Unveiling the Dark Side: How Influential Figures Spread Oblique Business Schemes

History is littered with loss-making operators across a range of #industries that have caused turmoil for many while making fortunes for a few (the founder, and less so the CFO and execs).

Looking at the examples in last week’s post on "How to Spot an impending #corporatecollapse," the potential for substantial #profit, power, and influence are significant motivating factors. The why is clear, but it is also interesting to look at how this is achieved: in short, it is down to a combination of distraction and incentivisation.

In addition to the "#redflags" previously discussed, there is also a strategic playbook historically used by Loss-Making Organisations ("LMOs") in establishing, growing, and sustaining their schemes.

"We are different, and you don’t understand our #business", got them only so far; few successfully pass under DOJ/ECJ scrutiny pre- or post-cash collapse.

Discover the shocking truth behind why they resort to this "one path to #wealth" and the jaw-dropping methods they use to get there.

Step 1: Market entrance

• Aim: Establish the prestige and credibility of the Founder and the business venture. This is also a critically important step in feeding the significant egos often at the centre of LMOs.

Method: The founder will typically start creating and promoting his or her personal brand as loudly as (if not louder than) the company itself with the assistance of well-paid marketing and PR advisers. This may typically be categorised as a combination of #billionaires, #philanthropists, industry geniuses, and/or misunderstood victims. Alongside this, the emphasis is usually (but not always) on their wealth. This way, when they spend the #money, it can be assumed that it came from funds acquired before the operation rather than from the client's money paid through related parties.

Rationale: This normalises an #extravagantlifestyle and opulent displays of wealth. If this forms part of the story from the outset, then future lavish spending on ultra #luxury assets, such as prime real estate, #fineart, and mega #yachts, can be presented as evidence of growing business success rather than seen as red flags that the founder is rinsing the business as a lifestyle asset to the detriment of #stakeholders.

What to look out for: Lots of paid marketing in #bluechip publications and glossy brochures. Expect to see him or her at (or sponsoring) plenty of high-profile events and rubbing shoulders with the great and the good.

Step 2: Establish a complex related party transaction structure designed to enrich the Founder (and perhaps other complicit parties)

• Aim: Use the business to generate vast wealth for the Founder, which can be preserved in the event of failure.

Method:

• Set up off-balance-sheet companies (usually incorporated in light-touch and low transparency jurisdictions).
• Use simple-sounding business activities to rationalise #payments to the Founder or off-balance-sheet entities. Sales commissions, #consultancy fees, #asset purchases, royalty payments, and option exercise payments sound legitimate.
• Use some accounting wizardry to hide the true picture. Things like netting and consolidating line items, such as directors’ loan accounts, related party payables and receivables, and inter-company loans, may all be done in accordance with internationally recognised accounting practices.
• It is important to note that the #agreements and negotiations between these off-balance-sheet vehicles and related #suppliers do not have to be disclosed. The focus will likely be on keeping these complicit third-party suppliers happy, well-incentivised and aligned with the interests of the Founder and the off-balance sheet vehicle, not necessarily the LMO.

Rationale: Complicated related-party transaction structures mean few people will bother to read the pages of footnotes involved. Fewer will understand them. Even fewer will consider questioning them.

What to look out for:

• Even if only spotted post-mortem, the names of the related party holding company SPVs used to conceal #debt or losses have often turned out to be retrospective red flags. One of Enron’s SPVs used to hide losses was "M. Yass." Move the full stop one space to the right, and the hubris becomes clear.
• Remember: Something that "must presumably be legal if it has been disclosed and the auditors have signed off on it", does not preclude other more nefarious designs behind the scenes.

Step 3: Raise external capital and secure funding from outside sources! How to Make Them Believe Your Success Story Predates Your Business Genius, Confirmed! Paid articles can't be wrong, right?

• Aim: Cash needs to come from somewhere to fund related-party transactions.

