Despite being so critical, intangible assets still don’t feature on most board or company agendas. This is especially apparent when you look at intangible asset risk, which is often regarded as either not important at all, or important but not urgent.
In more than 750 client engagements across both private and public companies, we have seen intangible asset risk feature on only one board’s risk register. Yet, the consequences of not identifying and understanding intangible assets and their associated risks are extremely serious
So, what are the top five intangible asset risks that companies face today and are they preventable?
RISK ONE: LEAKAGE OR THEFT OF CRITICAL CONFIDENTIAL INFORMATION
The number one intangible asset risk that companies face today is that they are constantly leaking key intangible assets, with the primary sources of those leaks being customers, suppliers or employees.
According to research by Code 42 in its Data Exposure Report, 72 percent of CEOs, 71 percent of CMOs and 49 percent of business leaders admit to taking intangible assets (including information, ideas, intellectual property and data) with them from previous employers, when they move to a new organization. The reason given for this was that 79 percent of the CEOs and 65 percent of the business leaders surveyed saw their work as belonging to them – even though the policies typically said otherwise. Ouch.
We see this scenario play out every day. Take, for example, a hardware company that asked us to help it review its policies after it was badly burnt by the loss of its confidential information.
In this instance, the company had developed a world leading new product category but, being unable to keep up with demand, it outsourced software development to an external supplier. As part of this project, the company provided the full details of code and key confidential information.
The initial project was delivered on time and within budget, but the supplier then shut down. Fast-forward six-months, and the supplier reappeared as a competitor utilizing the intangible assets it had developed to spring board 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.
Unfortunately for the hardware company, the bell couldn’t be un-rung. We could only work to help it prevent this situation happening to it again in the future.
RISK TWO: COMPANIES CANNOT PROVE THEY OWN THEIR INTANGIBLE ASSETS
The next most significant risk that we see company’s facing is around the fact that 8 out of 10 companies cannot prove they actually own their intangible assets. Unlike tangible assets, intangible assets are hard to inventory, are often not registered and do not appear on balance sheets or within profit and loss accounts. When you throw in issues such as joint development arrangements, joint R&D and outsourced contracting arrangements, it can be very difficult to actually pin down and establish who owns what.
We saw this recently when we were dealing with a company that was raising US$35 million in venture capital. A standard warranty that investors will require a company to sign is that it owns all of its assets. In this case, when push came to shove, this software company realised that it could not actually prove it owned its software code.
The reason was quite simple. The company had been founded by three founders who worked together for over a year without being paid, and without any kind of corporate entity. Then one of the founders left creating a split in the code, which eventually led to uncertainty around who owned what. Add to this that they used friends and outsourced contractors to contribute to the coding; merged with another company partway through, and also used a large amount of open source code and the result was a Gordian knot of software code where it was extremely difficult to actually prove who owned the assets. This caused a major problem for the investment, but the issue could have been prevented if the company had taken steps along the way to clarify the ownership of its code.
RISK THREE: HAZARDOUS USE OF OPEN SOURCE CODE SOFTWARE
The third key intangible asset risk is around the hazardous use of open source code software. Today, 80% of all software code is open source – that is, software that has been developed by one individual that is freely (or not so freely) available for use by other individuals.
The problem with open source code really breaks down into three issues:
1. Understanding who actually owns the software;
2. The license terms of open source code software can be poisonous to proprietary code developed by your company; and
3. Open source code is a very effective way of getting malicious code such as hacks or trojans into a proprietary source code base.
The primary solution to this problem is to first understand where and how you are using open source code software – and it is almost certain that you will be. We work with a major open source code firm out of the United States, and in 10 years and 13,000 audits, it has found open source code software being used in every instance.
Once you know whether or not you’re utilizing open source code software, the next step is to understand whether or not the license terms present an issue with your proprietary software code, and whether or not there are also security threats as a consequence of the use of that open source code software. Once you have these things sorted, you need to ensure that you can establish chain of title to the proprietary code you have developed for your own purposes.
RISK FOUR: NOT OWNING BRAND, OR BRAND INFRINGEMENT
The fourth most significant intangible asset risk is the fact that many companies we see do either not own or control their brand, or face major brand infringement risk.
A brand is often times a company’s most valuable asset, yet many companies do not understand trademark law or trademark strategy. We often find that companies create new markets and new products, enter into new geographies, or establish new relationships without ensuring that their trademarks cover the new arrangements. Likewise, we find that many companies are not putting the right measures in place when they enter a joint venture or distributor arrangement, which can create a risk that the partner will end up owning or controlling the brand.
As an example, we were recently engaged by a company that was growing very fast and that had been spending around $1.5 million per month building its brand. The company engaged us to review its trademarks and we quickly realised that its trademark protection was completely inadequate, including in the United States – a key offshore market – where its brand was in fact owned by a competitor. What this meant was that the company had spent the previous 24-months (and roughly $36 million dollars) building a brand it did not in fact correctly own or control. This created a massive loss for the company, which would have been entirely preventable with better planning and foresight.
RISK FIVE: THREATENED OR ACTUAL IP LITIGATION
The fifth key intangible asset risk is actual or threatened intellectual property (IP) litigation. There has been a huge increase in IP litigation in the United States and Europe over the last decade. However, IP litigation is often entirely preventable if a company has taken the time to understand its risk exposure early on and taken proactive rather than reactive measures.
A recent example in Australia (and a stark warning that these threats need to be taken seriously) comes from Cochlear (ASX:COH), which last year had AU$377M in intangible asset damages (including for willful infringement) awarded against it for patent infringement in the US. Particularly concerning was the fact the damages award was 17 times more than the contingent liability Cochlear had set aside for the case based on an ‘independent damages expert assessment’. Companies need to be very careful to utilize expert advice when assessing potential liabilities — to be out by this magnitude is extremely concerning.
At the time the announcement was made, Cochlear shares fell 3.8 per cent or AU$380M — about the same amount as the damages award and creating a double blow for the company and its shareholders.
While Cochlear is appealing the judgment, it may not receive a ruling on this for two years or more. In the interim, the company has had to lodge an AU$464 million insurance bond with the court to secure the judgment amount, and any interest and costs. This process is costly both financially and also from a management perspective, given it can be expected that a great deal of management team resources will be going into managing and fighting this case.
However, with foresight and planning, this issue can be prevented effectively by running through patent and trademark checks prior to launching – and preferably before developing – any products or ideas. Once the level of risk exposure is understood, action can be taken to correct or modify the product or idea thereby avoiding that level of risk exposure.
A SERIOUS THREAT
Intangible assets are the most important assets that companies own today, which means that they are also the primary source of risk for most companies. But, while these risks are significant, they are also in many cases entirely preventable if the right steps are taken to mitigate these threats.
It is vital that the Boards and management teams take a leadership role in protecting and managing a company’s innovation, with the first steps being to identify:
1. What are our intangible assets?
2. What are the impact of these assets on our business and how are they driving economic benefit?
3. What risks are we exposed to through these assets?
By working through these questions, companies will be able to identify the major potential risks faced by their business and work to mitigate these issues before they have a significant negative impact on the business.