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Tax-funded tech venture plummets to bankruptcy

Senior Staff Writer
Tuesday, September 4, 2012

At its peak, former Red Sox pitcher Curt Schilling’s video game development firm 38 Studios boasted two East Coast offices with roughly 400 employees. With the help of a $75 million loan from the Rhode Island Economic Development Corporation, it was on its way to developing Project Copernicus, intended to be a breakthrough massively multiplayer online role-playing game. Schilling had high hopes for Copernicus, which was poised to join the ranks of MMORPG classics like World of Warcraft and Star Wars: The Old Republic. 

Schilling personally invested $5 million to start 38 Studios in 2006 in Maynard, Mass. The company struggled to attract interest in Copernicus – particularly from investors – until July 2010, when RIEDC approved a $75 million loan made possible by the Job Creation Guarantee Program, which was passed just weeks before by the General Assembly.  

At the start of 2012, after six years of development, reports surfaced that Copernicus was still months away from official release. The company missed a $1.125 million loan payment to RIEDC May 1. Schilling laid off all employees May 24, and as a string of financial documents was released, it became apparent the company had been siphoning money for weeks. Public records revealed the company was $151 million in debt, and 38 Studios declared Chapter 7 bankruptcy June 14. As bankruptcy proceedings continue, any and all assets remaining in possession of the defunct company are being sold in an attempt to pay creditors. The company is most deeply indebted to RIEDC, which it owes $120 million on the 2010 loan. The most recent estimates place the company’s assets at a valuation of $22 million.  


Strife in the Statehouse

Rhode Island’s unemployment rate exceeded the national average by almost 2 percent in 2010, according to the Rhode Island Department of Labor and Training. With approximately 60,000 residents out of work, legislators passed the Job Creation Guarantee Program almost unanimously in May 2010. Introduced by former House Finance Committee Chair Steven Constantino, the program was designed to “promote the retention and expansion of businesses and the creation of jobs in Rhode Island.” After a series of revisions, the legislation granted RIEDC $125 million to fund the program. Only one of the 118 lawmakers in the General Assembly voted against the measure.

“This program was created to take advantage of the burgeoning knowledge economy that has so much potential, particularly involving graduates of Brown and (the Rhode Island School of Design),” said Larry Berman, press secretary for House Speaker Gordon Fox, D-Providence.

“The way it was packaged was that it would enable small entrepreneurs to share in the ability to create new companies that would help to employ unemployed Rhode Islanders,” said Senator Rhoda Perry P’91, D-Providence. “Why wouldn’t someone vote for that?”

In August, two months after the loan program was passed, 38 Studios received $75 million of the $125 million allotted to the program. Only two other companies – the Corporate Marketplace and NuLabel – received loans, totaling $5.5 million, stemming from the Job Creation Guarantee Program.  

Had she known that the majority of the funds from the loan program would go to one company, Perry said she most likely would not have voted for the legislation.  

Rep. Robert Watson, R-East Greenwich and West Greenwich, was the only legislator who opposed the loan program. The program was too loosely concocted to gain his support, he said. He added that it seemed there were details and dealings being held from the general public.

“Democratic leadership in the legislature conspired with the governor’s office to withhold information from the rank-and-file legislators when they sought approval for this deal,” Watson said. “Had the full facts been put before the legislature before the vote, I probably would have had more company in opposition.”

Fox has repeatedly defended the loan program, despite the failure of 38 Studios. In a press conference, he stated he would support similar legislation again.

Berman emphasized that the General Assembly was not involved in the 38 Studios deal, which was approved by RIEDC. “As Speaker Fox has said, the General Assembly provided the tools, but it was the EDC that built the house,” he said.


RIEDC and the executives

RIEDC aims to support the state economy and facilitate the business community in achieving all possible success, according to its website. Meant to serve as a mediator between residents, the state government and the private sector, RIEDC is chaired by the governor and an appointed board. In 2010, then-Gov. Donald Carcieri ’65 appointed Keith Stokes, a strong proponent of the 38 Studios deal, as director of the board. That March, both Carcieri and Stokes met with Schilling to begin investment procedures.

“Leaders and businesspeople were desperate for the win,” said Maureen Moakley, professor of political science at the University of Rhode Island. “Even though this was a risky investment, they were willing to take this risk because the payoff would be great. It would have been a big win.” 

And a big win was just what Carcieri was seeking, Watson said. “Don Carcieri had a meager legacy to brag about, and he wanted a quick-fix solution to that dilemma,” he noted. “He saw in this one risky move a chance to brag about bringing jobs and business to Rhode Island  – something he hadn’t done in his previous seven years.” The deal with 38 Studios came at the very end of Carcieri’s second term in office. 

Carcieri had held a reputation as the “CEO Governor,” which stemmed from his past experience working in the private sector as a high-ranking executive at Old Stone Bank and Cookson Group.

“These were sophisticated and accomplished businessmen,” Moakley said. “I would assume they understood the risk. It’s not like you had four legislators from Johnston saying ‘Gee! What a good idea!'”

The loan ag
reement was structured with the main purpose of bringing jobs to the state and set a variety of benchmarks for the company. In order to receive the full loan, the company was required to bring approximately 400 new jobs into the state. By November 2011, WPRI reported, the company had received almost $50 million for the relocation of the company to its new Providence headquarters and for the addition of 250 jobs with annual average salaries of $67,500 or greater.

But the loan was not awarded without opposition. In August 2010, RIEDC and 38 Studios received harsh criticism from then-gubernatorial candidate Lincoln Chafee ’75 P’14.

