Goldman Sachs and the $580 Million Black Hole(nytimes.com)
nytimes.com
Goldman Sachs and the $580 Million Black Hole
http://www.nytimes.com/2012/07/15/business/goldman-sachs-and-a-sale-gone-horribly-awry.html?_r=1&hpw
96 comments
There can be reasons to take part-stock deals. For example part-stock deals also ensure that the acquired are invested in the purchaser. In essence by trading stocks they are buying something more valuable, your loyalty. The question is, how much do you want to give it. If my business were buying your business, I'd go for a part-stock deal just because it keeps your wealth tied in part to my firm's performance. This is what is being purchased that's so valuable: power. But this is usually a good thing for all involved because it ties everyone together financially and prevents the acquired from calling it quits and running off to do something that undercuts the acquirer.
But all-stock deals? That suggests something is horribly amiss.
But all-stock deals? That suggests something is horribly amiss.
All-stock deals are usually very fishy because it generally illustrates that the buyer, quite simply, does not value their stock that highly (and values the seller's stock way more - so why are they selling?).
This is not a good sign.
Part-stock deals make some sense - to tie people up (vesting/milestones/lock-up) and align them with your interests. However it really should be a mostly cash deal (say 80-20 or 60-40 cash/stock) if it's public liquid stocks in a great company (but they usually do straight cash deals - e.g. Facebook/Google/Apple).
Trading private illiquid stock for private illiquid stock is a big no-no, unless it's a small amount (10-20%) with a high probability of a near-future liquid exit (IPO/public-cash acquisition).
This is not a good sign.
Part-stock deals make some sense - to tie people up (vesting/milestones/lock-up) and align them with your interests. However it really should be a mostly cash deal (say 80-20 or 60-40 cash/stock) if it's public liquid stocks in a great company (but they usually do straight cash deals - e.g. Facebook/Google/Apple).
Trading private illiquid stock for private illiquid stock is a big no-no, unless it's a small amount (10-20%) with a high probability of a near-future liquid exit (IPO/public-cash acquisition).
I see it as a bad sign for a different reason.
If a business is unwilling to part with significant operating capital for a purchase, that means either they can't be bothered (yeah, this might be valuable in the long run, why not? but not worth putting hard cash into now) or more likely that they can't afford to, which was pretty obviously the case regarding L&H..... Either way it's bad and shows either a lack of commitment or a financial hardship.
In other words, I don't care too much about how much stock is purchased. I want to see the cash impact of the transaction because that is an important indicator of the health of the purchaser. "You want to go from 20% stock to 80% stock? Fine as long as I get the same amount of cash directly from you either way! You can just give me additional stock if you like..." ;-)
Even if I was just an investor, if I heard a publicly traded firm bought another in an all stock transaction I'd be selling my shares.
If a business is unwilling to part with significant operating capital for a purchase, that means either they can't be bothered (yeah, this might be valuable in the long run, why not? but not worth putting hard cash into now) or more likely that they can't afford to, which was pretty obviously the case regarding L&H..... Either way it's bad and shows either a lack of commitment or a financial hardship.
In other words, I don't care too much about how much stock is purchased. I want to see the cash impact of the transaction because that is an important indicator of the health of the purchaser. "You want to go from 20% stock to 80% stock? Fine as long as I get the same amount of cash directly from you either way! You can just give me additional stock if you like..." ;-)
Even if I was just an investor, if I heard a publicly traded firm bought another in an all stock transaction I'd be selling my shares.
> Even if I was just an investor, if I heard a publicly traded firm bought another in an all stock transaction I'd be selling my shares.
Correct. But sometimes you don't get that option as a small company being acquired - so getting public liquid stock in good companies is perfectly fine (so long as the lock-up isn't too tight - and it's a part cash deal).
Berkshire Hathaway used this to great effect when acquiring Gen Re in 1998. As the stock market was racing, Warren Buffett swapped his overvalued Brk.A stock for all of Gen Re in a mostly stock deal. After the 2000 dot-com crash he just bought back Brk.A stock cheap with the large cash holdings he held due to the previously frothy market. Sell high and buy low people.
So if someone is trying to sell you some stock - remember - "You are the sucker!".
Unless of course they are Google. Then you're a genius. You win some - you lose some!
Correct. But sometimes you don't get that option as a small company being acquired - so getting public liquid stock in good companies is perfectly fine (so long as the lock-up isn't too tight - and it's a part cash deal).
Berkshire Hathaway used this to great effect when acquiring Gen Re in 1998. As the stock market was racing, Warren Buffett swapped his overvalued Brk.A stock for all of Gen Re in a mostly stock deal. After the 2000 dot-com crash he just bought back Brk.A stock cheap with the large cash holdings he held due to the previously frothy market. Sell high and buy low people.
So if someone is trying to sell you some stock - remember - "You are the sucker!".
Unless of course they are Google. Then you're a genius. You win some - you lose some!
>Correct. But sometimes you don't get that option as a small company being acquired - so getting public liquid stock in good companies is perfectly fine (so long as the lock-up isn't too tight - and it's a part cash deal).
It still tells me that something is amiss. Why not use working capital? What's wrong there? Not enough cash or cash equivalents on hand to do it? Or the company isn't worth committing to by parting with cash?
Either way if I am a stockholder in the purchasing entity, it's a bad deal for me.
It still tells me that something is amiss. Why not use working capital? What's wrong there? Not enough cash or cash equivalents on hand to do it? Or the company isn't worth committing to by parting with cash?
Either way if I am a stockholder in the purchasing entity, it's a bad deal for me.
Not if the acquired company is more valuable than the stock used to pay for it.
All-stock deals are usually very fishy because it generally illustrates that the buyer, quite simply, does not value their stock that highly (and values the seller's stock way more - so why are they selling?).
An all-stock deal is basically a merger. The seller doesn't necessarily value the buyer's stock way more, they might value the combined entity more than they value the sum of the parts. "Synergy" is the buzzword of the day.
