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October 31, 2008

Shareholder discussion: Deferred Bank Executive Bonuses

OK, we're all shareholders now in some large banks (through the US Treasury investment).  As a shareholder, what do you think of the article in today's Wall Street Journal (subscription required, excerpts below) on the more than $40B owed to executives at these banks for prior years pay and pensions?

The article opens with:

Financial giants getting injections of federal cash owed their executives more than $40 billion for past years' pay and pensions as of the end of 2007, a Wall Street Journal analysis shows.

The government is seeking to rein in executive pay at banks getting federal money, and a leading congressman and a state official have demanded that some of them make clear how much they intend to pay in bonuses this year.

But overlooked in these efforts is the total size of debts that financial firms receiving taxpayer assistance previously incurred to their executives, which at some firms exceed what they owe in pensions to their entire work forces.

The sums are mostly for special executive pensions and deferred compensation, including bonuses, for prior years. Because the liabilities include stock, they are subject to market fluctuation. Given the stock-market decline of this year, some may have fallen substantially.

Some examples: $11.8 billion at Goldman Sachs Group Inc., $8.5 billion at J.P. Morgan Chase & Co., and $10 billion to $12 billion at Morgan Stanley.

Few firms report the size of these debts to their executives. (Goldman is an exception.) In most cases, the Journal calculated them by extrapolating from figures that the firms do have to disclose.

Most firms haven't set aside cash or stock for these IOUs. They are a drag on current earnings and when the executives depart, employers have to pay them out of corporate coffers.

The practice of incurring corporate IOUs for executives' pensions and past pay is perfectly legal and is common in big business, not limited to financial firms. But liabilities grew especially high in the financial industry, with its tradition of lavish pay.

Deferring compensation appeals both to employers, which save cash in the near term, and to executives, who delay taxes and see their deferred-pay accounts grow, sometimes aided by matching contributions. In some cases, firms give top executives high guaranteed returns on these accounts.

The liabilities are an essentially hidden obligation. Even when the debts to their executives total in the billions, most companies lump them into "other liabilities"; only a few then identify amounts attributable to deferred pay.

The article describes how they estimated these amounts and that sources confirmed their calculations (but not on the record).  These are big numbers, but they aren't all payable in one year.  However, the obligations seem to be generally unfunded on the banks balance sheet, unlike their 'rank and file' pension obligations:

Obligations for executive pay are large for a number of reasons. Even as companies have complained about the cost of retiree benefits, they have been awarding larger pay and pensions to executives. At Goldman, for example, the $11.8 billion obligation primarily for deferred executive compensation dwarfed the liability for its broad-based pension plan for all employees. That was just $399 million, and fully funded with set-aside assets.

The deferred-compensation programs for executives are like 401(k) plans on steroids. They create hypothetical "accounts" into which executives can defer salaries, bonuses and restricted stock awards. For top officers, employers often enhance the deferred pay with matching contributions, and even assign an interest rate at which the hypothetical account grows.

Often, it is a generous rate. At Freddie Mac, executives earned 9.25% on their deferred-pay accounts in 2007, regulatory filings show -- a better deal than regular employees of the mortgage buyer could get in a 401(k). Since all this money is tax-deferred, the Treasury, and by extension the U.S. taxpayer, subsidizes the accounts.

Although the banks who have taken the US Treasury investment have agreed to limit executive golden parachutes in the future and have lowering the deductibility of high executive salaries, none of these rules apply to past obligations.  So, fellow shareholders, do you want your money being used to pay these past obligations that aren't reflected on the balance sheets of these banks?  I don't.

I think we (ok, Congress) should order the companies to put a moratorium on any deferred compensation payments to executives while the US Treasury is a shareholder.  They should also be forced to reflect these obligations on their balance sheets, lowering their short term profitability.  Of course, they are also welcome to renegotiate these obligations in order to lower them in the future.

Once the US Treasury is no longer a shareholder, their Boards can decide what to do with this deferred compensation.  But, in no way should they be able to avoid reflecting the costs of these deferred compensation plans on their balance sheets.  And, accounting rules should be clarified to make sure that they are required to disclose this in the future.

I've got no problem with high executive compensation, particularly for a company which performs well.  But, in public companies, that compensation needs to be clearly disclosed, including any deferred commitments.  If it can stand public and shareholder scrutiny, it's OK with me.

