When my sons were younger, they loved to play with Green Slime. Remember the stuff? It came in a plastic can, and that’s exactly where you as a parent wanted it to remain: once out of the container, it was nearly impossible to capture enough of it in your hands to get it off the furniture and back where it belonged. You could see it, you could feel it, but you just couldn’t get at it.

Valuing your company’s intangible assets is a bit like trying to scoop up Green Slime. If you find that notion frustrating, you’re not alone. By some estimates, over twenty million U.S. business owners are scratching their heads over the same thorny problem. In our 21st century environment, where bricks and mortar and machines are being rapidly replaced by "fluffier" assets such as ideas, people, client lists and software programs, attempting to assign a reasonable value to these intangibles is one of the major challenges facing players in the New Economy.

Experts have been debating the question for more than a few years in the business press, but I can’t resist commenting on it again here: one of the major problems in attempting to value a service business, or any company carrying a high percentage of intangible assets, is the fact that our good old accounting system was created 500 years ago---just a few years before the phrases "dot com" and "New Economy" were conceived. The genius we can thank (or blame) for the double-entry bookkeeping system we still use today was one Luca Pacioli, an Italian---didn’t that culture produce all the great ideas, as well as all the greatest tenors?!? The dude (a monk-dude, to be precise) developed a durable, original accounting system that has served the business world well for centuries. The only problem with the Pacioli methodology is that it relies on transactions.

And therein lies the rub. A heck of a lot of value in the New Economy is created in the absence of any ‘accountable’ transaction. And a heck of a lot of value can be destroyed in the same way. But changes in value---if you adhere to the Pacioli system--- have absolutely no impact on a company’s financial statements.

Think about it: when a company experiences fluctuations in customer satisfaction, major alliances, technology, brand identity or innovation, does anything change hands? Is anything bought or sold? Is there any transaction at all that can be expressed via an accounting entry using the existing method of matching revenues against expenses? Of course not. So it’s as if the change in the intangible asset never happened, because it cannot be reflected within the framework of our current accounting system.

Look at the stock market. Which companies’ shares are selling at astronomical price-to-earnings ratios? ---wait a minute, you can’t even use that measure when there are no earnings yet! Okay, which stocks are blowing the roof off all the indices? You guessed it: the companies with more joint ventures, more effective marketing and
manufacturing alliances, a higher level of innovation and cutting-edge technology. My favorite example is the oft-told story of American Airlines. In late 1996, its parent company, AMR Corp., sold 18% of its computer reservations system to the public, keeping the remaining 82%. Three-and-a- half years later, that reservations system alone represented a full 50% of AMR’s entire value. The other assets---hundreds of jets, 100,000 employees and landing rights in major airports all over the world---would, at first glance, appear to command more than their 50% share of AMR’s value. The difference is that the computer reservations system can be leveraged: there is no limit to the number of people who can use it, whereas you can fly only so many travelers on a finite number of jets with a finite number of available crew members.

The problem with hanging your hat on intangibles, however, is exactly that: they’re not tangible. They can be expensive to develop, as is true in the pharmaceutical industry, where it costs half a billion to develop and get a new drug approved. They are expensive to buy, as well, but huge companies are paying astronomical prices for smaller companies possessing "knowledge assets" that the big companies must have in order to stay in business.

For years, we have relied on tools, numbers and rules to guide us. Today, we’re walking the tightrope with no net on the floor of the big top, because no one has successfully developed a system to provide for the capture of human capital, brand name recognition, intellectual property and the like. The corporate audit, our guidebook of the past, no longer offers the traditional seal of financial approval that once allowed us to sleep at night, secure in the knowledge that the "experts" were protecting us. Rapidly growing high tech companies are most likely understating their results because they cannot account for innovation. Older, more traditional companies, on the other hand, are probably overstating results, with a resulting disconnect with a market that is supposed to reflect "reality"!

Doesn’t it give you a headache? You and I are probably not smart enough to improve on what Luca Pacioli created so long ago, but at least somebody out there is attempting to take a crack at valuing those slippery assets that are at the heart of the New Economy. A modern-day Luca, whose name happens to be Baruch Lev, an NYU professor of accounting and finance, has proposed a revolutionary system to measure what he calls knowledge assets, intellectual earnings and knowledge earnings. I’d use up another ten pages and wear out my welcome at Ventures were I to attempt to explain it all here, but the gist of it is that he computes something he calls "normalized earnings," taking into account history, but also a consensus of analysts’ forecasts as to the potential future earnings that knowledge creates. Then, he subtracts from these total normalized earnings an average return on physical and financial assets, based on the theory that these tangible assets are substitutable. Stay with me, here: the remainder, after subtracting the average return from normalized earnings, is what Lev terms "knowledge earnings," which are the earnings created by the company’s knowledge assets.

Using his innovative formula, Lev has actually computed the knowledge assets for dozens of big companies, among them Microsoft, Intel, DuPont, Merck and Dell Computer. Take a guess: which company has the highest level of knowledge assets? (Hint: it’s not DuPont.) Lev also looks at what he calls "structural capital", using
Dell Computer as an excellent example. There is nothing unique, of course about the computers Dell produces; what’s "different" is the way in which it markets them. Is it any surprise, then, that Lev shows Dell’s knowledge capital at a far greater level than that of the much-larger Wal-Mart?

Well, I could go on and on, but I am within just a few words of my column’s limit, so I will leave you with this thought: take heart. Lassoing those intangibles and converting them into reasonable values on paper ain’t easy, but at least somebody out there is burning the midnight oil trying to provide us with a decent tool with which we
might better navigate the treacherous waters of the New Economy.