The Law and Other Anomalies

Two pending cases in the United States Supreme Court, to be decided by the end of this June, involve issues of racial justice.

One case challenges the affirmative action plan for admissions at the University of Texas.  Many lawyers thought that several years ago a five-to-four Supreme Court decision upholding the University of Michigan admission plan resolved all these kinds of cases.  Apparently not.

The Michigan plan, approved by the Court, stated that universities could utilize race as one factor, although not the determinative, in establishing standards for admission.  The justification was that the university had a legitimate interest in creating a diversified student body, believing that such diversity created a better educational experience.

The University of Texas had in effect a “top 10% rule” which automatically admitted to its Austin Campus the top 10% of graduates in all Texas public high schools.  Since many Texas high schools werede facto racially segregated, this resulted in substantial student body diversity.  Texas now was intending to graft on top of its 10% rule a provision, affecting the recruiting of the balance of its entering class, using the Michigan system (race being one but not the only factor).

The case may even be thrown out; the plaintiff, a white student claiming she was discriminated against, has already graduated from another college and the only remedy she is seeking is the return of her application fee (a fee which the University of Texas never refunds in any case, whether or not an applicant is admitted or denied admission for any reason whatsoever).

The second case, Shelby County against (United States Attorney General) Holder, involves Section 5 of the 1965 Voting Rights Act, which identifies certain states as having bad racial history.  Any change in the voting laws of those listed states cannot be given effect unless the United States Department of Justice approves.  The Congress has five times extended the Act but has never once amended the list of states which are subject to this mandatory review.  The plaintiffs argue with some cogency: is it really possible that in the last forty- plus years, since the enactment of the original Voting Rights law, there has been no change whatsoever in any of the states subject to this pre-clearance procedure?

Does not a failure to make specific findings on a state- by- state basis, identifying anew those states which still require such scrutiny, prove that Congress is simply renewing the statute without a rational federal interest which would justify intrusion into state election laws?

How do you turn around a large company?  According to Mohamad Ali, Chief Strategy Officer at Hewlett Packard, by first attacking costs and then strategically reinvesting the enhanced cash flow in profitable product initiatives.  You also divest your extraneous parts, but you do that over a long period of time.

Ali, who has spent many years in strategic planning at IBM, told a breakfast meeting of the Boston Chapter of the Association for Corporate Growth some war stories about the crises faced by IBM in the ‘90s and into the 2000s.

Ali has worked at several companies doing the same thing: guiding them through corporate transformations.  It is not surprising that all these companies are in some phase of computer technology; aside from being Ali’s substantive sweet spot, computer-related companies have faced a constant need for transformation, as technological and consumer changes occur often and are abrupt in this space.

Ali has a “transformation playbook” which has some simple sequential steps. The first always is: “take cost out of the system.”  That gives you cash and if you don’t have cash, you have no flexibility for products, sales or M&A.  You also have to take a look at governance structure to make sure that that structure matches the new configuration of your businesses.

This transformation playbook apparently is in use today at HP.  Having gone through four CEOs in four years, and having purchasing Palm and other companies without measurable affirmative effect, HP did attack cost and has been working on products in markets that it missed historically, including tablets.

We are early in the HP “transformation” and Ali is of course optimistic as to the ultimate results, speaking glowingly of product innovations.  It remains to be seen whether HP’s “transformation playbook” will produce any silver lining.

It seems that the Rolling Stones will roll into Boston Garden this June.  Balcony seats are far north of $400 each; floor seats are officially priced at $600 but if you go on line you will see single seats (not even in a suite) priced up to $5,900.  But don’t blame TD Garden; they are the venue, but the tour promoters fix the price.

At the April 11^th breakfast meeting of Association for Corporate Growth/Boston, TD Garden President Amy Latimer attempted to share some of the background of TD Garden as a business.

Ticket prices for all events, whether the Bruins or the Celtics or the Circus or the twenty-five or so concerts that play the Garden each year, are fixed by, and paid over to, the teams or promoters.  It seems that TD Garden makes its money out of a rental of the Garden, and its ownership of the food services.  Aside from employees having to work very long and odd hours (most events go into the night and are typically attended by much of the staff), TD Garden sounds much like any other large business: their departments include HR, legal, sales and marketing.  Indeed, Latimer advises that TD Garden is very much like any business but with a couple of exceptions:

• “We do not control our product” which is to say they receive a quixotic mix of concerts and cannot guaranty the quality of the athletic contests; and
• Much of their schedule is filled at the last minute, which requires flexibility in every part of the organization, but particularly marketing and ticket sales.

Changes for the future at TD Garden?

