Tech companies value determined by future not past

By Nicholas Benbow

The recent upswing of tech IPOs and reverse takeover [RTO] transactions has highlighted a particular accounting judgment that is fast becoming the norm in the industry.  Management are expensing development costs arising from a research and development [R&D] programs rather than recognising them as assets.

As a result, they risk under-representing the value of their own companies and deterring investors.

Latest research by accounting firm William Buck reveals that the ten latest tech companies to undertake an IPO or RTO either did not capitalise any development costs or, if they did so, it was at low levels in-relation to their overall R&D program. This is most unusual, because for a company to list on the stock exchange, it usually has a commercially viable product or service; an indication that it has undertaken substantial R&D.

The criteria for recognising R&D costs as assets is highly prescriptive, but once a company’s proprietary intellectual property has passed its research phase and proceeds to its development phase, it may be capitalised as an asset.   Audit Director, Nicholas Benbow explains;

“If there is proof of technical feasibility, an intention and ability to sell or use the asset, or you can show there is a market for the asset then it will ordinarily meet accounting standards requirements and can be capitalised.”

Failing to capitalise R&D as an asset could result in tech companies underrepresenting their value.   Nicholas says;

“Here’s the irony – whilst directors and management do all that they can to present the company in the best possible light during a capital raising phase to investors, it appears that they may be forgoing the potential to capitalise a greater portion their R&D program in the balance sheet.”

There are many reasons why these companies may feel it’s better to take a more cautious approach to capitalising their intellectual property.  The need to progress a prospectus document through the regulatory oversight process appears to be one.  Nicholas says;

“Where a high level of R&D is capitalised, it can raise red flags with the Australian Securities and Investment Commission (ASIC).  If these values are challenged by the regulators there are significant costs attached to managing and re-issuing a replacement Prospectus.  As such, management would prefer to de-risk the process and expense the R&D rather than capitalise it.”

Potential investors need to recognise that the relevance of the capitalisation of intangible assets to the value of the company is relatively low.  What’s more important to the market of technology companies is their future value, which, on the whole, is not capitalised.