?Method:

• From setbacks to soaring heights: sell a story of the journey towards #success through (many) strategic #funding rounds, excuse the poor past, and make the unbelievable forecast, well, believable! (i.e., "Don’t worry about ongoing future losses; it’s all part of the growth plan"). All that might sound something like this:
• "The business is currently loss-making, but this is only because of how fast it is growing."
• "The business needs lots more capital to sustain this level of growth."
• "The business will soon reach scale, the profits will be enormous, and all #investors will benefit."
• "We could be profitable now if we slowed down investment, but if we chose to do that, we would sacrifice the unique #marketopportunity and squander future #growth and huge profits for all."
• Appoint an army of banks, #brokers, and advisers to do the debt or equity raise, and make sure they are incentivised with big transaction fees.
• The more they raise, the more they are paid, so there is great alignment between the Founder and the money-raisers. Rarely will these entities buy what they are selling and put their own ‘skin in the game’.
• Choreograph the raise to target the "dumbest money" first, and the "least dumb" last (try and avoid savvy investors).
• Believe it or not, one gullible person opens the door for the next! Don't miss out on the buzz! It's tough to say no when everyone else is saying yes, especially with #FOMO in the mix.

Rationale: The injection of potentially hundreds of millions of debt and/or equity into the business provides a significant source of cash to fund related party payments. Furthermore, offering documents that may run into hundreds of pages provides cover to conceal all sorts of disclosures (like related party transactions and risk factors), which can be used posthumously to excuse future accusations of wrongdoing. That must stop it from being wrong, right?

Step 4: Rinse and repeat for as long as possible

• Aim: Make as much money as quickly as possible and for as long as possible.

Method: Incentivise and distract, often at the same time.

• Buying companies through M&A
• This distracts by building the story of growing market dominance, justifies further fundraises, complicates accounts, and dilutes related party transactions involving the founder.
• This incentivises selling shareholders with the promise of outsized returns and vast future wealth by using complicated earnout and contingent consideration payment structures. This, combined with a big cheque up front, means sellers are unlikely to do much (if any) due diligence on the creditworthiness of the buyer, or, in straight-talking terms...
• Just pay in cash, lower the "earn out" to make the sellers less concerned about the buyer's strategy rationale, and swiftly move from "checking the accounts" to "contacting my lawyers—we're good to go."
• Management promotions: spot the bullies and boost their power; take charge of the masses! The more incompetence, the better (less chance of them going below #EBITDA in meetings).
• Fancy job titles distract by giving the impression of an expert team of experienced industry heavyweights providing unquestionable #governance and oversight.
• Salaries well above market rates compensate for working in a tyrannical dictatorship culture and disincentivise executive management from questioning motives, decisions, and maybe even #whistleblowing.
• Identify and promote the company as something it is not (such as a tech business).
• Why: #Tech businesses attract sizeable valuation multiples.
• Losses commonly associated with early-stage tech businesses legitimise losses.

Understanding the Dark Side: How High-Profile LMO #Founders enrich themselves at the expense of others is my view on how they did it and, in some cases, are doing it.

No cash, no compliance: Lawbreakers only stop when the money dries up and the circle of paid loyalty around them breaks—fast.

From boom to eventual bust, a trail of #creditors is usually left with major losses. Beware! Even the innocent can get caught in the web of a master manipulator and their accomplices, who are all too willing to aid in their deceitful plots.

Money talks, and it can even buy you a sympathetic listener and some trusty assistance from employees, owners of companies that sell, and experts. Everyone has a reason to do nothing, even when these LMOs in the past broke the law.

Many of them should have known better.

Our industry is going to change. The journey will be difficult, but I believe the long-term rewards for all will be worth it.

The landscape of our industry is poised to undergo a #transformation. Undoubtedly, the expedition ahead will pose significant challenges, yet I maintain the conviction that the ultimate benefits that will ensue in the future will be of great value to all remaining.

Well, it seems like even the most stylish panic pants won't be able to turn back time.

Warmest,

John.