Be it brand, data, designs or patents, the role of intellectual property in value creation is growing and directors need to ensure their IP is properly reported on and protected.
In 1975 — when the world’s five largest companies were IBM, Exxon Mobil, Procter & Gamble, GE and 3M — intangible assets made up 17 per cent of all enterprise value on the S&P 500. By 2020, with Apple, Alphabet, Microsoft, Amazon and Facebook in the top spots, that value had increased to 90 per cent. Yet, Michael Masterson, managing director Australia and New Zealand of EverEdge Global, an advisory firm specialising in intangible assets, and director of the Cure Brain Cancer Foundation, is concerned that too few directors have a deep understanding of their worth.
“Intangible asset risk is often regarded as not important, or important, but not urgent,” he says. “The problem is that when things go wrong, they can quickly become catastrophic. If you infringe on someone’s patent, lose a critical trade secret or are unable to assert ownership of a piece of software developed by your team, it’s impossible to unring the bell. It’s much easier — and more financially prudent — to take your intellectual property seriously.”
Intellectual property (IP) is used to describe the non-physical assets a company owns and has legally protected so they can’t be used elsewhere without permission. These include patents, trademarks, copyright and trade secrets. It is an intangible asset, but not all intangible assets are IP, for instance goodwill or brand recognition.
“Today, intangible assets such as data, confidential information, regulatory approvals, software, brands, designs, patents, internet assets and external relationships have complemented or, in many cases, replaced, machinery, vehicles and other physical assets as the primary drivers of margin and earnings growth,” says Masterson.
New and emerging technology is adding to the complexity. “Things like artificial intelligence (AI), blockchain, non-fungible tokens (NFT) and the interactive virtual reality world of the Facebook metaverse are raising new questions around what is IP, what can be protected and to what extent,” says Dr Massimo Garbuio, an associate professor in entrepreneurship at the University of Sydney who collaborated with the AICD to produce the landmark 2019 research Driving innovation: the boardroom gap. He notes that with the Internet of Things (IOT) and Industry 4.0, things are moving rapidly.
Directors need to recognise that the risks and opportunities associated with IP are now fundamental to corporate strategy. All directors should have a basic understanding of the issues, says Allira Hudson-Gofers, a director of Shelston IP, who is a biomedical engineer and former regulatory affairs executive at Cochlear. “Boards should be familiar with which of their products or services will create value over the next one, two or 10 years,” she says. “You can then identify the intangible assets you need and work out how to address any gaps. This could be by creating IP internally, purchasing it from someone else, commissioning bespoke IP or forming a joint venture or partnership. You may also find you’ve already created IP that doesn’t fit with your long- term plans. In this case, you could generate income by selling it or licensing it out.”
Collaboration and competition
Some companies find one innovation leads to a related portfolio of IP. “A drug could be developed for a particular condition then the formula modified for another use,” says Hudson-Gofers.
The mRNA vaccine technology provides a good example. “mRNA vaccine technology started out — and is still being developed for — the treatment of cancer and other diseases,” says Tony Shaw, a partner and patent attorney at Allens.
“The technology is quite amenable to modification, which is part of the reason why companies managed to roll it out so quickly for COVID-19 vaccines. The need for fast protection also led to unprecedented levels of collaboration between pharmaceutical companies, although now we’re seeing them jockeying for market share and using IP as a tool to help them secure that.”
Collaboration can also have a more commercial application. “Many people don’t realise that patent protection doesn’t give you the right to commercialise whatever it is you’ve patented; it gives you the right to stop others from doing so,” says Hudson-Gofers. “For example, you could get patent protection for a widget with features A, B and C, but, if a competitor has an existing and valid patent protecting A and B, they can stop you from making your widget. One way round it would be by negotiating an agreement such as a partnership or a cross-licensing arrangement where you have access to their IP and they have access to yours.”
Innovation can be very expensive. It stands to reason when companies have invested heavily in intangible assets that they’d be keen to find a commercial solution. However, IP occasionally becomes contentious when one party uses a patent to exclude other parties from the market.
“Bringing a product to market might need participation from three or four different companies,” says Shaw. “If one takes the position that they’re going to hold out for unreasonable terms, that can scupper a deal. Or one of the owners might already have an exclusive license elsewhere, so they no longer have the wherewithal to contribute it to a broader effort. Either way, this is an example of where IP can limit rather than support innovation, although this is the exception rather than the rule.”
10 things to know about your organisation’s IP
Knowing the answers to the following questions will help directors take a more measured view of how to manage and utilise their intangible assets. EverEdge’s Michael Masterson says that along with critical business assets, boards will also be able to identify strategic tools to drive value and profitability.
What are our intangible assets?
- How do these assets drive economic and strategic value for our business?
- How much are these assets worth?
- Is the full value of our intangible assets being captured in our company valuation?
- How can we unlock additional value from our intangible assets?
- What is our intangible strategy — are we actively managing these assets?
- Do our employees and management teams understand how important these assets are?
- What are our primary intangible asset risks?
- What is our strategy to manage and mitigate these risks?
- What systems and processes do we have in place to manage and mitigate risks to intangible assets and are they adequate?
Sealing the leaks
Not every company will face such complex issues. However, Jackie O’Brien MAICD, an intellectual property lawyer at Norton Rose Fulbright, who specialises in brand protection and social media, believes every organisation has a degree of vulnerability. “Two of the most common risks arise when employees with access to IP move in or out of a job,” she says. “When someone leaves your company, you need to ensure they aren’t taking confidential information with them. When you employ someone for their skills and industry knowledge, you’re in danger of infringing their previous employer’s IP, so you must have processes in place that make it clear what can be transferred and what can’t.”