For example, the merger of Confinity and X.com (i.e., paypal) was certainly worth more than either of the individual companies.
An all-stock deal is basically a merger. The seller doesn't necessarily value the buyer's stock way more, they might value the combined entity more than they value the sum of the parts. "Synergy" is the buzzword of the day.
For example, the merger of Confinity and X.com (i.e., paypal) was certainly worth more than either of the individual companies.
Perhaps. One note Confinity invented PayPal not X.com.
Confinity invented the name PayPal, not the product PayPal as we know it today.
No. 4 reminds me of a sign I still see in small businesses everywhere - "In God we trust. Everyone else pays cash."
I agree with the sentiment, but...
> When someone swaps a stock - they implicitly value it less than what they get. Hence if you swap your stock with someone else, the buyer implicitly states that your stock is worth more than theirs. Losing deal.
If you're implying that M&A is a zero sum game and that every win for the acquirer is a loss for the seller then no, you're wrong. Your argument really applies to any sale (of anything): for the buyer to buy they have to value the goods more than the price, but the beautiful thing in trade is that the seller can still value the price higher than the goods, without anybody being wrong. Voluntary trade can create value out of thin air.
In an M&A type stock swap deal the reason this works out is that the merger itself can create value. Merge a company with traction in the market with one with a killer product and you have something that's more valuable than the two separate companies.
> When someone swaps a stock - they implicitly value it less than what they get. Hence if you swap your stock with someone else, the buyer implicitly states that your stock is worth more than theirs. Losing deal.
If you're implying that M&A is a zero sum game and that every win for the acquirer is a loss for the seller then no, you're wrong. Your argument really applies to any sale (of anything): for the buyer to buy they have to value the goods more than the price, but the beautiful thing in trade is that the seller can still value the price higher than the goods, without anybody being wrong. Voluntary trade can create value out of thin air.
In an M&A type stock swap deal the reason this works out is that the merger itself can create value. Merge a company with traction in the market with one with a killer product and you have something that's more valuable than the two separate companies.
Obviously these are rules of thumb and do not apply to sophisticated agents that actually know what they are doing.
> In an M&A type stock swap deal the reason this works out is that the merger itself can create value
This is the exception not the rule. If you think you are a) sophisticated and b) in this rare situation - then disregard everything I have said.
> Voluntary trade can create value out of thin air.
If and only if both parties are sophisticated and value the exchanged items correctly. Trade can create value out of thin air. It can also turn value into thin air (booms/busts/fraud etc.).
Capitalism and trade are double edged swords - all I want people to do is watch the downside while they grab the upside.
> In an M&A type stock swap deal the reason this works out is that the merger itself can create value
This is the exception not the rule. If you think you are a) sophisticated and b) in this rare situation - then disregard everything I have said.
> Voluntary trade can create value out of thin air.
If and only if both parties are sophisticated and value the exchanged items correctly. Trade can create value out of thin air. It can also turn value into thin air (booms/busts/fraud etc.).
Capitalism and trade are double edged swords - all I want people to do is watch the downside while they grab the upside.
The stock swap thing seems to be common in M&A
It's done on the buyer's side, the seller company's partners get buyer's stock instead.
It's not "your baby for theirs", it's more complicated
It's done on the buyer's side, the seller company's partners get buyer's stock instead.
It's not "your baby for theirs", it's more complicated
> It's not "your baby for theirs", it's more complicated
How so? Use the baby analogy (as it was indeed Baker's child), what was it in this case in your view?
How so? Use the baby analogy (as it was indeed Baker's child), what was it in this case in your view?
Well, because you agreed to the sale, so "your baby" is already gone, stock swap or not.
And you're potentially getting a stock with more potential than the ones you have (which are most likely going away).
And most stock are not materialized as a physical certificate, so it's mostly "on paper" (and on controlling power of course)
And you're potentially getting a stock with more potential than the ones you have (which are most likely going away).
And most stock are not materialized as a physical certificate, so it's mostly "on paper" (and on controlling power of course)
Don't deal with anyone with a question mark over their head.
If anyone has even the slightest doubt upon them - bad business dealings, shady companies, or just general concerns - do not deal with them.
Life is too short to deal with shady characters - no matter how much money they give you.
Not worth the risk.
Life is too short to deal with shady characters - no matter how much money they give you.
Not worth the risk.
When I sold my company, our own advisers (not Goldman but a famous name) did something which in my opinion is much worse -- I'm 99% sure they told the winning bidder that we'd been prepared to accept a 20% lower bid from their competitor. The winning bidder, of course, then suddenly reduced their bid by 20% on the planned day of completion. The reason our advisers did this is that it was much more important to them to get future business from the buyer, a large multinational, than future business from me and my colleagues.
I feel sorry for the vendors in this case, but you don't do an all-share deal without being extremely cautious about the shares you're taking as payment. Even a pair of PhDs should have known that.
What interests me here is that we have a lot of news stories floating around at the moment lambasting financial companies for relatively minor misdeeds, because that's all journalists can pin on them without getting sued. If the real truth about what goes on begins to leak out the public reaction could be very interesting.
I feel sorry for the vendors in this case, but you don't do an all-share deal without being extremely cautious about the shares you're taking as payment. Even a pair of PhDs should have known that.
What interests me here is that we have a lot of news stories floating around at the moment lambasting financial companies for relatively minor misdeeds, because that's all journalists can pin on them without getting sued. If the real truth about what goes on begins to leak out the public reaction could be very interesting.
That's when you call the SEC because they both committed a felony and go with the other bid if it's still on the table.
> don't do an all-share deal without being extremely cautious about the shares you're taking as payment.
This.
Cash is king. Unless your acquirer is Intel, Google, Apple, Microsoft, Amazon or anyone of the other big boys.
One must remember: If someone is swapping their stock for yours - then they, by definition, value their stock less than they do yours. That's a losing deal in anyone's books. If they say they need the cash for growth - call BS - since if they grow that fast they should hold onto every last bit of their stock.
