The Systemic Risk of Sequential Liability

I want to use this moment, after the bankruptcies of EMX, Silicon Valley, and MediaMath, to highlight the dangers of sequential liability and the systemic risk it poses to the digital advertising supply chain: caused by sequential payment and liability. This risk is reminiscent of how one bank failure can trigger a chain reaction leading to multiple banks failing, sequential payments and liability pose a similar risk in the advertising realm.

Sequential liability is a feature unique to the advertising industry. Introduced in 1991 by the 4As, it was designed to protect media agencies from being held responsible for payment in instances where their advertising clients failed to pay them, possibly due to bankruptcy. This practice has become a fixture in the advertising industry over the past 30+ years. In real-world terms, the agency is only liable for payment to the vendor if it has been paid by the advertiser. Until that time, the advertiser is solely responsible for payment. While this might have made sense when the advertising supply chain was straightforward, the complexity of programmatic media now means that any number of downstream AdTech intermediaries can be left holding the proverbial bag.

Sequential liability also creates a clear, unfortunate side effect – sequential payments. As of today, downstream suppliers, particularly publishers, can wait upwards of 200+ days to be paid from the time they delivered their end of the transaction (media impressions). Even when advertisers attempt to 'do the right thing' and pay their bills promptly, the funds still need to traverse downstream from Advertiser to Agency to DSP to SSP to Publisher, adding significant time and significant risk to payment. This issue is dramatically exacerbated when advertisers demand extended payment terms.

With sequential liability, money cascades from vendor to vendor, and if a vendor in the middle of the supply chain goes bankrupt, the vendors downstream are left hunting for their money, often not even sure which upstream player was the last one holding their media dollars. Consequently, each vendor in the supply chain functions as an unregulated bank, with the ultimate costs borne by the advertiser, but the credit risk borne by the downstream suppliers.

This system gives rise to a systemic risk characterized by two factors: Redundant Financings and "Holdback" Provisions. Each entity in the chain establishes their own working capital lines to accommodate the inherent delays in payment and the need for working capital. Each programmatic media transaction can easily pass through 4+ vendors before reaching a publisher, which can result in 3+ financings for every media dollar. These credit lines, while necessary to bridge the gap between delayed receivables and urgent payables, are costly.

Additionally, working capital lending agreements often include "Holdback" Provisions. For instance, a vendor with $20MM in accounts receivables may secure financing at 80% of their value, allowing them to access up to $16MM in working capital. However, if an upstream partner goes bankrupt, reducing the receivables to $12.5MM, the new maximum credit limit would be $10MM (80% of $12.5MM). This sudden reduction in available credit puts the vendor at risk of violating loan agreements, which could lead to severe consequences, such as the lender obtaining warrants in the company, or the company being forced into liquidation to repay the lenders. This scenario can trigger a chain reaction, impacting the vendors' downstream partners and potentially leading to bankruptcy.

The current system of financing media introduces a significant risk that needs addressing to build a more accountable, stable, and healthy supply chain. The model of passing working media (and payment risk) from vendor to vendor does not align with how other mature supply chains function. In most supply chains, the buyer (advertiser) can finance the entire transaction via supply chain financing, ensuring prompt vendor payment and eliminating sequential liability, payments, and redundant financings.

The media supply chain must abandon its archaic practices and mitigate its risk, eliminating the systemic risks associated with sequential liability and payments. It's time for a change.