Characteristics of firms with intangible assets

            While firms with intangible assets are diverse, there are some characteristics that they do have in common. In this section, we will highlight those shared factors, with the intent of expanding on the consequences for valuation in the next section.

1. Inconsistent accounting for investments made in intangible assets: Accounting first principles suggests a simple rule to separate capital expenses from operating expenses. Any expense that creates benefits over many years is a capital expense whereas expenses that generate benefits only in the current year are operating expenses. Accountants hew to this distinction with manufacturing firms, putting investments in plant, equipment and buildings in the capital expense column and labor and raw material expenses in the operating expense column. However, they seem to ignore these first principles when it comes to firms with intangible assets. The most significant capital expenditures made by technology and pharmaceutical firms is in R&D, by consumer product companies in brand name advertising and by consulting firms in training and recruiting personnel. Using the argument that the benefits are too uncertain, accountants have treated these expenses as operating expenses. As a consequence, firms with intangible assets report small capital expenditures, relative to both their size and growth potential.
2. Generally borrow less money: While this may be a generalization that does not hold up for some sub-categories of firms with intangible assets, many of them tend to use debt sparingly and have low debt ratios, relative to firms  in other sectors with similar earnings and cash flows. Some of the low financial leverage can be attributed to the bias that bankers have towards lending against tangible assets and some of it may reflect the fact that technology and pharmaceutical firms are either in or have just emerged from the growth phase in the life cycle.
3. Equity Options: While the use of equity options in management compensation is not unique to firms with intangible assets, they seem to be much heavier users of options and other forms of equity compensation. Again, some of this behavior can be attributed to where these firms are in the life cycle (closer to growth than mature), but some of it has to be related to how dependent these firms are on retaining human capital.