Cash or big boy stock. Everything else is a lie.
This.
Cash is king. Unless your acquirer is Intel, Google, Apple, Microsoft, Amazon or anyone of the other big boys.
One must remember: If someone is swapping their stock for yours - then they, by definition, value their stock less than they do yours. That's a losing deal in anyone's books. If they say they need the cash for growth - call BS - since if they grow that fast they should hold onto every last bit of their stock.
Cash or big boy stock. Everything else is a lie.
On the other hand that's a standard negotiating ploy.
How many times, when buying a car, are you minutes from closing the deal when suddenly a new fee appears. Or suddenly an issue with your trade-in and it's not worth what they "thought" it was. It only changes your monthly payment by $10... do you really want to walk away after the effort you've put in to this point?
So not necessarily anything nefarious going on (though not discounting the possibility entirely).
How many times, when buying a car, are you minutes from closing the deal when suddenly a new fee appears. Or suddenly an issue with your trade-in and it's not worth what they "thought" it was. It only changes your monthly payment by $10... do you really want to walk away after the effort you've put in to this point?
So not necessarily anything nefarious going on (though not discounting the possibility entirely).
> do you really want to walk away after the effort you've put in to this point?
Can you afford not to? The company you're dealing with has now proven to be unwilling to stick to the points you spent all that time negotiating. They're counting on you conceding the $10 because it's easy.
Unless you show that you're willing to walk away and start all over from scratch (preferably with someone else), they'll push as hard as they think they can get away with.
Can you afford not to? The company you're dealing with has now proven to be unwilling to stick to the points you spent all that time negotiating. They're counting on you conceding the $10 because it's easy.
Unless you show that you're willing to walk away and start all over from scratch (preferably with someone else), they'll push as hard as they think they can get away with.
I was 99% sure our advisors had screwed us before they came in with the 20% lower offer.
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I don't think this happens if someone like Kleiner Perkins had a 10% or 20% stake in Dragon.
A serious VC partner would have been more likely to realize that Goldmans sent out the junior varsity here, and would have the standing and confidence to insist they do better or be fired. They would have asked better questions about the due diligence and been more attentive to valuing the buyer -- valuation is what VC firms do -- and might have spotted the problems themselves. In the worst case, where this disaster still strikes, Goldmans would be far more likely to be reasonable about its responsibilities, lest it spoil its reputation with a well-connected VC.
But maybe I exaggerate the business and financial knowledge of tech VC types?
I don't much like the idea of allowing big VC firms to collect rents based on their reputation. But you cannot expect fee-based labor to be as careful and paranoid as you must be on this sort of thing. Only partnership brings that level of attention. When the stakes get this high, you need a partner capable of taking these responsibilities. If your financial partner or CFO isn't up to the task -- and Dragon's CFO was not -- then you have to fill that gap in the _partnership_.
Another solution would be bringing in a CFO with an equity stake, but this raises the same problem of financial expertise evaluation that sank the founders here.
None of which excuses Goldmans.
A serious VC partner would have been more likely to realize that Goldmans sent out the junior varsity here, and would have the standing and confidence to insist they do better or be fired. They would have asked better questions about the due diligence and been more attentive to valuing the buyer -- valuation is what VC firms do -- and might have spotted the problems themselves. In the worst case, where this disaster still strikes, Goldmans would be far more likely to be reasonable about its responsibilities, lest it spoil its reputation with a well-connected VC.
But maybe I exaggerate the business and financial knowledge of tech VC types?
I don't much like the idea of allowing big VC firms to collect rents based on their reputation. But you cannot expect fee-based labor to be as careful and paranoid as you must be on this sort of thing. Only partnership brings that level of attention. When the stakes get this high, you need a partner capable of taking these responsibilities. If your financial partner or CFO isn't up to the task -- and Dragon's CFO was not -- then you have to fill that gap in the _partnership_.
Another solution would be bringing in a CFO with an equity stake, but this raises the same problem of financial expertise evaluation that sank the founders here.
None of which excuses Goldmans.
Yes you do exaggerate the business and financial knowledge of tech VC types.
During the late 90s boom, EVERYONE was snared in. KP, Sequoia, pretty much all the VCs lost a ton of money. Doubtful that their so-called expertise would have saved the Bakers.
Re-reading the article again, it seems like the Bakers did in fact have their suspicions. The mystery memo should have been a huge warning sign. The fact that Goldman sent bankers in diapers should have been an even bigger sign. There was one comment from the founder of Dragon: "If L&H was able to make so much money out of a lousy product they'd be able to make more out of ours.." which was a little painful to read.
During the late 90s boom, EVERYONE was snared in. KP, Sequoia, pretty much all the VCs lost a ton of money. Doubtful that their so-called expertise would have saved the Bakers.
Re-reading the article again, it seems like the Bakers did in fact have their suspicions. The mystery memo should have been a huge warning sign. The fact that Goldman sent bankers in diapers should have been an even bigger sign. There was one comment from the founder of Dragon: "If L&H was able to make so much money out of a lousy product they'd be able to make more out of ours.." which was a little painful to read.
They had Seagate as a 25% partner. Where were they?
Dragon CFO Ellen Chamberlain was from Seagate.
And they still lost 20% of $580 million ...
Are we sure Seagate didn't sell or otherwise collar the value of their stake soon after the acquisition? According to the article, there were about 60 days before the scandal erupted:
"The deal closed on June 7. By Aug. 8, the merged companies were in crisis amid reports that L.& H. had cooked its books."
"The deal closed on June 7. By Aug. 8, the merged companies were in crisis amid reports that L.& H. had cooked its books."
To me, the lesson here is clear: trust your instincts!
There are too many stories of founders who built a successful company and then let the "experts" run it into the ground. In almost every case, the founder(s) felt like something wasn't right, but they swept their concerns aside, because they had hired "experts" and felt compelled to listen to them.
