (the government people) and strategy (the business people).

Fed Chief Ben Bernanke gave the opening address, speaking about intangibles, innovation and job growth.  Bernanke did not bang his shoe on the podium or make any hand gestures

while speaking about this, probably to avoid sending signals to the intangible stock market about his intentions.

He did use the phrase “intangible capital” four times in its proper context, and overall gave a forward looking presentation.  You can read highlights of the speech here.

Many attendees were interviewed during the rest of the conference with the one-to two-minutes posted on YouTube.  Here’s my interview.

People attended from all over the world, which is appropriate because Europe and Asia are far ahead of the US in recognizing the value of intangible capital.  The Brazilian development bank even has an intangible component in its credit ratings for long-term borrowers.  Again, though, the divide was between the government/academic community who want measures for investment and results on research and development and innovation and how to correlate this with job growth and economic growth.

Those of us involved in business recognize the value of government investment and academic research over the years and the job growth that has resulted. (Think of the innovation out of the Defense Department and MIT alone.)   But we are more interested in how this applies to individual companies.

In various forums, we were able to point out that the balance sheet is basically worthless in trying to understand a service company, knowledge-based company or technology company.  You must understand your own firm’s intangible capital to 1) manage it better to increase value and 2) tell the company’s story better to borrow funds, attract investors or get the right price from an acquirer.

Many people at the conference started to understand how investing in and measuring intangible capital can make a difference in individual companies, just as we business-types got some insight about the approaches by the policy types.

The great aspect of this event is that the moderator will kick off by asking, “What would you do if you, as the business owner, had six months’ notice that you had to sell immediately (maybe because you were going to die?)?”  What a great perspective! (aside from the dying part…)

Here’s what I think:

Human Capital:

· Are there successors to take over for you in your company?

· Do these successors have employment contracts that will make them want to stay with the company?

Structural Capital:

· Do you have a will?

· Are all the key processes in your operation written down?

Relationship Capital:

· Are your customer relationships secured with long-term contracts?

Strategic Capital:

· Do you have life insurance?

· Is your family cared for financially?

· Do you know the value of your company?

· Are you prepared from a tax angle?

· Is your company prepared and attractive for potential acquirers?

· Could your company survive a rigorous due diligence process?

I’m sure there will be many great ideas and recommendations from the other panelists and in questions from the audience. I’ll be taking notes along with everyone else attending.

Anyway, I had been dying to read his new book The New Capitalist Manifesto. There were some great ideas here…Like his explanation of the societal cost of things like burgers (a $3 burger includes $10 in health and environmental costs) and $10 of subsidies of water, land and jobs) and oil (hidden costs add $4/gallon the price).

If you are familiar with the corporate social responsibility (CSR) movement, you know about the many “externalities” in our current economy–costs that are borne by the planet and/or society outside of the corporation. These externalities have always been there but they are becoming a bigger problem and–this part is important—a bigger opportunity for businesses everywhere.

Haque wants us to think about these and the iconic products that represent them: McMansions, Hummers and Big Macs. And then re-think how to change business for the better.

The alternative is what he calls Constructive Capitalism. He uses research of 250 companies to make his points. The contrasts between yesterday and tomorrow’s capitalism are instructive. His point is weakened by his bias for players like Apple, which to me is not that different in philosophy from Microsoft (they are both about control). But it’s hard to blame him for this—everyone loves to love Apple. And the book is still worth a read, although not nearly as fun as his blog.

By the way, Haque is not alone in his calls for reforming capitalism. I see new names associated with these ideas every week. The latest is the article on Capitalism for the Long Term by Dominic Barton of McKinsey.

Of course, in my opinion, no solution to capitalism’s ills is possible without giving value to the intangible knowledge assets that are critical to the future of every business as well as our national economy. It’s what we already know that will save us–but we will need to apply our knowledge in new, innovative ways. Let’s get busy!

-Mary Adams

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The photo was taken earlier this week at the Exit Planning Exchange Summit 2011.  The twist was that the legend for the graphs was hidden by a red pattern that could be filtered out with special glasses.

Everyone at XPX advises private companies and their owners on building and realizing value. OK, so I was nervous about trying this out in this very professional group. But it turned out to be a lot of fun!

The glasses were a great way to engage these professionals in conversations about the fact that 80% of the value of the average company is intangible — but hardly anyone  actually makes the drivers behind this huge value, well, tangible.

Here is one of the handouts we were viewing:

Don’t have red glasses? Want to know more? Check out the slides at www.icvaluedrivers.com and click contact us!