• They are moving toward “variable pricing” which is to say that tickets will be priced not only based on location but also on the quality of the team being played, the day of the week, etc.
• Printed tickets will be a thing of the past; admission will be by identity card with bar code, and if you provide a code to a client as your guest, you will also be able to “load” value into the card so that you can treat your guest to food and merchandise without being present.
• After an almost twenty year delay, TD Garden claims to be moving forward on the development of the open parking lot in front of the Garden, planning office space, a hotel, perhaps a grocery, and a new front door to enter the Garden (the currently used side doors, shared with commuters, were originally conceptualized as only serving the train station).
• TD Garden is working like crazy to install not only cell phone service but also WiFi capability.  Among other things, that capability will drive a variety of apps including replays, food ordering for delivery to your seats, and merchandise ordering.

According to a recent McKinsey survey of 1,600 corporate directors, only 20% said they fully understood the strategy of the company upon whose board they sat.  Perhaps not surprising, as only 10% said they had a full understanding of the industry in which that company competed.

What are the techniques that will permit boards to engage strategy, rather than spending their time on compliance?  This question was explored by a panel at the April 9^th Breakfast Meeting of the New England Chapter, National Association of Corporate Directors.

The panel (moderated by Willow Shire, independent director at TJX) included Jeffrey Naylor (Senior Executive VP at TJX), serial entrepreneur and angel investor Jean Hammond, and McKinsey director Jack Welch; they suggested:

• Educate yourself about your industry and company; this requires a CEO who will “let you in” sufficiently to get what you need.
• Regularly schedule board time to discuss broader trends; many boards feel restricted to passing upon strategic implementation rather than being able to discuss overall strategy.
• Push compliance issues down to committees to free up time for strategic discussion.
• Discuss long term strategies at retreats where there is less pressure.
• Reduce slides in management presentations; avoid “death by power point” and replace it with discussion.
• Define “strategic” as matters likely to have at least a 10% positive or negative impact on “corporate value.”
• Identify strategic subsets so as to create focus; examples include technology, competition, social trends, demographics.
• At executive session after a meeting wherein strategy was discussed, ask: how did that meeting go?

There was general consensus that strategy is first proposed by management.  Boards heavy on CEO membership must be careful not to forget.  But asking thoughtful questions can drive the strategic discussion.

And finally, remember that the literature suggests that diverse boards make better decisions.

Three leading Boston-based venture capitalists told an audience at the monthly Association for Corporate Growth Breakfast yesterday that even though the number of venture capital funds are shrinking, there’s still too much money out in the market-place.  Additionally, significant alternate sources of financing, notably angel groups, had become increasingly available to the entrepreneur.

Representatives from Boston Millennia Partners, Atlas Ventures and Polaris Venture Partners seem to agree that making money in venture capital these days is a lot harder than it used to be.

First, average deal holding periods appear to be about 6 years these days, up from 4 years in the not too distant past; longer holding periods reduce internal rate of return, and the illiquidity implicit in a longer holding period obviously negatively impacts the limited partners.

2012 saw the birth of approximately 180 new funds, a third of which were first fund offerings.  While institutions might be gun shy of newer funds and might seek out “the brand name,” statistics indicate that smaller funds had an easier time providing superior (3X) returns.  Further, in balancing portfolios, investors need a certain percentage of their money in “alternative” investments which include venture capital; as the overall market rises, the absolute number of dollars that must be placed into these alternate investments rises also.

Perhaps the most interesting comment involved “strategy creep.”  Funds that are successful at the smaller deal size tend to capitalize on that success by raising larger funds.  As a practical matter, with a larger fund there is a greater tendency to make larger investments.  But making larger investments in different kinds of companies requires a different expertise.  Thus, there may be a tendency for successful smaller funds to end up, in their subsequent larger funds, conducting a business in which they have no experience.

Where does VC deal flow come from?  Professional referrals, but also networking, particularly with investors who made profits with a fund manager in the past.  This is particularly true in early stage investments.  In later stage investments for more mature companies, VC’s are approached by investment banks but also undertake a cold call outreach.

The panel also criticized the entrepreneur’s emphasis on valuation in a particular round; “the current round is never the round that matters.”  And the real question is whether a VC is truly a value-added partner.

How is value added?  Through team building and through introductions for strategic relationships.  Whether or not a VC is a true-value added participant perhaps can be determined by an entrepreneur speaking with CEO’s of other companies in the portfolio.

What do exits look like?  Certainly the IPO is not a reliable exit; there was some suggestion that it never really was, if you were to consider not just whether the IPO took place, but also whether the offering price was in fact sustained.  For sale to a PE firm, a company typically needs substantial cash flow.  The least risky exit is through a strategic sale.  Entrepreneurs are advised to nurture relationships with other larger companies within their space so that they are known to potential acquirers when the time comes.

Finally, the “perennial” question was asked:  How important is it to you, in running the fund, to enjoy capital gains treatment on your carried interest?  As with every other panel I have heard on this subject, the fund managing partners on the panel shrugged, looked at each other and said, in effect, that it did not matter to them at all.