“The state was putting a lot of eggs in one basket,” said Christine Hunsinger, Chafee’s press secretary. “It was not being fiscally disciplined or fiscally smart.”

The probability of Chafee suceeding Carcieri as governor was fairly strong in August 2010, which put pressure on Carcieri and RIEDC to push through the loan without carefully reviewing the company’s finances, Moakley said.

That month, Chafee requested a meeting with the RIEDC board to express his concerns about the 38 Studios loan. Carcieri blocked the request, assuring Chafee that the “loan guarantee was carefully considered over several months with extensive due diligence by the board,” which was composed of “12 of this state’s most successful business leaders,” according to a public letter.

In April 2011, four months into Chafee’s first term, the loan program was revised to include a cap on all future loans of $10 million.

RIEDC has denied all requests to comment on the 38 Studios loan scandal.


Take the money and run

After 38 Studios moved to Providence in April 2011, the company continued its aggressive hiring initiative, bringing in hundreds of new employees to meet RIEDC guidelines. Financial records show the company was spending tens of millions of dollars each month, despite a lack of product revenue.

That same year NuLabel – a start-up tech firm manufacturing self-adhesive labeling founded by Brown alums Ben Lux ’09, Max Winograd ’09 and Mike Woods ’09 – received a $1.5 million loan from the RIEDC as a part of the Job Creation Guarantee Program. NuLabel committed to bringing 49 new jobs to the state as it grew in Providence in return for the money.

The loan has helped the company plan for the future, Winograd said. But a year after the loan was awarded, NuLabel has not needed to tap into any of the funds it received from the state, he added.

When 38 Studios turned to RIEDC for a loan, the company had been turned down by numerous investors, including the state of Massachusetts. 

But NuLabel was required gain private capital before receiving a loan guarantee from the state, Winograd said. “This provides an added assurance to the state that there is other money from other investors coming into the company.”

Winograd said that NuLabel’s founders also put up “personal guarantees” for the loan to ensure RIEDC that “people’s dollars were committed to turning into more dollars.”

The Corporate Marketplace received the third and last loan from the Job Creation Guarantee Program. RIEDC describes the company as a “success story” on their website, and CEO Chris Crawford told WPRI that the company is growing at a rate of 40 percent each month and is expecting tens of millions in revenue this year thanks to the assistance it received from RIEDC.

“By promoting the knowledge economy, it is helping the overall state of employment in Rhode Island,” Winograd said. “The more people we can attract into the knowledge economy, the greater the effect onto the larger economy.”

State politicians have been pushing the Knowledge Economy initiative for years, and RIEDC had been loaning funds to small businesses for even longer.

Charlie Kroll ’01, founder and CEO of Andera – an online account-opening tool for banks that has grown to serve over 500 financial institutions – received a startup loan from RIEDC in the early 2000s. Andera could not be where it is today without assistance from sources like RIEDC, Kroll said.

Kroll described the 38 Studios scandal as an aberration, noting that most companies that receive assistance from RIEDC maintain financial stability.

 “It was surprising that they allowed themselves to run out of cash without cutting any expenses beforehand,” Kroll said. “You would expect that if the company is running out of money, they would cut costs before that happens.”


End of the Line

38 Studios released its first and only game – “Kingdoms of Amalur: Reckoning” – in February to mixed reviews. The company never set an official release date for Copernicus. 

The company’s bankruptcy filing was moved from Delaware – where it was originally incorporated – to Rhode Island last month at the request of RIEDC, the company’s largest creditor, where it is likely to reach a more favorable settlement.

The studio owes contractors and employees millions in payroll, but the taxpayers in Rhode Island will be responsible for the majority of the company’s $150 million of debt, as reports suggest that the 2010 loan has ballooned to $120 million of value due to interest taken out on bonds.

Moakley said that while taxpayers will be paying a significant portion of the company’s debt, it is likely that negotiations will reduce the strain on taxpayers.

The scandal is expected to increase voter confidence in Chafee, Moakley said. Rhode Islanders understand the role that Carcieri, Fox and others played in the misuse of taxpayer funds, but they also understand that Chafee foresaw the company’s failure, she added. 

Chafee accepted Stokes’ resignation in May during the initial backlash from the scandal. The governor’s office has now requested an outside analysis of RIEDC and is looking to move forward from the scandal, Hunsinger said.

“Clearly, we won’t have any big blockbusters for a long time,” Kroll said. “It could end up being a good thing, though, if it influences policymakers to make a lot of smaller investments into startups instead of a few big investments in riskier companies.” 

As companies like the Corporate Marketplace and NuLabel grow, Winograd said he hopes they will send a ripple effect through the community. Initiatives like Betaspring are working to help start-ups find their footing in the state, hinting at the larger trend toward small tech firms in the state’s business climate.

“Everyone gets that we’re not going to just be able to weather the storm. We’re going to need to change the rules of the game and really try to change the economy here,” Winograd said.

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  1. This, along with all news reports, and statements from the governor and lawyers involved, insist the taxpayers will bear the expense. From everything I’ve seen, The RIEDC (read Rhode Island) may elect NOT to honor the “moral” obligation. But I imagine it reads better to say all those involved are doing it for the taxpayers instead of for the Mellon Bank of New York, who presently stand to lose. I don’t understand how the State of Rhode Island stands first in secured loans when they may yet refuse to honor obligations.

  2. It’s reached a point where people, particularly Rhode Islanders, have become accustomed to this kind of shoddiness. Missing from this excellent piece was the fact that Governor Carcieri was cited four times for violations by the state’s own Ethics Commission.
    One hundred and twenty-five million, and all squandered supposedly for the perception of a legacy?
    Oh, OK, I can go with that.

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