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When there is incomplete information about the details of business, reputation becomes a proxy for its overall success. That’s how small problems can have much greater effect than perhaps they should. If stakeholders do not have a clear picture of what’s going on, they will assume the worst. In the long run, we believe that good intangibles management and transparent communication will diminish the wild swings of reputation that many companies experience today. In the short run, you can make this happen yourself.

1. Do Things Right

It may sound overly simplistic to say it but the principal way that you should manage your reputation is by getting everything else right. That is the essence of the challenge. Reputation is influenced by what you do, how you do it and what you say about it. The best defense is to do it all as well as possible. The best way to do that? Glad you asked. The answer is to build structural capital.

In the first section of this book, you (hopefully) learned that structural capital is a great way to get rich. Good structural capital takes knowledge and turns it into repeatable, scalable processes that have a low marginal cost. Google’s search engine is the best example there is of this kind of structural capital, $22 billion in revenues and counting. But there is another advantage to structural capital: it enshrines “best practices” of your organization in reusable form. There are different levels of structural capital, with varying degrees of power and benefit. As we look at these levels, you will see a repeat of a number of concepts from earlier parts of the book.

If you take what you know and record it, you have yourself a set of policies. Policies are good because they create a standard by which work can be done. They also provide a tool by which work can be audited. And hopefully a set of data that can be used to measure success of the policy.

While policies are good, processes are better. Processes are work patterns that are used over and over again in an organization. They are the operationalization of policies. They put policies to work. The best kind of process is automated. It is integrated with the everyday work or the organization. If it is implemented correctly, this ensures that the policy is also followed. All the time.

The best processes of all are those that are audited. A lot of intangibles management should be incorporated into internal reviews of processes and controls. This ensures that learning will happen over time. And, of course, there is always the command and control aspect. Audits are a good way to enforce standards—I am much more likely to do something if I know that someone is watching.

Many recent problems in global supply chains have been the source of a number of reputational crises in recent memory. Lead paint used on toys supplied to Mattel. Tainted peanut butter supplied to Kellogg for crackers. Contaminated milk in China. These kinds of mistakes obviously indicate a problem somewhere between the policy, the process and the audit. They become reputational crises because they cause sickness and/or endanger the health of large numbers of people.

But the size of the crisis really depends on whether or not the company can pinpoint the problem. The important facts are what happened, how it happened and what the company is doing to ensure that it will not happen again. The size of the crisis grows depending on which of these three questions you can answer. If you are facing a problem, what happened is already obvious. But can you explain—in light of the policy, process and audits that you surely have—how it happened? That will diminish the crisis somewhat. But the most important thing you can do is explain how you have changed your policy, process and audit so it doesn’t happen again. Can you answer these questions?

Seen this way, reputation truly is the bottom line for the quality of your operations, your knowledge factory. Good process and quality control are your best insurance policies for continued reputational success. The quality movement has already moved into more and more knowledge processes. Over time, knowledge processes will be managed with greater and greater rigor. It will be in everyone’s best interest.

2. Be Proactive

The next basic rule for managing your reputation is to be proactive. That means communicating early and often about what you do and how you do it. There are a number of channels of communication with stakeholders—and the number grows every day. Corporate communications, marketing and, really, every client-facing staff person is part of this communication process.

In this discussion, it is important to make a distinction between your reputation and your brand. They are related but have some important differences. Up to this point, we have actually talked a number of times about brand as an asset of your organization. Brands are part of the relationship capital of your organization. Brand is usually associated with a product or service so, by definition, it is something that you create and build. You can actually protect your brand legally. You invest in trying to influence how people understand your brand through activities such as advertising. Ultimately, you have a lot to say about how your brand is defined and how it is perceived in the marketplace.

Your brand can affect your reputation. But reputation encompasses much more than that. As we have said, it is the sum total of your entire organization. While everything you do as an organization influences your reputation, it is ultimately external stakeholders that will give you the thumbs up or down. You should try to help your stakeholders understand the important factors of your operation in order to support your reputation. But there is less room for the kind of artful and creative communication that marks good brand building. With reputation, you need to let the facts speak for themselves. The best protection against unexpected challenges to your reputation is consistent and proactive communication. Build and protect your reputation by providing good information about your operations—tangible and intangible—on an on-going basis.

3. Be Transparent

We recently worked with Nick Shepherd on a paper for the Institute of Management Accounting on intangibles reporting. We undertook this paper together because we shared a belief with Nick that there will be significant changes in the reporting of intangibles in coming years. Nick helped us see the historical context to this trend. The current reporting paradigms were created in the aftermath of the Great Depression. Prior to that time, shareholders in a company did not have access to its financial statements. When new reporting requirements made this mandatory, they were met with all kinds of resistance and fear. Yet, today, we cannot imagine making an investment without this basic information.