Sports recap

Although I am a huge sports fan, I haven't written much about sports lately.  Politics and the economic meltdown have dominated my thinking.  So, here's my recap on the sports I pay attention to:

Baseball -- When my Yankees were out of it, I paid much less attention.  The Yankees were the fourth best team in the American League this year, after the Rays, Red Sox, and Angels.  Unfortunately, that left them third in their division and out of the playoffs.  Given all their injuries, I thought that the Yankees fared pretty well.  But, I continue to want them to turn over their roster and focus on younger players.  They have a lot of young talent, particularly pitching.  They also have a lot of big salaries coming off of their books.  I expect them to be big players in the free agent market, which is fine as long as they are signing players in their prime and not those on the way down.  I was rooting for the Rays in the World Series as I thought they were a great story.  But, I wasn't watching.

Football -- To me, the Patriots got much more interesting when Tom Brady went down.  With his and other injuries (Laurence Maroney, Rodney Harrison, all the running backs), the fact that they are contending for a playoff spot is remarkable.  I do expect them to have some ups and downs throughout the rest of the season, but every game is a challenge.  Compared to past years where you expected them to win just about every game, this year is harder to predict.  They've played incredibly well (Denver) and horribly (Miami).  Interestingly, other AFC powers like Indianapolis and San Diego (who whipped the Patriots) are also struggling.  This week's game at Indianapolis will be interesting.  The Colts really can't afford to lose another game as they are only playing for the Wild Card at this point (unless the Titans collapse).  The Patriots defense and running game needs to keep the game close as the Pats aren't good at playing catch up.  Overall, I think that the Patriots will make the playoffs but won't advance too far.  Given the injuries, that would be a very good outcome.

Basketball -- The Celtics look primed for another great year.  Barring injuries, they should be even better than last year.  Their Big 3 have a year of playing together under their belt.  I expect Ray Allen to be a bigger contributor on offense as he was in the second half of the playoffs last year.  Their young players (Rondo, Perkins, Powe, Davis, Pruitt) should all be improved.  If Tony Allen keeps playing the way he did in 2007 before he got hurt, he'll make up for the loss of James Posey.  When the starters played in the preseason, they looked excellent.  They had a slow start against Cleveland in their opening game, probably due to the emotion of their championship ring ceremony.  They showed how well they can play by holding Cleveland to 35 points in the second half.  As long as they remain committed to defense, they'll be fine.  It's hard to predict a champion this early in the season, but they have to be one of the favorites.

Go Pats!  And, Go Celtics!

October 29, 2008

We got flocked!

Some friends of ours "flocked" our house recently as part of a fund raiser for the Bedford project of Habitat for Humanity.  They paid to have Habitat deploy a flock of pink flamingos on our front lawn for a few days.  That, of course, motivates us to pay to have flocks set up on some of our other friends' lawns.  It was done anonymously, but we have our suspicions.

This is a great idea for a viral fund raiser.  It's visible (but mysterious) to our neighbors, and certainly had us guessing as to who decided to target us.  We'll get our revenge by passing it on to others, all for the good cause of affordable housing in our town.

There's nothing on the web site that describes how you can get in on the flocking.  But, you may want to contact them via email if you'd like to flock some people you know to support Habitat for Humanity.

October 22, 2008

Can't we remove the labels?

I'm so tired of the brash labeling that has been going on in the Presidential race.  I think that this type of thing is one reason why we all get so tired of the long election cycle.  Real debates of the issues would be worth having, even over a long cycle.  But, the labeling is very divisive.  One thing I really want to see happen is the country come together to solve our problems.  Divisive labeling defeats that purpose.

Does anyone really believe that Barack Obama is a terrorist because he knows Bill Ayers?  There is no doubt that their paths crossed, but only 30 years after Ayers bombed anything.  I'm not defending Ayers's tactics in the 60s, but he had obviously cleaned up his act enough for the Annenbergs.  This issue is only being harped upon to get the words Obama and terrorist in the same sentence.

Although she apologized for it, why would Sarah Palin suggest that some parts of the country are more 'pro-America' than others?  That sentiment wasn't an isolated mistake.  One of McCain's aides also talked about Virginia vs. 'real Virginia.'  Do you really think that there are any parts of this country that aren't 'real' Americans or 'pro-America?  Can anyone say that Obama isn't pro-America?

Most recently there is the socialist label.  You may not agree with Obama's tax plan.  You may not like that he's going to raise taxes on higher wage earners in order to lower taxes and refund payroll taxes for lower wage earners.  But, that's a shift in the progressive tax scheme, not socialism.  I don't think anyone in power in Washington is a socialist, even those reluctantly having the US government buy stakes in our troubled financial institutions.