The reality is that no one has more expertise in your company than you do, and more importantly (particularly in this case), no one cares as much as you do. So yes, surround yourself with experts and seek as much wisdom as you can from them, but (almost) never go against your gut to follow their advice. Your instincts are usually what got you to that point in the first place.
There are too many stories of founders who built a successful company and then let the "experts" run it into the ground. In almost every case, the founder(s) felt like something wasn't right, but they swept their concerns aside, because they had hired "experts" and felt compelled to listen to them.
The reality is that no one has more expertise in your company than you do, and more importantly (particularly in this case), no one cares as much as you do. So yes, surround yourself with experts and seek as much wisdom as you can from them, but (almost) never go against your gut to follow their advice. Your instincts are usually what got you to that point in the first place.
Funny, when I read your 3rd paragraph, that made me think of the danger of putting too much faith in doctors.
Doctors get really peeved at people who research online and self-diagnose. On the other hand no-one cares about your health as much as you do, and no-one has access to as much information about what the root causes of malady could be.
Although Christopher Hitchens hated the expression 'X is battling with cancer', the phrase implies a personal engagement (as opposed to delegating) which can indeed make all the difference in the world.
Doctors get really peeved at people who research online and self-diagnose. On the other hand no-one cares about your health as much as you do, and no-one has access to as much information about what the root causes of malady could be.
Although Christopher Hitchens hated the expression 'X is battling with cancer', the phrase implies a personal engagement (as opposed to delegating) which can indeed make all the difference in the world.
Here's a description I like: you know more about your own body than your doctor does, but your doctor knows more about bodies in general than you do, so you have to work together.
That's well said, as far as it goes, but I wouldn't leave out the point about different incentives and levels of investment in the outcome for the two parties. (The pithy, cynical versions: "First, let them get sick" (Seth Roberts) and the life/dinner principle (Dawkins and Krebs).)
> Doctors get really peeved at people who research online and self-diagnose
Good doctors encourage patients to understand their condition. Let's not conflate that with exasperation over people who have a week old cough that they've decided is lung cancer because they've spent too much time on wrongdiagnosis.com.
Good doctors encourage patients to understand their condition. Let's not conflate that with exasperation over people who have a week old cough that they've decided is lung cancer because they've spent too much time on wrongdiagnosis.com.
The larger point about personal responsibility is more important than applying the metaphor to every possible case.
No matter who you hire, in any context, it is up to you to make sure they do a good job with the tools available to you.
No matter who you hire, in any context, it is up to you to make sure they do a good job with the tools available to you.
Every possible case? Your analogy was terrible. Your follow up was much better, and is what you should have said in the first place.
I'm sorry - I just couldn't resist: http://9gag.com/gag/2074385
You are completely right about the "wrongdiagnosis.com" conclusion. Be aware of your health, and the general statistical chance of various diseases (heart/diabetes/alzheimers etc.). Also get a second or third opinion from other reputable doctors if you disagree. The chances of them all being wrong is very small.
Those examples you hear of people going to "10 doctors who all say they're fine when they in fact have a rare disease" are, by definition, insanely rare.
It's usually the flu :D.
You are completely right about the "wrongdiagnosis.com" conclusion. Be aware of your health, and the general statistical chance of various diseases (heart/diabetes/alzheimers etc.). Also get a second or third opinion from other reputable doctors if you disagree. The chances of them all being wrong is very small.
Those examples you hear of people going to "10 doctors who all say they're fine when they in fact have a rare disease" are, by definition, insanely rare.
It's usually the flu :D.
I am sure, they ignored their gut feelings along the way - L&H's bad technology should have rung alarm bells. Also its not known if they met L&H founders - one should be able to smell snakes!
Basically whether you pay a $5M fee or $100K fee. Your business should be your business and not somebody else's business.
Also who in their right mind would agree for a 100% all stock acquisition. Looks like they were also desperate and did not trust their business completely. But still heart goes out to them. Since they clearly were the pioneers in that space, and Nuance became so popular, that even general people having tech interest heard about them, and not many heard of Dragon Systems.
Basically whether you pay a $5M fee or $100K fee. Your business should be your business and not somebody else's business.
Also who in their right mind would agree for a 100% all stock acquisition. Looks like they were also desperate and did not trust their business completely. But still heart goes out to them. Since they clearly were the pioneers in that space, and Nuance became so popular, that even general people having tech interest heard about them, and not many heard of Dragon Systems.
It sounds like they trusted their instincts, took an all stock offering, and that's where it fell apart.
I'm reminded of AOL vs. Time Warner, Steve Case vs. Ted Turner.
But on Feb. 29, Dragon received an odd memo from Goldman. It wasn’t addressed to anyone in particular at Dragon, and it wasn’t signed by anyone at Goldman. The Goldman Four testified later that they had no idea who had sent it. But the memo referred to many of the same due diligence issues that Ms. Chamberlain raised. The memo asserted, however, that Dragon’s accounting firm, Arthur Andersen, should do the work, not Goldman. [...] To support the argument that Goldman was not obligated to perform due diligence, the firm points to that mystery memo of Feb. 29, 2000 — the memo that no one at Goldman has acknowledged sending — as establishing that Dragon Systems needed to push its accounting firm to explain any red flags or resolve outstanding worries.
Given that GS is now using this memo to cover their asses, it makes me wonder whether someone there knew what was going on...
Given that GS is now using this memo to cover their asses, it makes me wonder whether someone there knew what was going on...
Exactly. Goldman is off the hook for sending it and the 4 bankers are off the hook because none of them officially sent it.
There are a multitude of cases involving technology companies and shenanigans with Goldman Sachs, including Marvell Technologies: http://dealbook.nytimes.com/2011/04/11/marvell-co-founders-s...
If I could use one word to make a generalization about the financial industry as a whole, including Wall Street, banking, etc., it would be this: shenanigans. You need to be very very careful when dealing with them, and I would also avoid their world as much as you reasonably can. Perhaps not a complete boycott is wise or possible, but as much as you can.
