Any investment in Intellectual Capital is completely invisible when it is first made. With time, the value inherent in Intellectual Capital shows itself in higher EBITDA margins, and/or higher sales growth relative to peers and the company’s historical performance.
There is always a time lag between when there is an investment in Intellectual Capital and when it is reflected in the income statement. There is also a time lag between when a company stops investing in intellectual capital when when profitability starts to decrease.
When you sell a company, you want to be able to document your investments in Intellectual Capital. This permits the buyer to be assured that profitability will be maintained or increase, and for the seller to obtain a higher selling price.
When you build or buy a company, you want the direction of change to be positive and the rate of change to be increasing, ceteris paribas. This is the reason for conducting an intellectual capital audit, whether for mergers and acquisitions or making a credit decision and determining optimal leverage .
When analyzing a company, it is critical to assess whether a company’s investment in intellectual capital has been increasing, constant, or decreasing. While the company may not show any signs outwardly, the precursors are all in place, and the metrics used to measure these precursors have tremendous predictive power.
Companies that have invested in their Intellectual Capital have precursors that can be observed.. Those that have installed CRM and conducted Strategic Marketing (Relational Capital), invested in training and cross-training (Human Capital), invested in R&D and refined and integrated its processes end-to-end (Structural Capital) will show signs of the future benefit, even though only part of it may be visible in current profitability. Enhanced customer engagement, increased employee engagement, improvements in business development pipeline, and other key performance indicators will be the next level of metrics to improve, prior to profitability enhancement.
Some forms of Intellectual Capital take years to show themselves. Talent acquisition and talent management can take years to show up in profitability. But succession planning take years measured high single or double digits. One of the primary areas of deficiency of lower middle market companies – those from $5-$50mm in sales, is in developing succession plans.
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