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Self Interest vs. Self Destruction
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
June 28th, 2002


By Brent Holliday
Greenstone Venture Partners

 

"Money, it's a crime.
Share it fairly but don't take a slice of my pie. "
- Pink Floyd, Money

Technology is a bad, bad place to be if you watch the markets and the media. What can I tell you? Those of you that still like technology are probably looking for a little crumb, a little insight, a little hope… Are we at the bottom? We have dipped back to the post September 11th market value through a perception that all accountants are crooked, every CEO stuffs his pockets and runs and no numbers generated by public companies can be trusted. The new irony: Osama Bin Laden's achievement in striking at the symbol of the American capitalistic system and the fear and panic that gripped that system immediately after driving markets to new lows, has now been matched by a bunch of corrupt, morally bankrupt senior executives... from America.

The implications of the Enron/Adelphia/Tyco/Global Crossing/ImClone/Worldcom debacle are huge. From the 100,000 foot level, capitalism is taking it in the gonads. Self-interest is at the heart of the capitalistic system. Self-interest is a milder euphemism for greed. Martha Stewart was using some form of "self-interest" when Sam Waksal called her and told her that the FDA called his bluff on the colon cancer drug at ImClone. Pop ethics quiz: You are Martha. Do you say, aww too bad, I lost this bet. OR do you sell now and avoid losing money. Hmmm. Is the latter illegal? Yes, but only if you get caught. Drat! Those cell phone calls are traceable with a date and time stamp.

Enron execs used "self-interest" when they decided to use the grey areas of accounting rules and create off balance sheet limited partnerships to hide losses. This pumps up earnings and makes their stock options more valuable as investors are duped into thinking that this company prints money.

So, is self-interest evil? Is greed bad? Where's Gordon Gecko when you need him? Not if you play by the rules and the rules are enforced. Because of the fallout and lack of investor confidence in the world's largest capitalistic system, the rules are about to change, big time.

Auditing is under a microscope and changes there will be profound. Board of Director rules and responsibility will change. Punishment for breaking securities laws will step up and many CEOs will be scapegoats and get to walk with orange jumpsuits and leg irons instead of fighting legal battles from their cellphone on a beach in the Grand Caymans.

I wanted to talk a little about a proposed change being considered that really is profound and has great implications in wanting to be a founder or an officer in a new company. In order to better protect investors, shareholders and employees, the senior officers (C level - CEO, CFO, CTO etc.) of the top 5000 public companies in the US may be asked to sign personal indemnity clauses that put them on the hook for any impropriety in the companies that they manage. In other words, no more option of claiming that they did not know what was happening in the company. So, if the company does anything wrong in the eyes of the law, the senior officers are wiped out. Kaput. All the houses in Aspen are gonzo.

This has a nice balance to it if you think of CEOs as money grubbing bastards with big cigars in their mouths and no concern for the little guy investor, shareholder or employee. They can't take the money and run. If there was something untoward done on their watch, and even if they knew nothing about it directly, they will be on the hook and lose everything. Call it the "Captain goes down with his/her ship" mentality.

If you are thinking about being a senior officer at one of these companies and believe more in the spirit of free enterprise and open markets, this scares the kaka out of you. The whole proposition of running a company becomes a LOT riskier under this new proposal. Why would you want to take the risk of losing everything that fortune has bestowed on you on the off chance that you hired some cretin that runs afoul of the laws without you knowing? This would make you think twice about checking references on the people you hire, huh. The trust that you would need to have with your staff would be huge.

Which side is right? You can see good to both sides. Wouldn't it be nice to make a CEO responsible and capable of losing everything? Wouldn't that force open, honest and accountable senior management? But who would take the risk? Wouldn't we drive away a lot of capable leaders because of the added risk of catastrophe?

I mentioned that the proposal was aimed at the top 5000 public companies in the US. In the start-up venture capital world, this type of senior officer responsibility has been commonplace for years. Founders and senior managers of start-ups have often signed personal representations and warranties in order to get money from investors. The recourse for misrepresentation or breach of employment or key person agreements is often the entire amount of money invested and/or all of their shares. So if a founding member of a technology company that raised $5M is found to have materially breached one of these agreements, the investors could go after them for the entire amount, essentially wiping them out.

