Crony capitalism is the pretend version of capitalism when you gain sales or market access or funding because you can get favors from government instead of having a product that the market wants and finds appealing. 

Success through favors instead of superior products.

Today’s illustration is from a failed video game company, 38 Studios, founded by a former Red Sox pitcher.  Anthony Fisher has the story – 38 Studios:  Curt Schilling’s Crony Capitalism Debacle.

The pitcher put in millions of his money but needed another $50M.

The venture capitalists are the usual source for that funding. They said no.  One investor is quoted as saying

“it would have taken a lot of babysitting to do a deal with Schilling because he was inexperienced and the management was inexperienced.”

Borrowing $50M with no experience in the market you are moving into. Not a good formula for success.

The pitcher sought funding from the state of Massachusetts, who said no.

Then the governor of Rhode Island stepped it. He wanted to fund the company, so he pushed through approval from the state development outfit and pushed $75M funding though the state legislature in 2010.  The funding was in the form of a loan guarantee, which means the private company can borrow money with the state guaranteeing that the lender gets paid back if the company goes under.

Notice the perceptive comment from one legislator:

Each loan guarantee must be approved by the Rhode Island legislature, and when the votes were cast in 2010, only one lawmaker voted against it. Rep. Bob Watson (R-Greenwich) noted “a lot of red flags” in a “very risky” deal that was “too fast, too loose, and frankly, a scandal waiting to happen.” Watson added “more often than not, politicians are very poor when it comes to making business decisions.”

By May 2012, their burn rate was $5M a month with more than a year before hitting the market, according to the article.

That’s obviously unsustainable.  A new governor said no to more funding.  The article says the company ran out of money in May 2012 and shortly thereafter laid off all their staff.

Now the state has to make good on the $75M loan. Only with interest compounding,

…the already economically depressed state of Rhode Island, thanks to the interest on the 38 Studios loan, is now on the hook for more than $100 million.

So, the state of Rhode Island put $100M of taxpayer money on the line for a brand new startup with minimal experience who wanted to get into the extremely competitive video game market of multi-player on-line games after the lending market (i.e. venture capitalists) decided it wouldn’t work.  The state took a bath on their loan.

Crony capitalism at work.

Remember that money quote:

“more often than not, politicians are very poor when it comes to making business decisions.”


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