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Posted by MMMman

With friends like these…

Early November saw the unlikely continuation of a long running saga as another, less surprising one, entered its dark middle chapter. Earlier this year 38 Studios, founded by baseball player Curt Schilling, folded only a few months after the release of its first game, Kingdoms of Amalur: Reckoning. At the time the studio was also still in production of an MMO tentatively titled Copernicus. In 2010 38 Studios agreed a $75 million loan from the Rhode Island Economic Development Corporation (EDC) to “relocate to Rhode Island, complete production of […] Copernicus, and to capitalize the company’s growth and expansion in Rhode Island.” In short, the State of Rhode Island would fund the remainder of development, presumably with the intention of creating jobs and ultimately reaping the financial benefits associated with a community of successful professionals in the form of tax revenue. This, evidently, did not play out the way any of the parties involved would have liked.

A couple of weeks ago I stopped renting with friends. Over five years have passed since I first partook in this practice, partly because I was a student then and you just don’t live alone but mainly because I couldn’t afford any other option. Apart from my first year of university I’ve been pretty good with managing my cash flow; the same can’t always be said for my cohabitants. There has been a few times where I have found myself lending friends money, always with the proviso that it is paid back promptly, so they can make their rent or bills. The sums aren’t huge, a couple of hundred here and there, and I trust these people. What harm can helping someone out really do?

I find worrying parallels between this and EDC vs. 38 Studios. I sought no financial gain from my transactions, granted, but the general though behind these decisions are very similar; lend someone some money to continue making a living. If my friends default on rent and bills they eventually lose their home and job, likewise, 38 runs out of money and everyone, eventually, loses their job.


The best-laid schemes o' mice an' men

The accusations made by the EDC are plentiful; I will attempt to summarise. 38 Studios, its lawyers, numerous advisory bodies and selected employees of the EDC knew or should have known that not all of the $75m loan would reach the coffers of the developer after fees, safeguards and extraneous costs were deducted. The actual amount was much lower at around $50m, though the projections for Copernicus’ completion supplied to the EDC were all based on a full $75m investment. The projections also didn’t take into account any of the cost of moving the company from Massachusetts to Rhode Island. This, according to the EDC’s allegations, was projected to run to $5m but eventually cost over double that initial figure. Furthermore, projections didn’t take into account annual repayments on the loan that would total $1.125m. Taking all of these unaccounted costs into consideration the EDC concludes, that “38 Studios’ own financial projections showed that the company would run out of cash in 2012 and actually have a negative cash flow in 2012 of $8,868,987. Even excluding [conservative] relocation expenses, that cash flow would be negative $3,868,987.”

I am reminded of the time my more financially soluble housemate and I sat across from the stony faced recipient of our aid. “Make sure you take enough to pay off all your debts” I said, “it’s no use taking too little and ending up behind again in a month’s time.” While this may sound unflinchingly selfless it was also an act of pragmatism. I am often too nice for my own good while my co-financier, on the other hand, is a hard man when pressed. We both saw the need to rectify our friend’s financial shortfall, though he only the once. It was my role to bring the disparate parties together for the good of the whole; thus I found the words “take more money from us it helps” falling from my mouth.

38 studios weren’t in the enviable position that my friend found himself in. They and others who brokered the deal were, if the EDC’s allegations are to be believed, fully aware of the loan’s funding shortfall yet sought to use it as a means to secure further investment. An email selected by the EDC from Mark C. Lamarre of placement agent Wells Fargo to Jennifer MacLean, CEO of 38 Studios, is purported to prove this accusation. “The email notes the “[o]bvious but important conclusion is that completing the EDC low-cost financing adds material value to current shareholders [primarily Schilling] . . . .” Lamarre was thereby recommending that 38 Studios accept the loan from the EDC even with the shortfall. Lamarre’s email also states that “[w]e have discussed with you the benefits of ‘safety’ in raising equity near-term versus not doing so.” Lamarre was referring to the fact that trying to raise equity in the near term was safer than waiting until the funds received from the EDC were exhausted before raising additional funds.”

This, if proved to be true, goes a long way to explaining why vital financial figures were so misleading. It appears 38 were convinced Copernicus could attract further investment deeper into development and took the EDC loan to tide them over until that occurred. It had struggled up until then to secure anything meaningful and the loan would buy them significant development time to improve their offering to other investors. Furthermore it, and less importantly Reckoning, would be sizeable successes, injecting more capital into the studio within two years. All of these factors feature within the claims made by the EDC, along with the consequences of events playing out differently.


