Source: The AREOPA Group
The problem…
Large AAA rated bank was offering loans to startups, especially Information and Communications Technology (ICT) related projects. The Bank used the traditional collateral concepts to back up the loans they gave. This resulted in several nonperforming loans issues:
The organizations, or even individuals, who asked for a loan were in most cases innovative companies who were involved in disruptive innovational product development. This was not in line with the traditional way of thinking in banking terms.
Once the loan was granted, the borrower used the money for other purposes as initially was meant. The borrowers stopped their initiatives and started some other ventures. The borrowers couldn’t pay back their loans nor the interests. All this led to a lot of conflicts between the borrowers and the Bank; and resulted in 67% of nonperforming loans. In many cases the bank needed to use the collateral to get their money back and in many cases this collateral was the guarantee from family, friends, or property of one or more of the borrowers. Most of the time the people who gave the collateral were also customers of the Bank as private persons and due to the situation, the Bank was losing a lot of customers.
The total operation was not profitable, not from a commercial standpoint but also not from a customer satisfaction point of view, so the Bank wanted to stop this service, which they have revived after the AREOPA’s intervention.
In the above scenario the collaterals the Bank asked for were still based on the tangible assets, and not connected to the intangible assets the startup companies possessed. Moreover, the companies not always used the borrowed money to strengthen their intangible assets and used it for paying all kind of expenses. The Bank, on the other hand, didn’t had a follow-up system that was looking at the real value creation that the companies created with the borrowed money.
The solution…
AREOPA proposed to review the activity and bring it in line with the concepts of the knowledge economy. After that, the solution proposed was the following:
Split the cost up in Intellectual Capital (IC) related costs (such as, training, licenses, Joint Venture costs, development costs, IC inventory creation, IC protection costs, IC value creation exercises, etc. – today in most companies maximum 2% of all the costs) and non Intellectual Capital related costs (such as, fixed costs, salaries, offices, equipment, overhead, etc. - today in most companies minimum 98% of all the costs). AREOPA, jointly with the Bank’s management decided to finance only the Intellectual Capital related costs (if proven). This also included the education of the Bank’s officers, in order to be able to make the distinction between Intellectual Capital related and non Intellectual Capital related costs.
Moreover, it was not an easy task to help the banking officers as well as the startup entrepreneurs to put their focus on spending the money on the right Intellectual Capital related costs and how they could turn these into assets, owned by the company, which was also the underlying collateral for the loan towards the Bank; and secondly how to create revenue streams from these assets. AREOPA helped the startup companies also in managing their organization as a Knowledge Company. To do so, the following steps were followed:
Prepare: IC Quick Scan, Build IC Inventory, Create Management Plan, Estimate Value
Protect: Safeguard the knowledge, Ensure Ownership, Protect
Deliver and Grow: Control, Manage, Create and Combine to Deliver additional Value
Account and Audit: Prepare AREOPA IC Accounting System, Audit using IAS 36 and IAS 38
The result was very satisfactory: The non performing loans, which were at a rate of 67% before the intervention, dropped to 3%.
The scientific explanation could be summarized in the following graph:
This graph indicates the relation between an “IC asset” growth and “revenue” created by this increase of “IC assets“. The analysis starts here by making a split between IC related costs and non IC related costs (example of IC related costs: new product development, training costs, purchase of licenses, Joint Venture costs, collaboration costs with universities, branding costs, knowledge management costs, knowledge transfer costs, process improvement costs, risk mitigation costs, Intellectual Capital & Intellectual Property protection costs, etc. This list of costs are in most of the companies very small in comparison with the traditional costs such as salaries, office rent, equipment, purchases, etc. In most organizations the IC related costs are seldom more than 2% of the total costs package of the company; and by consequence, the traditional costs mount up to 98%. A Company, active in the knowledge economy should have ideally at least 30% IC related costs versus 70% classical costs (this are just statistical assumptions).
In this graph we use the relation between IC related costs (not the classical costs) and calculated the correlation between the increase of the IC related costs and the increase of the IC value of this company (IC value increase). The average correlation that was able to be calculated (in companies active in the knowledge economy) was r=0.84. When it is known that a r=1.00 is the maximum, it can be stated that the correlation (between IC cost and IC value increase) or the causal relationship, is very high. In a sense, it seems very logical because if you invest a lot in IC related costs, then at least most of the efforts would yield in more understanding of your product and service offerings, more understanding of the possible money flows that can be created, more options on a larger product and service portfolio and by definition more IC value (if there is a capturing, storing an making re-usable model used, in order to make tacit knowledge more explicit).
If the newly created or acquired IC (in the format of more understanding, larger product and service portfolio, etc.) is transferred throughout the company by all means, (calling this managing the IC assets) it can be expected that the newly created revenue would be caused by the increase of the IC value. The correlation calculation proves that this is correct r=0.86. This means there is a causal relation between creation of IC value and revenue.
This statistical model proves that by increasing your IC value (with IC costs as a basis) and by managing this IC value increase so it creates new money streams for the company, it can be predicted even the future revenue by the use of the newly developed IC. If an organization would permanently invest in IC development (see above) then this leads to permanent innovation and it will be possible to calculate the future revenue of the newly developed IC based on correlation indexes. This would mean that would be possible to compose “roll over business plans“, which can show all the future revenue streams from this company.
If a Bank, addressing startup companies or companies involved in innovative knowledge driven Activities, is considering of lending or financing these companies and they want to reduce risks, they should focus on financing the IC related costs and should manage the IC creation and the revenue creation based on the IC related costs made.
1 For reasons of confidentiality, the name of the Bank was omitted, but it Is a real case of application of AREOPA’s methodologies.
2 AREOPA was founded in 1987 as a management consulting firm. AREOPA has built up a strong reputation over the years in the development of methods, models and tools in such areas as “Change Management”, “Intellectual Capital” and “Knowledge Management and e-Learning and the provision of consulting services making use of these methods, models and tools.
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