We see new changes coming in reporting. The reason why was put very succinctly by former SEC Chairman Cox a few years ago:

At a time when we have 24-hour news—and even 24-hour pizza delivery—why are we still living by the 10-K and the 10-Q? If investors are going to be responsible for the growth of their investments, for picking which funds to put into their 401(k) nest eggs, they’ll need user friendly, responsive numbers that are easily accessible.

What will be the driver of this change? Will it be a top-down imposition of new reporting standards by a governmental agency? We do not believe so. That’s so industrial era. We believe, we hope that it will be a bottom-up movement from stakeholders like investors, analysts, bankers, boards of directors and even managers. Stakeholders that want to understand the full picture of what is really going on in a company. Stakeholders that know that a knowledge-dependent company should be able to describe and measure the knowledge side of its business.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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The first driver is the shift in the control of the means of production. In the industrial era, a company’s profits were driven by what it owned. Workers had to come to the employer to get access to the means of production. It gave companies a greater level of control over its workers. With the rise of the knowledge economy, however, the knowledge held by employees and, indeed, external stakeholders have become an important part of a corporation’s “means of production.” The knowledge factory relies on the unique contribution of human and relationship capital elements. This shift in the balance of power means that companies have to pay more attention to the interests and priorities of their stakeholders as “partners” in the success of the knowledge factory.

The second driver of the increased focus on reputation is the acceleration of communications. If you didn’t understand this before, you certainly do now given the events of wikileaks, Tunisia, and Egypt. Blogs, Twitter, Facebook and other social networks are just the latest developments in a society that had already developed 24-hour news. It is easier than ever before for anyone to get a message out. Sometimes all it takes is a blog post or a YouTube video by one disgruntled customer to go viral and threaten your reputation in an instant.

The third driver is an increased interest in sustainability and corporate social responsibility. Sustainability is an umbrella term for a number of related trends including corporate social responsibility and triple bottom line. CFO magazine defines sustainability as “the practice of publicizing a company’s environmental and social risks, responsibilities and opportunities…it can be thought of as an environmental-impact statement for the entire corporation, with ‘environment’ defined not only in terms of natural resources and climatological effects but also the economic and social impacts of labor practices, charitable endeavors and governance structures.”

The fourth and final driver is the lack of transparency of intangibles. There is a shocking lack of information available to internal and external stakeholders about the knowledge side of business. So when news does get out about a problem or a failure, then the reaction is swift and often very negative. If your stakeholders don’t understand how your business works and don’t receive periodic information beyond just the financials, then bad news is a warning to get out. The less your stakeholders understand about your business and the less you share about non-financial aspects of it, the more vulnerable you are to severe reactions to bad financial news.

You need to consider all four drivers as you think about managing your reputation. But we ask you to pay special attention to the last driver—intangibles reporting. You have a lot of control over your reputation—if you are getting the kind and quality of information to your stakeholders. And very few companies have developed good reporting on intangibles. That means that the 80% of corporate value that is driven by intangibles is invisible. Stakeholders can only guess at it unless you give them the information they need. This is really the goal of Intangible Capital. Helping you see, leverage and communicate about your intangibles. Because it will help you perform better AND because it will help you get the reputation you deserve.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

1.  Open conversations with many lenders.  If you need a different bank, they will have the notes to say that you have been talking and didn’t just rush through the door in desperation

2.  Take a look at your capital structure.  How much senior debt will a bank lend you?  How will you make up the difference?  Mezzanine debt, a subordinated loan or more equity?  It’s going to cost you more, but if you need financing, then you have to find it.

3.  Get your financial statements in good condition.  A tax return is inadequate.  Your CPA should probably prepare at least a compilation.  A review or full audit is better.

4.  Make your credit request stronger.  Provide everything a bank wants at the same time – company history, your own analysis of recent financial statements, competition, the future (your exit strategy)?  The easier you make the request on the bank officer, the more favorably you and your request will be viewed.   A solid request will also be a good drill for your own strategy.

5.  Be ready to answer the basic questions every lender is trained to ask on for a commercial loan request from a corporate borrower:

• What will you use the money for (Use of proceeds)
• How will you repay it? – (Source of repayment)
• How will repay it if that doesn’t work? (Fallback)

6.  Tell your intangible story better.  Most businesses these days do not have lots of tangible assets to secure loans.  And the lender, no matter what the interest rate, wants to know your business will be around to repay the loan (the answer to question #2 above).    Your story will likely be around your intangibles:  relationship capital, structural capital, human capital and strategic capital.  It should also include fallback (answer to question #3).

We are finding good reception with bankers for specific, data-driven descriptions of intangibles. 80% of the value of the average company today is intangible. Most bankers and businesspeople understand this intuitively but they often don’t have the information to tie value and intangibles together.