When you're dealing with top investment bankers you have to realize you're playing the lottery. Goldman will always be hedged and you will always be carrying the risk, not the least of which is that they will mislead you in some subtle way that costs you big. They have more knowledge, more experience, and better lawyers than anyone, so good luck proving any misconduct on their part.
Everyone in finance who is not a fish knows this, but they still deal with Goldman, why? Because they're making more money than anyone else, so you still have better odds with them than anyone else.
Everyone in finance who is not a fish knows this, but they still deal with Goldman, why? Because they're making more money than anyone else, so you still have better odds with them than anyone else.
While I don't blame the founders for choosing Goldman, I do think that they should have recognized that paying a flat fee was a bad idea. Incentives matter, and it's easy to see how even the most reputable investment bank would allocate fewer resources to your deal if there is no potential upside to them.
Yeah. This is why I don't invest -- I don't really see it as investing, I see it as waiting to have your money taken away by someone who is really good at taking money from others.
You realize that historically U.S. markets have not worked that way, and putting your money under your mattress instead of investing it resulted in dramatically lower returns?
So, can we declare shenanigans on Goldman Sachs then?
So, Goldman made $5M from fees due to this deal. They could have potentially made billions if they had known the extent of L&H's fraud during this period, by shorting stock or the options market, so there is absolutely no reason to think that this was intentional or knowingly done. It was far more valuable to Goldman to uncover the fraud than to just get this deal signed, they left hundreds of millions on the table by not doing this research.
It's a heart breaking story, but the shareholders of Dragon did it to themselves, they went to the meeting (without Goldman advisors) and they signed the contracts which traded their valuable stock for stock that ended up being worthless (although nobody knew it at the time due to fraud). Why didn't Dragon insist on a thorough auditing of L&H's books before agreeing to a deal? They went ahead and traded what they had without even looking at what they were getting in return. They made a blunder out of greed, it's common, and it's not anyone's fault but theirs.
If Goldman had certified that L&H was solid, then there might be a leg to stand on here, but they explicitly punted and said it wasn't the job of a banker to audit a companies books. This seems logical to me, and if Dragon didn't like that answer they could have gone and found another investment banking firm to advise them.
What was the 'right' thing for Goldman to do here? Drive to the Dragon office and put a gun to their head, tell them they weren't allowed to go to a meeting with L&H that was set up directly between Dragon and L&H?
It's a heart breaking story, but the shareholders of Dragon did it to themselves, they went to the meeting (without Goldman advisors) and they signed the contracts which traded their valuable stock for stock that ended up being worthless (although nobody knew it at the time due to fraud). Why didn't Dragon insist on a thorough auditing of L&H's books before agreeing to a deal? They went ahead and traded what they had without even looking at what they were getting in return. They made a blunder out of greed, it's common, and it's not anyone's fault but theirs.
If Goldman had certified that L&H was solid, then there might be a leg to stand on here, but they explicitly punted and said it wasn't the job of a banker to audit a companies books. This seems logical to me, and if Dragon didn't like that answer they could have gone and found another investment banking firm to advise them.
What was the 'right' thing for Goldman to do here? Drive to the Dragon office and put a gun to their head, tell them they weren't allowed to go to a meeting with L&H that was set up directly between Dragon and L&H?
> They made a blunder out of greed, it's common, and it's not anyone's fault but theirs.
As the saying goes, "never attribute to malice what can be sufficiently explained by incompetence". The Bakers themselves say the worst part was not being able to complete their work on the technology... I'd rather schalk this one down to naiveté.
As the saying goes, "never attribute to malice what can be sufficiently explained by incompetence". The Bakers themselves say the worst part was not being able to complete their work on the technology... I'd rather schalk this one down to naiveté.
This seems logical to me, and if Dragon didn't like that answer they could have gone and found another investment banking firm to advise them.
Weren't they already in the hole for $5M at this point, though?
Weren't they already in the hole for $5M at this point, though?
I made part of my living in the 90s from selling and installing Dragon's software, and was perplexed to see L&H buy the company and then implode. What an appalling story, though I wonder why it has taken so long to end up in litigation.
Maybe because Dragon Systems was acquired by Lernout & Hauspie, that in turn was bought by Scansoft, that was bought by Nuance, that did a partnership with... Apple! to make Siri, and Siri tech is now worth millions/billions (Source: http://en.wikipedia.org/wiki/Scansoft)
Minor but Scansoft bought Nuance and took the name.
This makes me sick - I'm no M&A expert so it's unclear what Goldman's exact due diligence responsibilities should have been but clearly they screwed up if they helped execute a transaction against a company that basically didn't exist.
The article lets the founders completely off the hook, however, which I believe is also unfair. A $580M all-stock deal at the height of the bubble? Signing away your life's work without calling your acquirer's customers? Come on.
I hope the founders get paid (on Goldman's dime) but they have to carry some of the blame here.
The article lets the founders completely off the hook, however, which I believe is also unfair. A $580M all-stock deal at the height of the bubble? Signing away your life's work without calling your acquirer's customers? Come on.
I hope the founders get paid (on Goldman's dime) but they have to carry some of the blame here.
> Signing away your life's work without
> calling your acquirer's customers
Places where I do think that they deserve some blame:
1. They seemed to have some reservations about the company. They questioned the Goldman Sachs' bankers about them. It doesn't seem like they got a very satisfactory answer, but instead of pushing for one, they just assumed that the bankers knew what they were doing.
2. They let that phantom memo fall between the cracks. No one followed up on finding out who sent it. No one followed up on this idea that the accountants need to do the due diligence instead of the bankers, even though the suggestion 'shocked' them.
3. They went to meetings, and made agreements without consulting the bankers. Sure the bankers probably should have warned them about (e.g.) taking the all-stock deal over the half-cash/half-stock deal, but I find it odd that they would make this agreement without consulting the bankers. They could have either gone over the possibilities prior to going into the meeting, or made the agreements contingent on a review by the bankers.
