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Getting out of Technology Jail

July 19, 2011

It is often said that banks can’t finance small to medium sized enterprises (SME’s) these days. Well that’s not necessarily so. True, a technology rich SME does need to get ‘Out of Jail’ first and that means doing things differently.

Let me give you an example from my own experience. I once consulted to a small company that designed and manufactured access control security systems.  This company produced relatively cost-effective security solutions and relied strongly on referrals to market and sell its products.

One day this company asked if I could I help them with their business plan, of course!

At the time of our engagement, the company was in the final stages of developing a new suite of security systems to take the company to the next level. The company estimated they needed an investment of $3 million to initiate the new plan, for which they we’re prepared to give up 33% of the company’s equity. My task was to prove to a potential investor that $3 million in new money was “worth” 33% of the company.

One look at the books and I could see they were in Technology Jail. I quickly discovered that they had been steadily re-investing every extra dollar that was available into R&D, a continuous stream of re-designed and new products. Their financial statements were (as usual) prepared solely for tax purposes, expensing everything allowable:

After an initial assessment, I decided to call in accounting specialist Joe Batty C.A. to see if the company had alternatives to an equity investment. And sure enough Joe was able to assist. The initial accounting assessment:

  •  Revenues had grown steadily over the 9-year period from less that $500,000 in Year 1 to slightly more that $14 million in Year 9.
  • According to the books, the company had shown losses in Years 1 through 8 and showed a profit in Year 9 of approximately $200,000.
  • Accumulated deficits for the 9 years were over $5 million.
  • The company had limited assets and limited liabilities.

Joe asked the simple question, “Do you know what your assets are?

They answered: “Certainly, it is our line of products.”

He then asked them: “Why don’t your financial statements show these assets?”

They had no answer.

Joe’s recommendation, they needed to treat their product line as assets. Joe told them they should re-examine their procedures for engineering, manufacturing and then capitalize the costs associated with the development of these assets. (While still taking advantage of allowable R&D tax considerations)

They asked Joe to lead them through such a process.

After about a week of analysis with their engineering staff, their accounting staff and the external accountant, we were able to adopt a series of policies that would lead to a change in their approach to accounting. The external accountant agreed to allow us to re-state their last 5 years of financial statements and show the product line as assets on these statements. The change was dramatic:

  • Stronger Balance Sheet: we added $4.5 million worth of assets on their balance sheet.
  • Improved Income Statement:  financial statements showed strong and growing profits for the last 5 years
  • Recent Performance: Year 8 showed a profit of approximately $ 1 million and Year 9 showed a profit of more that $1.5 million.
  • The accumulated deficit was almost written off.

The Result: their bank manager provided them with a line of credit for the $3 million they needed to finance their expansion.

Things to Think About:

1. If Its Not An Asset to You, its Not An Asset: there is a process to unlocking the value in intangibles. The first job is managements. Begin by identifying the underlying intellectual property “IP”, clarify what you own and determine how it delivers value. Then, if suitable, mature it into a form of intellectual capital “IC”, a revenue generating property owned by the company. If the IC has sustainability and therefore asset-like qualities capitalize it as an Intellectual Asset “IA”.

2. Most importantly: surround these valuable commodities with asset disciplines and metrics so that they fit within the traditional asset framework that covers any or all asset classes. If you do this and manage it effectively it might help your company escape from Technology Jail and avoid the leverage trap that plagues many SME’s today.

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