Accounting for the value of intellectual property in business still lags aeons behind
Where IP does get taken into account, the result is often undervaluation or overvaluation
In 2014 the medical technology company Theranos was valued at $9bn and its founder, Elizabeth Holmes, had a net worth of almost $5bn. Partner Fund Management had just purchased 5.6-million shares at $17 a share, and the Palo Alto firm’s blood-testing tech was being rolled out to hundreds of chemists across the US thanks to a lucrative agreement with the Walgreens pharmacy store chain.
Theranos’ now archived website states that Holmes was named inventor on more than 200 patents (US and international), “foundational for the company’s more than 1,000 pending and issued patents, many related to less-invasive lab testing on smaller samples”. Holmes had dropped out of Stanford University to found Theranos, inspired by a desire to help people by finding ways of replacing extensive and expensive blood tests with a machine that could test for a long list of diseases with just a single drop of blood.
By 2015, despite numerous testing problems, questionable reports and a public relations nightmare in the form of an article by Wall Street Journal reporter John Carreyrou, the company continued making fantastical claims, faking demonstrations for investors and board members, and gagging staff, researchers and engineers. Through all the scrutiny, she was able to convince powerful figures such as Larry Ellison, Henry Kissinger, Rupert Murdoch, Bill Clinton and Betsy DeVos to legitimise her vision and work.
Incredibly, Theranos’ success bowed, then broke, on just one fundamental property. Intellectual property (IP). An intangible, largely invisible asset — hidden both in financial accounts and physically. Intangibles are difficult to see, much less to understand and disclose. So how was Theranos able to create such a behemoth of biotech on unproven, impracticable intellectual property? And how was it that so many investors failed to carry out due diligence on the intangibles into which they were pouring millions of dollars?
The Theranos story is by no means unique. The fall, recently, of a major listed company in SA can be linked, in part, to a lack of information on IP in contracts in financial statements. The problem is not limited to for-profits or listed entities. SA’s governing political party has recently displayed ignorance of trademark fundamentals by failing to gain control of its domain name. Custodians of valuable African cultural heritage — the Basotho and Zulu leadership — are also letting the proverbial genie out of the bottle by failing to understand, disclose and control their IP. This means their culture is at risk.
Yet Theranos is also a classic example of how an IP-backed firm can create wealth. Much of the hype (which extended for many years) was based on a story around IP. This hype generated interest and significant funding, which is fundamental to the success of any small or medium-sized enterprise. If only the story were true. Theranos illustrates what can be done if a business strategy is linked with an IP narrative, and the massive information gap even if IP (in this case patents) is disclosed.
There appears to be a yawning gap between good governance and the role of IP disclosure and value creation. The global and local trend is towards better and increased governance, reporting, transparency and disclosure. There is increasing spend on governance, but very little attention paid by boards to the intangibles on and off the balance sheet, and to the relationship between intangibles and IP.
The challenge for board members is multifaceted. The role of the auditor and accountant in valuing and recording intangible assets on the balance sheet is far from clear. This is both an international and national debate driven by concern that internally generated IP is not disclosed in annual accounts, leading to sometimes significant under- and overvaluations of business entities. This presents both risks and opportunities for businesses. With the increasing rise of the value of intangibles over tangibles in corporate value over time, the dearth of information relating to a business’s IP is a real concern.
These cases illustrate the desperate need for the education, accurate disclosure and scrutiny of IP at board level. So where should the education process begin? There needs to be a step-by-step approach to IP, education, identification, disclosure and governance, with a focus on self-audits, the need for IP advisers, a management plan, and an IP narrative. The message is clear: boards have a duty to recognise the role of IP in governance and value creation — before the blood clots.
• Olivier, an intellectual property strategist, is a partner at Adams & Adams.