I realize that these are all labels thrown out by the McCain campaign.  I'd be happy to respond to labels tossed out by Obama if people can point them out in the comments.

For a humorous view of the label game, check out last night's Daily Show (and here)



If you share my concern about the government's involvement with our private sector as part of the economic bailout, you should read BailoutSleuth.com.  This is a site that is paid for by Mark Cuban.  Mark is a true maverick since he owns the Dallas Mavericks basketball team.  He also owns the HDNet TV network and was the founder of Broadcast.com, sold to Yahoo for more than $2B during the bubble.

As you can see in the October 17th post on BailoutSleuth, the financial details of what the government is paying Mellon for their role in managing the bailout has been redacted.  This isn't national security, folks.  This is a government contract.  We know how much military contractors charge us for weapons, but we can't find out what we're paying the contractors for the bailout?  In today's post on BailoutSleuth, there are portions of the contracts with PriceWaterhouseCoopers and Ernst & Young that have been redacted.

No matter who wins on November 4th, I hope we get back to a more open and transparent government.  Kudos to Mark Cuban for keeping the focus on how we're spending one of the largest piles of our tax dollars.

Update: I updated this post after publishing it initially to clarify what is referenced from bailoutsleuth.com

October 20, 2008

Median is worse than mediocre

Today's VentureBeat had an article pointing out that the uptick in some of the macroeconomic factors won't translate quickly into an uptick in the venture capital economy.  Of course, there are some links between the overall economy and the VC world:

  • Late stage investors are heavily influenced by the public stock markets.  They have to calibrate the higher valuations they pay with the exit timing and ultimate exit valuation that the company will earn.  This applies to companies going public (not any time soon) or companies being acquired.  Public acquirers obviously worry about their own stock price when determining what they can pay for an acquired company.
  • Buyout firms are like late stage investors, but also tend to finance a significant portion of their deals with debt.  Obviously, the debt market is incredibly tight these days.  Not much of this type of deal activity here, although you may see some debt free deals such as small public companies going private to avoid the cost of being public while they regroup.
  • Early stage VCs shouldn't worry about the public market too much.  The deals they do now won't exit for 5-8 years.  Who can predict the exit environment then?  Early stage VCs should worry mostly about uniqueness of the opportunity, target market size, team strength, and capital efficiency.  However, early stage VCs also tend to get skittish during these times.

The most interesting statistic in the VentureBeat article is in the following:

But most venture capitalists will remain under considerable strain. Even when they invested during the last down cycle of 2002 and 2003 — when valuations were lower, letting them get a larger ownership stake in companies they backed — VCs didn’t do well. The median internal rate of return (IRR) for a 2002 vintage VC fund (a fund that began investing in 2002, when the stock market was rock bottom) is -1.2%, according to PE Wire, citing Thomson Reuters data. That means they’ve lost the equivalent of 1.2 percent every year over the past six years, even though VCs have had about that long to grow the companies. With the market turning downward now, it’s unlikely that number will increase significantly, as firms may have a tough time selling companies and locking into profits.

The median IRR for a 2003 vintage VC fund is 0.9 percent.

These performances are worse than many expected. The question is whether VCs will do as poorly with their 2009 funds. Uncertainty about this will only cloud the outlook for startups going forward.

The problem here isn't that a down cycle is the wrong time for an early stage investment.  In fact, I think that it is the best time as many investors are on the sidelines, lowering the competition for the new company.  However, I think that the reason why the median returns for these funds is so low is that there are just too many venture funds with too much money to invest.  By the time you get down to the median fund, you are much closer to the bottom of the barrel than you would like to be.  If the current top quartile of venture funds were all that existed, the category would look pretty strong.  So, that means that VCs will only be able to deliver the returns that their investors expect if the number of funds is cut by 75% and the amount of capital by about 60% (many of the top funds are also larger than the average).

LPs who invest in venture funds have figured this out, but the exodus from venture is slow.  And, there are many more LPs who have been waiting to get into the category who may be propping up funds that should otherwise be going away.  Over time, venture can only be a healty category if it takes a haircut just like the Dow Jones Industrials have.  Unfortunately, I don't see that happening any time soon.

PS - This is one reason why my new fund will be doing something different than traditional venture capital.

Update - Just after publishing this, I found this report from Silicon Valley Bank that includes lots of details on venture fund performance on page 9.  See the table below from the report that shows that even the top quartile VC fund hasn't done extremely well lately.

