News Why it pays to innovate

There have been a number of media stories over the last few weeks focussing on the fact that British businesses are failing to innovate. Reports by both the government and the private sector have highlighted that there is less investment in research and development in the UK economy now than has been the case in the recent past. From this, the conclusion is often drawn that there is a lack of innovative ability in the country. However, it is not ability that is missing – the problem is a lack of funding for innovation.

Since the stock market crash in 2007, investors are not as open minded as they once were. Naturally, after such a fall in share prices, there is a reluctance to move away from the known surety of returns. This has led to less money becoming available to create a legacy – the trend is towards profit taking rather than the reinvestment of profits and future expansion. Less speculation and more conservatism means that budgets are tuned to the continuation of the sales growth of existing products, rather than the introduction of new products to further business development.

Temporary shift

Britain is historically one of the most innovative economies in the world, with an abundance of talent in technology and science. The temporary shift of emphasis in the market does not mean that there are suddenly no new ideas in the pipeline. There are many, but they are not currently the main focus in the boardroom or for the majority of private equity investors.

The value of innovation

In corporate finance, benchmark comparison is a valuable tool that is often utilised in measuring one business against another for the purposes of valuation. Two companies of similar size and business mix, which have taken a comparable length of time to develop, could expect to have a similar valuation.

If one of them has continually allocated part of its budget to developing new products and the other has not reinvested its earnings, the former is more likely to maintain and increase its earnings in the future than the company that has not taken the risk. Thus the company investing in new products is far more likely to be attractive to potential buyers and be valued at a higher (strategic) amount.

Innovating companies that are tax aware have further improved both their cash-flow and their value by claiming enhanced tax relief on qualifying research and development expenditure – at the rate of up to £2.25 for every £1 spent this can generate an immediate reduction in a company’s tax bill, with total claims amounting to almost £1.36bn in 2012/2013. All as a result of innovating and developing new products or possibly even just doing something in a company’s process quicker or cheaper.

Where innovation results in patented technology then the UK Patent Box introduced in April 2013 can reduce the tax on the profits arising to as little as 10%, and whilst 2016 will see the introduction of “Son of Patent Box” the government has confirmed that UK companies will continue to benefit from patent related tax relief.

Companies need to innovate, and in Britain the ability is there to do so. It is up to company directors, both executive and non-executive, to demonstrate to potential buyers and investors that there is mileage and profit in reinvesting earnings – and benefiting from the longer term investment that is needed to create good product innovation.

Summary

We sell numerous companies and a common feature of those that have attracted the very highest valuations has been their ability to innovate. Strategic purchasers will often acquire in order to fill voids in their internal innovation and this can be very lucrative for the people selling. It pays to innovate and it is something the UK continues to be very good at.