It really isn't clear what GS was providing if they didn't do the most basic due diligence. I did that kind of stuff as a lowly associate at a university-affiliate VC fund, so I don't see how a firm being paid millions of dollars can't find someone to make a few phone calls.
Proceeding without the DD questions being resolved and going ahead with a last minute change to the deal doesn't seem like incredibly good judgement on the founders' part, but then again, shouldn't GS have - in their advisory role - warned them about any of this? And, while the founders being non-business type people may excuse them from some of the blame here, their CFO really doesn't have a similar excuse and probably didn't do them any favors.
Where was Seagate at in all of this? Unless I missed something, they owned 25% and could have at least been useful in helping with due diligence on the supposed Asian customers.
If all of this is true, GS really doesn't look good here, but a lot of people had a hand in this getting so screwed up.
OT: Was anyone else surprised by how much vacation the supposed junior level associate was able to take at GS?
Proceeding without the DD questions being resolved and going ahead with a last minute change to the deal doesn't seem like incredibly good judgement on the founders' part, but then again, shouldn't GS have - in their advisory role - warned them about any of this? And, while the founders being non-business type people may excuse them from some of the blame here, their CFO really doesn't have a similar excuse and probably didn't do them any favors.
Where was Seagate at in all of this? Unless I missed something, they owned 25% and could have at least been useful in helping with due diligence on the supposed Asian customers.
If all of this is true, GS really doesn't look good here, but a lot of people had a hand in this getting so screwed up.
OT: Was anyone else surprised by how much vacation the supposed junior level associate was able to take at GS?
While Goldman are culpable for at minimum the fraudulent valuation services and poor deal preparation, I would foot the blame for the overall transaction almost squarely on Dragon's CFO and a pressuring board. Regardless of the advisor, it seems clear they would have made a poor deal.
What CFO does not insist on rigorous due diligence when dealing with a potential merger? This is basic finance.
It is rarely the responsibility of the M&A adviser to conduct due diligence themselves. They recommend and sometimes oversee accountants and legal bodies on behalf of the client.
So, this NY piece is missing a fair bit of key info about who, if anyone did due diligence on behalf of the client.
In addition, the proposed changes to the terms of the deal should have been obvious flags to the CFO that there was something very wrong (if you have due diligence concerns why would you give up even more/all the cash in a deal?).
Finally, anyone, but especially the CFO, should understand the incentives of the kind of advisor and buyer you hire:
- if you hire a bulge bracket adviser, you can expect their primary motivation are upfront and transaction completion fees for a tiny deal and little future prospects.
- if you are targetted by a buyer who is aggressive in offering a share deal, it is a clear indication that they consider their shares overvalued at that time.
What CFO does not insist on rigorous due diligence when dealing with a potential merger? This is basic finance.
It is rarely the responsibility of the M&A adviser to conduct due diligence themselves. They recommend and sometimes oversee accountants and legal bodies on behalf of the client.
So, this NY piece is missing a fair bit of key info about who, if anyone did due diligence on behalf of the client.
In addition, the proposed changes to the terms of the deal should have been obvious flags to the CFO that there was something very wrong (if you have due diligence concerns why would you give up even more/all the cash in a deal?).
Finally, anyone, but especially the CFO, should understand the incentives of the kind of advisor and buyer you hire:
- if you hire a bulge bracket adviser, you can expect their primary motivation are upfront and transaction completion fees for a tiny deal and little future prospects.
- if you are targetted by a buyer who is aggressive in offering a share deal, it is a clear indication that they consider their shares overvalued at that time.
I agree.
I'm totally biased against Goldman to begin with and based on what I read in this article (assuming it is truth) I do think they should be on the hook for dropping the ball here (though I don't think they should be on the hook anywhere near $1 billion, maybe $100-200 million or so).
However, it sounds like this was a clusterfuck across the board, and the founders and their then-CFO aren't totally blameless here.
I'm totally biased against Goldman to begin with and based on what I read in this article (assuming it is truth) I do think they should be on the hook for dropping the ball here (though I don't think they should be on the hook anywhere near $1 billion, maybe $100-200 million or so).
However, it sounds like this was a clusterfuck across the board, and the founders and their then-CFO aren't totally blameless here.
I agree too. I also realize that the Times article can't possibly delve into every detail. It's quite possible that the incompetence at Goldman Sachs was egregious and that Goldman really should be massively punished. But, like you, the article does not show the Dragon executives in a flattering light either.
I don't know if I entirely blame Goldman for this, Dragon bears some of the responsibility for accepting a bad deal from a shady company. Afterall Dragon's board of directors all voted to approve the deal without a clear signal from Goldman if that was safe or not. And sure, Goldman was clearly being unresponsive, but in that case Dragon should've fired Goldman for being unresponsive sought out another bank to perform the due diligence.
Single page link here - http://www.nytimes.com/2012/07/15/business/goldman-sachs-and...
Horrifying story. I hope Goldman gets held liable for that billion in damages.
At the same time I think that there are some important lessons here. The big one that comes to my mind is always have an exit strategy. For example, if I am able to make my business take off great. If it gets acquired and I end up not liking the new bosses, great, I can quit. But what can I take with me? What do I do after that?
I am fortunate in this area to have a lot of people who, while not aware of the whole situation can still nonetheless provide some help with that question. And I am grateful to those who have pushed a greater open source angle here.
And of course we can find how many missed opportunities there were to notice that this deal was bad on everyone's side. But the question for the rest of us not involved in litigation is what we take away from it.
I take away from it:
1) Be very careful about M&A. If something doesn't look right, it probably isn't.
2) Always have an exit strategy.
At the same time I think that there are some important lessons here. The big one that comes to my mind is always have an exit strategy. For example, if I am able to make my business take off great. If it gets acquired and I end up not liking the new bosses, great, I can quit. But what can I take with me? What do I do after that?