October 13, 2008

In the Globe again

In today's Globe, Scott Kirsner was nice enough to quote The Fein Line again, this time on my response to McCain's plan to bail out homeowners and mortgage lenders by repurchasing mortgages that are under water.

The quote in the paper focuses on my criticism of McCain's plan because it really gets the lender off the hook as well as the homeowner.  I also proposed some solutions that would require the lender to write down the mortgage and provide them some incentive to restructure the terms of the loan to make it more affordable for the homeowner.  I think that any resolution to this problem is going to be incredibly complicated due to the varying terms of home mortgages and each person's situation.  Should you treat the homeowner who saved up to buy the nicer house that they couldn't really afford and sacrificed right and left to make the payments the same way you treat the person who mortgaged their house to the hilt in order to buy a fancier car and take a nice vacation?  Both homeowners are in over their head, but I've got more sympathy for the former.  Who is going to decide which ones get help?

Fundamentally, I have a problem helping out companies who knew that they were taking inordinate risks just because the market let them.  And, I have a problem with homeowners who bought a house (or refinanced to the hilt) because they could and not because they could really afford it.  The majority of us live within our means (I hope!) and shouldn't have to bail out those who didn't.  We need to rescue our economy and the credit market, not the risk takers and profligate spenders.  These aren't just Wall Street fat cats.  They could also be your neighbor who spent way beyond their means, fueled by easy mortgage lending.

Over the weekend I learned of a friend of mine who is a small business owner (not high tech) who got in way over his head.  Fundamentally, he had two problems:  1) He expanded too quickly without getting to profitability first and 2) he had raised money from friends and family and could not face telling them that he was struggling.  So, he kept up the appearance of success as long as he could, which only led to him digging a deeper hole.  There is nothing wrong with dreaming big, but that shouldn't mean building a bigger house of cards.  Instead, focus on getting the foundation solid and building from there.

October 11, 2008

Focus on what really matters

My political biases may be clear to those who read this blog, but I have to admire John McCain for resisting the temptation to roll in the muck with many of his supporters.  "I have to tell you he is a decent person and a person that you do not have to be scared of as president of the United States," McCain said of Obama, much to the consternation of some of his supporters.

I can understand people who want to vote for McCain because they think he will be more fiscally responsible than Barack Obama, or who feel he will do a better job in foreign policy.  I don't necessarily agree, but those are principled positions.  However, when Republican supporters are whipped into a frenzy because they think Obama is an 'Arab', or commits 'treason' or is a 'terrorist', they're just stupid.  I don't like McCain's positions, but I acknowledge that he is patriotic and is advocating what he thinks is the right path.  I'm glad that he's willing to acknowledge the same about Obama.

I think that most Americans are exhausted from the partisan rancor.  We need legitimate discussions of how to deal with all the big issues we face, including the loss of the world's confidence in America.  I think that the best solutions are those that include elements from both sides of the aisle.  With the hatred of the opponent so high, it makes compromise difficult.

When McCain's supporters exhort him to 'take off the gloves', why does that have to be character assassination?  Why can't he rally support around his own proposals and discredit Obama's (without lying, of course)?  If his proposals can't win on their merits, then McCain doesn't deserve to win, either.  And, I feel exactly the same way about Obama.

October 10, 2008

Our 'Sponsors'

I don't have or need sponsors for this blog.  I don't have any ads or generate any revenue.  And, I don't have any real costs, either.

Nevertheless, while starting up a new firm, it's great to get help from others.  I want to recognize three of our partners who have been incredibly helpful.  All of them would be great for any new business to work with.

Our office is at the Emerging Enterprise Center of Foley Hoag.  Foley Hoag is our law firm, and we've had incredible support from Bruce Kinn on fund formation, Dave Broadwin as our 'landlord' and expert on small public companies, and John Patterson as our overall sponsor.  In addition, the whole team at the Emerging Enterprise Center has been very supportive, treating us as part of the company.  If you are an entrepreneur and can convince Foley Hoag to host you at the EEC in Waltham, you'll be well taken care of.

Our firm is investigating opportunities in the public markets.  As you can imagine, we do a lot of research on public companies.  Although you can find a lot of this information in free public sources, you can't be productive in this endeavor without a real tool that automates and organizes this research.  CapitalIQ is a fantastic tool for mining data on public companies.  And, our account team has been very supportive during our start-up phase.  In addition, Capital IQ has incredible support -- fast, helpful, and willing to do some custom work on our behalf.  If you have a company that needs to research public companies, you need Capital IQ.