Why does this common form of agreement to put CEOs and founders on the hook exist? Especially given that start-ups have inherently more risk and unpredictability than one of the top 5000 public companies. The answer is that the senior management and founders of a start-up are usually unproven and the threat that misrepresenting or acting in a fraudulent manner could lead to financial ruin is an effective way to get them to pay attention to the investors and the Board. The "self-interest" for a founder or senior officer in a start-up is the value of the shares increasing. Guiding them to act in everyone's interest is easier with this yoke on their shoulders.

The fact that most start-ups have these terms applied personally to the founders and senior management does not deter a lot of start-ups from receiving venture capital and going on to success or failure. The risk of personal ruin is actually quite low statistically. Very, very few start-ups have actually had investors enforce their right after a judgment against a founder or senior manager. It just doesn't happen that often. Perhaps, then, this is evidence that it works and management acts honestly when they are personally liable.

A number of start-ups with more experienced founding teams do not sign personal warranties with investors. Both sides feel comfortable that they will act appropriately and the personal piece becomes unnecessary.

Going forward, if this new proposal takes hold in the US, its easy to see that it will percolate down to smaller firms as investors on the private equity side make it mandatory for funding. Then the effects of CEO and founder behaviour at the technology start-up might be the example that proponents point towards.

Let's wait and see if this is a mere knee jerk reaction to the scandals plaguing the market today or a fundamental shift in the relationship between management and investors. Interesting times, that's for sure.

Letters From Last Time:

Hi Brent,

Your column on WiFi is spot on. The real question is whether an entrepreneur can find a good way to get ahead of the trend, and whether there is enough customer demand to sustain a WiFi carrier.

It would be interesting to see if an aggressive telco would want to exploit this opportunity. Check out T Mobile Wireless Broadband (http://www.tmobilebroadband.com/), which does the Starbuck sites in the US and a whack of airports. 576 sites in the US. If they expand aggressively, they'll be in enough places for the casual US business traveler to sync up. T Mobility is a subsidiary of Voicestream Wireless, which is a sub of Deutsche Telecom. The giant turns nimble? US$30 per month for unlimited access is a heck of a lot cheaper than the number quoted to you by the Telus Mobility exec. And For a different approach check out the Boingo Wireless site (www.boingo.com) and Cafe.com (www.cafe.com) There are a number of companies trying their hand at making money out of providing WiFi services, including Vancouver's very own FatPort (www.fatport.com). You might want to ask them for their perspective on the situation.

Only time will tell whether these types of companies will get enough customers to survive.

All the best,
Bruce Tattrie
Campney & Murphy

Thanks for the additional links and examples. As you will see in a second, Sean O'Mahony from Fatport and I might appear to be in cahoots on this topic. As for the opportunities in the market, there are more coming, other than service providers. Didn't someone once say that they didn't want to fight the war, but rather, supply the bullets? Something like that.

Oh the sheer beauty of it all as I read your great article from Seattle airport while roaming on the Wayport network.

I'm just on my way back from Boston (the inaugural plenary meeting of Pass-One) where both Boingo and iPass indicated that they are completely behind the initiative. It's interesting how many of the US cellular carriers are becoming actively involved.

Then I came to Seattle for the Eye for Wireless conference.

The sector is hot and heating up further.

Here's the really beautiful thing though. I traveled from Vancouver to Chicago to Boston to Denver to Seattle to Vancouver. Connectivity all along my route.

I've tasted a little bit of the future and I like it, I like it a lot. I'm deeply involved in this and I'm excited like I haven't been by a technology movement since I too used Mosaic back in 1994.

Sean O'Mahony
Fatport

OK. From the entrepreneur locally in the space, an un-biased view of how hot things are... thanks for your views and best of luck.

I had multiple requests for the Pringles Can antenna upgrade. Here is the official link, but beware of the warnings http://www.oreillynet.com/cs/weblog/view/wlg/448


What Do You Think? Talk Back To Brent Holliday

 



Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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