Originally published on Forbes.com Apr 26th, 2013
The sad story of 38 Studios LLC, Curt Schilling and the State of Rhode Island is in the news again thanks to a piece in the New York Times. The company played an interesting role in my life and every time I read about it I once again try to figure out what the lesson is for me. There is a tremendous amount that I have learned thanks to 38 Studio LLC. So far the only overall lesson I have been able to draw is that it is better to be lucky than good. You see, I was not 38 Studio LLC’s accountant. My firm never did any business with them. This was not due to lack of effort on my part. I firmly believed that I was destined to be 38 Studio’s tax accountant.
The Dream Begins
I think it started sometime in 2007, but the chronology may be a bit off. My son, William, who was 14 at the time, asked me if he could use my credit card to buy some gold. I quickly realized that it had something to do with a computer game. He and I both liked computer games, but over the years are tastes had diverged. The high point of our collaboration was when we were playing Lords of the Realm II. Lords of the Realm was a combination turned based strategy game, real time battle game. I handled all the resource allocation, civilian morale and food productions decisions. William took over when war broke out and troops had to be managed in real time at a tactical level. We both came to like the various releases of Warcraft which was real time strategy, tactics and resource management. Our big difference was that he favored orcs and I stuck with humans.
Then came World of Warcraft. WOW was based on a similar back-story to Warcraft, but it was an MMORPG. Basically you are managing a single individual inside a 3-D cartoon. When I looked over his shoulder it always seemed like something running over a strange landscape bopping things over the head. In reality, that is probably about 60% of WOW. The other 40% is what is interesting. The “something” is your avatar (William called it a “toon”), which as you get absorbed will feel like you. Your avatar has a race (human, elf, orc etc), a class (warrior, priest, wizard, etc), a more or less extensive inventory of all sorts of stuff (weapons, armor, potions, fishing rods, etc), a level and, in effect, a bank account. Money is denominated in gold, silver and copper but all your money is always available and does not encumber you.
It is very hard to earn gold, which is why William wanted to buy some. I thought it was an utterly absurd notion and mockingly intimated that there must be kids in China playing WOW to earn gold to sell to the likes of him. Silly me. I started doing research and found that mining WOW gold is a major industry. I also started playing WOW myself and began to understand the temptation to violate the terms of service and buy gold, although I never succumbed.
And then, in the lunch room, I spied a story in the Worcester Telegram about a local company that was going to make the next WOW, only better. There was something about it being backed by a Red Sox player but what stood out to me were three letters in the name – LLC. Limited Liability Companies are usually taxed as partnerships. Partnership taxation is a significant part of my professional reputation, such as it is. I’m sure there are other CPAs who are better at partnerships than I am. But how many of them have level 50 warrior avatars ? How many of them had researched and bought stock in every single public company that runs MMOs ?
The Chase Is On
The firm was trying something that accounting firms try from time. Business development executives. The way public accounting at the regional level usually works is that the most valued skill, once you have more than ten years experience, is the ability to bring in business. This is rather hard on someone who would rather be doing tax research than playing golf.
I looked at the BDE as a godsend and I started explaining this whole new industry that was wide open. I went to a conference on the video game business at MIT, where I met the CEO of Linden Labs, who explained to me how the challenge of controlling the money supply in Second Life was like being the Fed. Somebody from state government spoke and indicated that Massachusetts had over 150 game companies. I learned that the other game company center on the East Coast was Orlando, where the University of Central Florida was offering a Masters in Game Design. Much of my business is in Orlando. Another sign.
On one of the industry leader panels at the conference, Curt Schilling was up there with the others all of whom, inevitably, had twenty years experience. There was of course nobody with more than twenty years experience because none of them were much over 40. The crowd was suitably impressed by Schilling, but you have to wonder what the other guys on the panel were thinking about him.
The BDE got me a meeting with a fellow who was doing a start-up. I was massively impressed because he had come out of Turbine and been involved with Lord Of The Rings Online. His concept was an MMO in which you would be managing a football team. I could see the merit. There are quite a few people who grew up reading Lord of The Rings multiple times and playing Dungeons and Dragons, but they are dwarfed by the number of people who follow football. It was a rather bizarre lunch conversation as this fellow, who was really smart, carried on a conversation with me about business and theoretical aspects of game design while simultaneously talking about football with the BDE.
Finally Some Research – Albeit Free
My takeaway from the meeting with the start-up guy was to do some research. It was GAAP research not tax research. Since he was a start-up he was interested in recognizing revenue not deferring it. The question is when you have an MMO on free-to-play model how do you recognize the income for the extra goodies like the magic sword or, in the case of his game, the star quarterback that the player pays for. Rather than ask the audit partners, I did the research myself, by looking at the 10-Ks of all the public companies in the business. If I recall they all seemed to end up coming up with 36 months or something like that. I don’t think he liked the answer as he wanted to book the revenue right away.
Explaining All This To My Partners
That was a real challenge. I would start off by explaining what an MMO was, which was about as far as it got, because they all thought it was pretty stupid and then there was this other deficiency on my part. I don’t follow sports, so the thing that made 38 Studios LLC so exciting to so many people in the region was kind of incidental to me. I did not say “Curt Schilling has put $50,000,000 into this computer related start-up right in our back yard. We should go after it.” I would say “Somebody in our backyard is going to build a big, better WOW (Spend the next 10 – 30 minutes trying to educate about how big the industry is.) Oh, yeah. The guy backing it is on the Red Sox, Curt something. I think he’s a pitcher.”
The Hunt Continues
I managed to get a meeting with one of the lawyers representing 38 Studios LLC. I was trying to come up with what a likely tax angle would be. I was thinking that maybe Schilling might have issues with the passive activity loss rules. Apparently that was a laughable concern as he spent a tremendous amount of time on the project. The one thing I never dug into was the R&D credit, but I would have been quickly all over it. The BDE came within inches of getting a meeting with Schilling, himself, but somehow it never happened.
Better To Be Lucky Than Good
Clearly I have no envy for whoever ended up with the work I lusted after and thought I was destined for. I’m not even experiencing schadenfreude. It’s conceivable that whoever got the tax work did OK, but the effect on the audit firm will end up being ugly even if their work was pristine. I do have a reflection on the whole story when I think about it from beginning to end.
Excellence Is Overrated
More than anything the story of 38 Studio LLC reminds of an anecdote from the turn of the twentieth century. There was a major arms race going on and it was all about battleships. There were all sorts of theories about how to have the best battleship and people were coming up with designs. So Kaiser Wilhelm decided to give it a try. He sent his design to an Italian naval architect for comment.
The architect’s response indicated that the Kaiser’s design was impressive. Better guns, better armor, a brilliant layout, great facilities for the crew. There was one problem. If placed in the water, the ship would sink like a stone. Excellence is overrated might not be the right way to put it. Excellence is good, but you scorn adequacy at your peril. The 38 Studio MMO was going to be so much better than WOW because it would have all these features a passionate gamer, who was excellent at his own profession, would want. Sadly, it would never float.
You can follow me on twitter @peterreillycpa.