Masterson considers leaked information to be the biggest risk to intangible assets. “This can involve customers and suppliers as well as employees,” he says. “One example is a hardware company that asked us to help review its policies after it was badly burned. They had invented a new, world-leading product and decided to outsource their software development, which meant sharing confidential information. After delivering the project on time and within budget, the supplier shut down. Fast- forward six-months and the supplier reappeared as a competitor, using the intangible assets it had developed to springboard ahead of its former client. The supplier was able to grab a majority market share at a direct cost to the hardware company of $150m.”
Risks can also lurk in the supply chain. “If you were a director of a company managing a large infrastructure project, you might have critical plans and specifications in which IP rights exist,” says O’Brien. “If their creators became insolvent or hadn’t acquired the necessary permissions, you could find yourself without access to the resources you need to complete the project. We advise companies to identify the vital aspects of both their business and particular projects, then check that protections are in place in the areas beyond their direct control.”
A place on the boardroom agenda
Shaw would like to see more discussion about IP at board level. “Directors should understand IP as a governance and risk issue,” he says. “If your company is generating IP and other intangible assets, you need to know how those assets are being managed. Or, if you use a lot of technology, you need to be aware of — and manage the risk of — inadvertently infringing someone else’s patent.”
Masterson says up to 80 per cent of companies he has worked with cannot prove they own their intangible assets. “Intangible assets are hard to inventory, frequently not registered and don’t always appear on balance sheets or within profit and loss accounts,” he says. “When you throw in issues such as joint development arrangements, joint R&D and outsourced contracting arrangements, it can be a challenge to pin down and establish who owns what, and where your risks and opportunities lie.”
Hudson-Gofers is concerned directors don’t necessarily have the appropriate skills to grapple with some of the complex and critical strategic decisions that should be made at board level. “If your company is built on intangible assets, you might consider appointing someone with IP experience to the board although, typically, responsibility is delegated to senior management,” she says. “This can work well as long as the people making the IP decisions also understand the corporate strategy and can keep the board informed.”
A consultant can make more sense for smaller or less IP-rich companies. “Boards must base all of their decisions on accurate and up-to-date information,” says O’Brien. “IP is no different from tax, real estate or IT — you can get the quality information you need from the right external service provider.”
Garbuio believes the board should have much more probing conversations about the activities that create value, distinctiveness and, ultimately, a competitive advantage. “This level of discussion will also help directors to allocate resources to the activities with greatest potential for developing and nurturing these assets,” he says.
Finally, as Masterson points out, directors and officers should never lose sight of the fact that they have a fiduciary obligation to generate a return on, and manage risks to, all assets under their stewardship and control. “That ‘all’ does, of course, include intangible assets,” he says.
“The fact that they may not feature in company reports doesn’t obviate the board’s obligations to manage them correctly. With so much company value now tied to intangible assets, it’s more important than ever for directors to take proactive steps to manage and protect these assets before they have a significant negative impact on the business — or you lose out on opportunities for growth.”
Accounting for change
Intangible assets are typically either off the balance sheet entirely, hidden under “goodwill” or listed at cost. Understanding the increased importance of IP to value creation also has implications for accounting policies and practices.
In a recent Directors on Digital podcast, Diane Smith-Gander AO, chair of ZipCo, said directors have to think about their accounting practices because “the way you think about the life of the intangible assets that you’re building around these digital ecosystems is going to be very, very different to assets that we’ve built in the past. Boards need to have a bit of a lockstep between the way you think about accounting for these new assets we’re building.”
Boards first need to understand that not all intangible assets will appear in the balance sheet. “Certain technology assets such as hardware and software licences will be included, but many others, such as data and the costs associated with implementing a new cloud or software as a service, might not be,” says Pat McLay, managing partner Oceania of EY’s financial accounting advisory services.
The age of the relevant accounting standard is another hurdle. “The original was issued in 1998 and there have been no significant amendments since 2008,” says McLay. “When you think about the changes we’ve seen in technology and intangible assets in the past 13 years, it’s easy to see where problems might arise.”
He believes that in order to gain a complete and accurate value of the business, the baseline financial reports need to be supplemented with additional disclosures. “We’re already seeing a move towards more holistic reporting to cover technology and related matters such as innovation and how a company deals with change,” he says. “The biggest challenge here will be getting the accounting and finance people to work hand in glove with the technology and commercial specialists early on in the process.”
As a consultant, McLay is frequently confronted by oversights such as missed costs, assets randomly lumped together and inaccurate asset lives. “Early involvement by other specialists is the best defence against these kinds of errors,” he says. “Innovation and technology need to be embedded into the accounting process, not put in a corner to be dealt with separately.”
In 2021, Amazon is the world’s most valuable brand at $US638b, according to researcher Statista, followed by Apple at $US612b, Google, $US458b, Microsoft, $US410b and Tencent, $US240.9b.
Source: Kantar, Statista
Open source code can be copied, studied, adapted, improved and distributed. However, if you incorporate it into your work, your innovations could be subject to the same freedoms.
Source: IP Australia
IP Australia notes trade mark activity is shown as an important predictor of export entry and performance. In 2020, trade mark applications were up 8% on the previous year with plant breeders’ rights filings up by 12%.
Source: IP Australia
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