I am fortunate in this area to have a lot of people who, while not aware of the whole situation can still nonetheless provide some help with that question. And I am grateful to those who have pushed a greater open source angle here.
And of course we can find how many missed opportunities there were to notice that this deal was bad on everyone's side. But the question for the rest of us not involved in litigation is what we take away from it.
I take away from it:
1) Be very careful about M&A. If something doesn't look right, it probably isn't.
2) Always have an exit strategy.
And, never, never, never, never, NEVER do a stock swap for a payout. In the finance world, holding $580 million in equity in a single position--a single company--is called flushing that cash down the toilet.
The objective of anyone with a single position composing a majority of their value, or even anything much larger than a double-digit-percentage, should be to get out as quickly as possible. Why? Tail risk associated with your position introduces volatility cost into your portfolio, and the risk alone chips away at the value. That $580 million was probably already worth less than $500 million the instant that they decided to do a stock swap, just because of the volatility risk of being that undiversified.
Lesson learned: get a third party financial adviser who will mediate with Goldman for you on your half-a-billion-dollar deal. Don't pay Goldman a flat fee disincentivized from performance. And NEVER leave all that equity tied into a single position. Yes, Goldman could be at fault here, but it would in the same capacity that a negligent driver is at fault for rear-ending someone who let their brake-lights burn out without replacement.
The objective of anyone with a single position composing a majority of their value, or even anything much larger than a double-digit-percentage, should be to get out as quickly as possible. Why? Tail risk associated with your position introduces volatility cost into your portfolio, and the risk alone chips away at the value. That $580 million was probably already worth less than $500 million the instant that they decided to do a stock swap, just because of the volatility risk of being that undiversified.
Lesson learned: get a third party financial adviser who will mediate with Goldman for you on your half-a-billion-dollar deal. Don't pay Goldman a flat fee disincentivized from performance. And NEVER leave all that equity tied into a single position. Yes, Goldman could be at fault here, but it would in the same capacity that a negligent driver is at fault for rear-ending someone who let their brake-lights burn out without replacement.
I mean for a deal like that, the immediate question is "why no cash?" Cash is operating capital and it requires business commitment to pay for it. Equity is an accounting entry, limited only by laws and bylaws of the organizations.
The only reasons I can think of are:
1) The stock of the purchaser is overvalued and the purchaser knows it,
2) The purchaser doesn't want to spend operating capital on the acquisition...., or
3) The purchaser doesn't have the operating capital to spend on the acquisition.....
1 and 3 seem likely in this case.
The only reasons I can think of are:
1) The stock of the purchaser is overvalued and the purchaser knows it,
2) The purchaser doesn't want to spend operating capital on the acquisition...., or
3) The purchaser doesn't have the operating capital to spend on the acquisition.....
1 and 3 seem likely in this case.
This sort of story makes me feel the as horrified and disgusted as I do when I hear a story about how someone's child was molested by someone they trusted.
I can only hope that if, in the course of the trial, it is established that these are the facts. That Goldman pays dearly for it.
I can only hope that if, in the course of the trial, it is established that these are the facts. That Goldman pays dearly for it.
If you equate business malpractice with child abuse, you need to take a long, hard look at your priorities..
To the Dragon deal, Goldman assigned four bankers, two in their 20s and one in his early 30s. That wasn’t unusual. Although Dragon Systems was worth everything to the Bakers, the company — with $70 million in revenue and 400 employees — was small beer on Wall Street.
Illustrating why you don't want to be a small fish in a big ocean. Should have gone with a smaller, hungrier firm.
Illustrating why you don't want to be a small fish in a big ocean. Should have gone with a smaller, hungrier firm.
I feel for the Dragon founders, but with $580 million of L&H stock at one point, they also could have and should have done some prompt and serious hedging/collaring. Perhaps they did, but not nearly enough?
Was L&H public though?
Statements in the article like "Dragon was wondering why L.& H.’s share price had been gyrating wildly" made me think L&H must have been public. (Before the recent emergence of pre-IPO secondary markets, a private company wouldn't even be commonly described as having a generally-known 'share price' unless/until it went public.)
Wikipedia confirms L&H had gone public on NASDAQ in 1995:
http://en.wikipedia.org/wiki/Lernout_%26_Hauspie
Wikipedia confirms L&H had gone public on NASDAQ in 1995:
http://en.wikipedia.org/wiki/Lernout_%26_Hauspie
If I am reading the story correctly it was.
"And Mr. Elliott assured Ms. Baker that investors were worried about the market in general, rather than L.& H. in particular"
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There were a few things that were hard for me to follow in this article:
1. If the company was worth $1B before as X before selling it to Y, wouldn't Y+X be at least worth $1B?
2. If L&H made fraudulent claims, why not make a claim against L&H to recover the software, brand, intellectual property? According to the Wikipedia page (http://en.wikipedia.org/wiki/Lernout_%26_Hauspie) their software ended up being bought by Nuance (Siri).
1. If the company was worth $1B before as X before selling it to Y, wouldn't Y+X be at least worth $1B?
2. If L&H made fraudulent claims, why not make a claim against L&H to recover the software, brand, intellectual property? According to the Wikipedia page (http://en.wikipedia.org/wiki/Lernout_%26_Hauspie) their software ended up being bought by Nuance (Siri).
Here is a better example:
X = acquiring company, worth $2B ($1B in debt, but future earnings valued at $3B) Y = acquired company, worth $1B ($0 debt, $1B future earnings)
Merger:
X+Y = $3B (+ some factor account for cost savings or new revenue streams)
Company X was lying about their sales:
X+Y = $0B ($0B from future earnings, $1B in debt + $1B from company Y)
Company declares bankruptcy and debtors come in and get every asset with any value. Shareholders value = $0.