Things falling apart

It appears that 38’s blind conviction is to be blamed where the EDC is concerned. The management’s biggest mistake was their unwavering belief in a product. Curt Schilling wanted to make an MMO regardless of the business sense that made for a first time developer and the huge financial implications of its failure. While any creative industry needs driven individuals who are unafraid of challenges, those same people need to operate within both the realms of financial responsibility and, more crucially, the law. However, while Schilling’s name is indeed mentioned within the claims, others are referenced conspicuously more often. The various financial advisory companies, and individuals directly linked to investment and capital generation, are present heavily throughout. Wells Fargo, for instance, allegedly obtained an extra $500,000 payment in undisclosed fees. Parties under the employ of the EDC itself sought to disregard evidence from a prominent RI political figure that discredited and even directly warned against the loan. Various testimonials were altered to be more favourable toward the deal and its approval. All of the above counts are simply the accusations of the EDC at this point; none have been answered by the defendants yet. If proved true, though, they paint a picture where the naivety of Schilling was thoroughly taken advantage of in the name of personal gain. While it is he who has borne the brunt of criticism from within the gaming community, the court papers point more certainly at the brokers of the failed investment. Whether he was party to the doctored projections to simply facilitate the continuation of work on Copernicus, or for more insidious motives, we cannot be sure yet. What is clear is that the deal, and the period thereafter, was littered with bad decisions, ones which ultimately cost good people their jobs.

My friend was lucky enough to never lose his job, though like 38 Studios his financial shortcomings certainly cost him dearly. The money he was lent, the sum that was supposed to make him solvent, was repaid in due course and all was well for a time. A couple of weeks later bills started to be paid late and eventually months would pass between me receiving remuneration for my paying of them. Words were exchanged and promises were made, though their impact was lessened the more times they were uttered. The final indignity came on the morning we moved out and he assured the rest of the house his rent arrears were all paid off. That payment, like many of his rent cheques it transpired, had been late by over a month, though now everything had been “taken care of.” He moved back in with his parents and we learned later that so had his money.


A matter of trust

For all the accusations that make up the EDC’s ninety four page document, everything boils down to a couple of lines near the end. They simply, and understandably, sought that 38 and the other defendants would show “due regard to the interests of the EDC” and “refrain from abusing [its] confidence by obtaining any advantage for themselves or any third party” and to, ultimately, “be loyal to the EDC.” These three simple assumptions not only encapsulate the entire case but also highlight how these events came to pass in the first place.

I trusted my friend until the very end, lending him money and letting him skip responsibilities because I trusted that he would eventually make good. I wanted to see the best for him and in being so lenient could have simply made matters worse. He didn’t have to manage his money strictly because if he ran out I would help him. I saw him as a victim of circumstance, he, I now feel, saw me as a soft touch who couldn’t say no. If the allegations are proven to be accurate, it will be clear that the EDC took everyone involved at their word and ended up in much the same place as I did. If information is withheld, whether it be a friend overspending every month or a $25m funding deficit, the financer behind any deal will be oblivious of the terrible choices they are making.

Video games are a very unpredictable investment prospect for anyone, let alone a group of volunteers acting almost entirely on good faith. It is doubtful the outcome of the case will satisfy most of the parties involved and almost certainly be of little solace to the former employees of 38 studios. What should be gained from this is the knowledge that financial backing for video games simply can’t come from bodies representing the public interest at this point in time. The sums of money involved are too large, the decision makers too removed from the industry and the risk of failure too perilously real. The EDC almost certainly set out with good intention for both Rhode Island and 38 Studios. Sadly, good intentions can only get you so far.

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Edited by Salarn

The goal of these kinds of loans is to bring highly paid professionals to an area as seen with the 38 studio's loan having requirements to bring 450 jobs to Rhode Island. The idea is that with all these new people being taxed and spending in the state, state the initial investment will grow the economy base.

The $75 million for 38 studios was a a small amount of money in comparison to other game development investments and tiny compared to other government employment investments. Yes it did fail, however the lesson here isn't "don't to invest in companies" nor is it "don't to invest in game companies". It's the simple business fact, not ever investment works out, be smart with your money (and smarter with the money of others).

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Posted by MMMman
@Salarn I fully understand that the investment sought a return through taxation. I do feel, though, that an organisation such as the EDC, which is made up of volunteers, is in no position to approve a substantial loan for a project which they have very little understanding of in good conscience. In this way their processes were, seemingly, open to exploitation.
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Posted by MordeaniisChaos

Investment like this happens all the time all over the place. It's not unusual, this is not some weird happening (somewhat in the game's industry, but not even that really, it's still pretty common for governments to invest in drawing development studios to their states).

I don't really have time to read your post, but I'll say this: investments aren't a sure thing. Sometimes, they fail. Maybe this wasn't the best sought out investment, but that doesn't mean it can't be done well. And 38 seems to have made a good game (at least most people who aren't me seemed to think very much so), so it can't have been that stupid of an investment. There was potential with them, they just spent too much money too fast, instead of just building up to the MMO project.

This was a poorly handled thing that probably shouldn't have happened the way it did on any side of things. But that doesn't mean every other situation like this is bad.

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Posted by MMMman
@MordeaniisChaos Investment in games is rife, I agree, and attracting business to a particular area of a country will continue to occur. Amalur, if all documentation is to be beleived, was not a direct recipient of the loan. Its success was used in part to justify the loan approval but was never to be funded by it. News stories cannot distill the entire case into a minutes reading and so facts like this are easily misread. This case is significantly more complex than one would initially assume and I feel, without sounding self congratulatory, that it deserves thorough examination. If the EDC's claims are vindicated it casts a large shadow on the industry as a whole when it comes to capital generation. This is far removed from a 'deal went bad' scenario, particularly because tax payer's money was involved. It could theoretically involve counts of fraud and misrepresentation of the truth that have very far reaching consequences.