Playing for High Stakes: Mitigating Intangible Asset Risk

Anyone who has spent time in board meetings will recognise that one word guaranteed to grab even the doziest director’s interest is “risk”. Boards are particularly animated by risk because while most director’s like to seeing earnings grow and loath the idea of earnings falling, they are typically petrified of legally imposed risks such as health and safety or compliance that could result in an unseemly performance in front of media or worse, a judge. To put it another way, the average director has an asymmetric relationship between risk and reward.

The irony of all this is that many directors are complete unaware of a major and systemic source of risk to their organisations: intangible asset risk.

It is well established that over 90% of the value of companies in the S&P500 today is contained within their intangible assets (such as data, brand, confidential information, software, code, patents and trademarks). It is also these assets that contribute the overwhelming portion of all earnings growth in virtually every industry, excluding real estate speculation. So, it makes sense then that if 90% of your assets and virtually all your earnings growth come from intangible assets, this is also where the majority of your risk lies. Arguably the most well-known of the 20th century’s economists, John Maynard Keynes, summed this up succinctly: “concentrate thy risk, concentrate thy mind.” Yet despite this many boards fail to identify their intangible assets, much less manage the risks to them.

So what is intangible asset risk? Put simply it is any risk that derives from, or could materially impact, significant intangible assets. Examples include: the loss of a key brand (due to inadequate trademark protection or a major public relations disaster), being sued for patent infringement or inability to prove you own core intangible assets (also known as Chain of Title risk).

Every intangible asset class from data to plant variety rights to brand to content carries with it attendant risks. However, these risks are not equally likely, nor equally consequential. Through the analysis of more than 1,000 client engagements, we have found that some risks come up again and again. From this, we have identified the top 5 intangible asset risks companies face, which are outlined below.

1.  Leakage or Theft of Confidential Information

Most companies are constantly leaking valuable intangible assets, with customers, suppliers and employees being the main perpetrators of these leaks. Whether intentional or inadvertently, the leakage of confidential information via these channels results in the constant loss of competitive advantage and ultimately market share or margin erosion.

To understand more about how to mitigate risk in this area, click here.

2. Not being able to prove ownership of 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. Intangible assets are unlike physical or tangible assets, in that they are often off-balance-sheet and don’t feature on any kind of asset register or inventory. When you throw in issues such as joint development arrangements, outsourced contracting arrangement, restructures and employment disputes it is often very difficult to actually pin down exactly who owns what.

To understand more about how to mitigate risk in this area, click here.

3. The hazardous use of open-source code software

Many companies also face a significant risk related to 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. However, there are several problems that can arise over the use of open-source software around ownership, licensing terms and potential security issues.

To understand more about how to mitigate risk in this area, click here.

4. Not owning your brand or brand infringement

Many companies we see do either not own or control their brand or face major brand infringement risks. This is often the result of companies launching new products, entering new markets and geographies, or establishing new relationships without ensuring that their trademarks keep up with and cover those new initiatives and arrangements.

To understand more about how to mitigate risk in this area, click here.

5. Threatened of 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, Europe, and China over the last decade, but again, this risk is entirely preventable by taking the time to understand any risk exposure early on and taking proactive rather than reactive measures.

Management of this risk is challenging as it involves a careful consideration of multiple competing factors which vary by jurisdiction, technology type, industry and company situation / risk profile.

For more detail on managing IP litigation risk please get in touch with our team here.

A fiduciary duty

Many boards and management teams, lulled into a false sense of security by the relative absence of these assets from company balance sheets tend to overlook or discount intangible asset risk. This is a mistake for three reasons:

1. Intangible assets are the most important assets that companies own today, failing to manage these risks leaves the company vulnerable to serious risk.
2. While these risks are significant, they are also in many cases entirely preventable with a bit of planning and foresight.
3. Last and perhaps most motivating, Director and Officers have a fiduciary obligation to “generate a return on, and manage risks to, all assets under their stewardship and control”. The word all there is important. All assets means just that ALL assets, including intangible assets. The mere fact these assets may not feature in company reports or have a non-physical character does not obliviate director and officers obligations to manage them correctly.

With so much company value now tied to intangible assets, it is more important than ever that management teams and officers take proactive steps to protect and manage these assets and to mitigate any issues before they have a significant negative impact on the business.