If you clicked through to our sparse website, you got a glimpse of the design work done by Rebecca Fagan of Fagan Design.  We love the work that Rebecca has done on our logo, web site design, business cards, letterhead, and marketing materials.  She's been very easy to work with, gets things done quickly, and meets her commitments.  If you need design projects done, you can't go wrong with Rebecca.

Thanks to all of you for your support of Sempre Management!

All In A Day's Work

My friend Angelo Santinelli has started a new blog called All In A Day's Work.  He's focusing on issues that entrepreneurs and small businesses face in today's challenging business environment.

Angelo has always been someone to focus on the reality of the situation and not on the emotion.  Read some of his recent posts for his thoughts on what entrepreneurs should be doing in light of the current economic crisis.

October 08, 2008

Please make this ride stop

This is like one of the roller coasters I love.

Slippery Slope

At last night's Presidential Debate, John McCain said that he would order the Treasury Department to purchase up to $300B of consumer mortgages at the original value of the mortgage and renegotiate them down to the new diminished value of the home.  The idea is to get people into a loan they can afford so they don't lose their house.  It sounds like a nice idea to help out homeowners, but I think that it is an incredibly slippery and expensive slope.

First of all, the taxpayer will be taking the loss on all of these mortgages.  That seems like one of the biggest government handouts ever.  Secondly, this loan will bail out banks who overextended credit, falsified appraisals to inflate home values, or engaged in other practices to over-mortgage properties.  These banks will be made whole.

However, the most complicated part is bailout out the homeowners who over-mortgaged their property and spent the money on something else.  There are plenty of people who mortgage their homes to the hilt and spent the money on new cars, vacations, etc.  This was encouraged by banks.  Now, the taxpayer is going to pay for this profligate spending.  And, McCain calls Obama a liberal!

The worst is that this rewards all the people who took advantage of the easy credit at the expense of those people who lived conservatively and didn't end up in trouble.

I'd prefer a program where the level of debt that the homeowner owes isn't reduced.  Perhaps some level of debt has to be moved to a soft second mortgage that is only paid out when the property is sold (or is possibly forgiven if the homeowner stays in their home and pays their mortgage for 10 years).  Mortgages will be restructured so that homeowners are given 'prime' terms even if they are subprime borrowers (30 year fixed rate mortgages only).  The banks will have to take a write-down for the diminished value of the loan, but that will be cheaper than doing a foreclosure.  And, perhaps, the government can provide some sort of tax credit proportional to the value of the writedown that a bank does to encourage this and soften the blow.

Homeowners who can't afford their mortgage even with the terms above should be required to pay whatever they can towards a restructured 'prime' mortage in order to get a six-month moratorium on foreclosure.  This gives them time to move to something they can afford.  It keeps some cash flowing to the lender during the foreclosure process, softening the loss from the foreclosure.  A tax credit for restructuring the loan as described above is also a possibility.

I prefer this type of approach because the homeowner doesn't get to wriggle out of their responsibilities.  I think that the very large majority of homeowners subjec to foreclosure knew that they were borrowing more money than they could afford.  Shame on the banks for making this loan available, but shame on the homeowner for getting in over their head.  This approach also limits some of the losses of the banks, but the banks will certainly take some losses (somewhat offset by some tax credits).

Minimizing foreclosures will help the banks financial situations and will help stop the drop in home prices from foreclosed homes flooding the market.  There are probably still many challenges with this approach as the restructured loans are securitized and may be difficult to change.  Part of the government rule would be allow these changes to happen without making the banks liable for changing the terms of the loans.

We have to do everything we can to make sure the money we spend during this time bails out the economy, not the individuals or companies who took advantage of the easy credit environment.  Individuals and companies can survive, but they'll have to give up a lot financially in order to do so.  Unfortunately, I don't know how we can reclaim the profits and bonuses that were legally made during the runup before this crisis.

October 04, 2008

Peace, Love and Understanding

Can't get this song out of my head today.  The sentiment is as great now as when the song first came out in the 1970s.


October 01, 2008

No Matter What, You Gotta Vote

Time is running out to register to vote.  In Massachusetts, you have to be registered by October 15.  In New Hampshire, you can register on Election Day (great!).  With all of the things going on in the world today, this election is certain to be extremely important.  No matter where you come out on the issues, please be sure to register and to vote.  Google has a nice site with voter information here.

So many people decide not to vote for many reasons (apathy, laziness, busy schedule, etc.).  With more and more states offering absentee and early voting options, your schedule on November 4 isn't a viable excuse.  Please be sure to register and vote, and get your friends to do so, too!

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