Investing in a knowhow company

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MANGING KNOWHOW

of view. Investors have every reason to ask themselves and the management the question: 'are we really needed?'

Companies seeking risk capital list their shares on the stock exchange. The exchange has two roles: to act as a source of capital and to be a marketplace for shares. Companies with no need for risk capital need no listing. Indeed, to seek a listing would be tantamount to an attempt to defraud investors. Consultancy-type companies need no risk capital unless they are entering phase two of the three growth phases we encountered in the previous chapter or are in transition from consultancy to 'knowhow multiplier' or 'asset manager'.

Even if a consultancy firm claims it needs money to expand through acqui- sitions, the investor should be wary. Saatchi & Saatchi appears to have been successful, for a while at any rate but, as we have seen, the mergers and acqui- sitions growth strategy is beset by problems. There is no evidence that Saatchi &

Saatchi's prodigious acquisition-led growth has been matched by equally rapid knowhow growth.

• Capital intensive knowhow companies need money

Knowhow companies like merchant banks, fund managers or high-technology firms need capital from outside shareholders but they must abide by the rules of knowhow management if their investors are to make money. The latter should always remember that there are no quick profits from such investment and that without patience and sympathy there are no long-term profits either.

• Routine intensive knowhow companies may be good investments Knowhow companies in which a few key people act as 'knowhow multipliers', transferring their core knowhow into routines, systems and software which can be run by less knowledgeable staff, are more robust. They need capital to invest, mainly in computers and working capital. The few key people remain very valuable however because it is their knowhow which determines success or failure in the marketplace.

• Assessing risk

It is very important for the investor to arrive at a proper judgement of the risks associated with each investment. The risks of industrial company investment can be divided into:

1. Operational risk: the inherent risk of the market in which the company operates. For example, shipping has a greater inherent risk than food manufac- turing.

2. Financial risk: the stability of the company. In the manufacturing industry the relationship between debt and equity is the most important measure of stab- ility.

With a knowhow company investment the picture is very different. The operational risk is normally low but stability is usually a problem.

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The financial risk in the knowhow company usually appears to be low but the visible balance-sheet does not show the true position. The invisible balance sheet provides the real clues to the stability or otherwise of the knowhow company. Unfortunately, as we have seen, traditional accounting methods and legal reporting requirements are far from adequate measures of the strength of the invisible balance sheet. From the point of view of the outside investor the stability of a knowhow a company will have to be taken very much on trust until such time as researchers can provide ways of accounting for knowhow.

The special risk that needs to be assessed might be called 'Knowhow risk', i.e. the risk of knowhow leakage because of inadequate R&D or the departure of key people. We call the asset on the invisible balance sheet that is at risk in this sense the 'knowhow capital'.

The investor can get quite an accurate picture of the risk by using the key indicators referred to in Chapter Five.

• The value of a professional

What is the value of a professional? It is important for investors to get an im- pression of the profit potential of the company they invest in. The key to future profit is the profit potential of the individual professionals. The investor should thus be willing to pay a certain price per head when putting money into a knowhow company. As we have seen, the added value of a professional varies from the short, high-peak performance of a Diego Maradona or a Bjorn Borg to the steady increase of a Henry Kissinger.

The potential of a professional depends on the market and the business idea.

If we compare similar companies the average added value per professional does not vary much. The law of big numbers tends to even out individual differences between professionals who work in teams. The differences that exist between companies can be interpreted as the differences in managerial knowhow.

It is the knowhow of the individual professionals which adds the value clients pay for. This knowhow must be maintained with R&D and education.

Equipment and support services for the professionals must also be paid for out of added value.

One must also consider the professional life-cycle. Very old and very young professionals tend to be less effective than the experienced, middle-aged ones.

The professionals must also be given pensions and opportunities to shift careers.

These costs must also be paid for out of added value.

A certain level of R&D and other costs are also needed to expand rather than merely maintain the knowhow capital of the company. These are policy deci- sions but the money for them must come from the added value of the pro- fessionals.

What remains after all these costs is the added value from which the investor and the professionals take their cuts. The value of the professional can then be calculated as the discounted present value of the added value produced by the professional over his or her active life - say 40 years.