X = acquiring company, worth $2B ($1B in debt, but future earnings valued at $3B) Y = acquired company, worth $1B ($0 debt, $1B future earnings)
Merger:
X+Y = $3B (+ some factor account for cost savings or new revenue streams)
Company X was lying about their sales:
X+Y = $0B ($0B from future earnings, $1B in debt + $1B from company Y)
Company declares bankruptcy and debtors come in and get every asset with any value. Shareholders value = $0.
Bankruptcy is a laundromat for assets, it's pretty much impossible to get them back.
The people holding Bernie Madoff paper had no trouble standing in line for a share of the recovery, and the people who had gotten too much out had no barrier to getting it clawed back.
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“We guided them to a completed transaction.”
I noticed that too. It's a real-life "The operation was successful but the patient died".
I don't understand why we don't require investment bankers to be licensed, the same way we require lawyers to be licensed, and require as a condition of obtaining and maintaining that license that they take a course in ethics, and they operate ethically in regard to their clients.
If a big law firm did the kind of questionable things toward a client that Goldman Sachs did with Dragon, there would be people up for disbarment.
If a big law firm did the kind of questionable things toward a client that Goldman Sachs did with Dragon, there would be people up for disbarment.
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Very interesting article with ties to Wall St as well as Siri. It should serve as a reminder that in business dealings, only -you- have your best interests in mind.
Virtually every business entity and sub-entity, large and small, have customers and vendors. Customers generally expect to receive a worthwhile expertise, product or service from a business. Along the same lines, vendors generally seek to provide worthwhile expertise, product and/or service to a business.
The provision of these products and services at all levels may or may not involve:
A) Either a vendor or customer of the business desiring or actively seeking to harm said business (i.e., the opposite of the businesses best interest)
B) Either a vendor or customer of the business having no opinion or and no interaction whatsoever with said business outside of the provision of product and/or services (i.e., having no interest in the business)
C) Either a vendor or customer of the business intending to help and/or provide worthwhile help to said business (i.e., having the businesses best interests in mind)
It is quite possible that a businesses vendors and/or customers do have said businesses best interests in mind (example C above). Examples A and B are also possible.
Saying that "only -you-" have your best interests in mind is certainly a possibility in some dealings, but my guess that other scenarios are also common.
I agree that it may be wise to assume negligence and double check extremely important matters to a much greater degree than normal. The scenarios outlined in the linked article are a perfect example of negligence, inexperience and lack of communication at many levels. But, at some time, you simply must trust others and can only use your wits, experience and the expertise of even more parties to ensure that those involved in your dealings are doing what they should to the highest professional standards.
The provision of these products and services at all levels may or may not involve:
A) Either a vendor or customer of the business desiring or actively seeking to harm said business (i.e., the opposite of the businesses best interest)
B) Either a vendor or customer of the business having no opinion or and no interaction whatsoever with said business outside of the provision of product and/or services (i.e., having no interest in the business)
C) Either a vendor or customer of the business intending to help and/or provide worthwhile help to said business (i.e., having the businesses best interests in mind)
It is quite possible that a businesses vendors and/or customers do have said businesses best interests in mind (example C above). Examples A and B are also possible.
Saying that "only -you-" have your best interests in mind is certainly a possibility in some dealings, but my guess that other scenarios are also common.
I agree that it may be wise to assume negligence and double check extremely important matters to a much greater degree than normal. The scenarios outlined in the linked article are a perfect example of negligence, inexperience and lack of communication at many levels. But, at some time, you simply must trust others and can only use your wits, experience and the expertise of even more parties to ensure that those involved in your dealings are doing what they should to the highest professional standards.
Businesses may share common interests with their vendors or customers but they also almost always share conflicting interests. Unless both parties' interests completely align with each other's, I can't see how a vendor/customer can be considered to have the business's best interests in mind.
The article says Dragon agreed to pay Goldman a flat fee of $5 million. What if Goldman did perform due diligence, reported the issues to Dragon, and caused the deal to get cancelled, would Goldman still get $5 million? I don't think so, but if their agreement says they should and I were in Goldman's shoes, I would find reasons to recommend against the deal, because, to earn $5 million, it seems much easier to just advise against the deal than to assist the transaction and bear the risk of a bad outcome. On the other hand, if Goldman gets nothing (or a fraction of the $5 million fee) in the event that the deal gets cancelled, it would be in Goldman's best interests to see the deal go through and avoid performing any potentially deal-breaking services (e.g. due diligence) not specified in the written agreement.
There are scenarios where vendors or customers do have the business's best interests in mind. One such scenario is when the vendor or customer has very close family relationship with the business owner (e.g. husband-wife, father-son, etc.) These scenarios are uncommon. To be on the safe side, I agree with the sentiment that only you have your own best interests in mind.
The article says Dragon agreed to pay Goldman a flat fee of $5 million. What if Goldman did perform due diligence, reported the issues to Dragon, and caused the deal to get cancelled, would Goldman still get $5 million? I don't think so, but if their agreement says they should and I were in Goldman's shoes, I would find reasons to recommend against the deal, because, to earn $5 million, it seems much easier to just advise against the deal than to assist the transaction and bear the risk of a bad outcome. On the other hand, if Goldman gets nothing (or a fraction of the $5 million fee) in the event that the deal gets cancelled, it would be in Goldman's best interests to see the deal go through and avoid performing any potentially deal-breaking services (e.g. due diligence) not specified in the written agreement.
There are scenarios where vendors or customers do have the business's best interests in mind. One such scenario is when the vendor or customer has very close family relationship with the business owner (e.g. husband-wife, father-son, etc.) These scenarios are uncommon. To be on the safe side, I agree with the sentiment that only you have your own best interests in mind.
It should also serve as a reminder that stock is just a piece of paper (not even that anymore, just bits in a computer) until you can sell it.
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A piece of paper you can sell for numbers that represent pieces of paper
All 4 rules were broken here. Seller beware.
Reasons?
When someone swaps a stock - they implicitly value it less than what they get. Hence if you swap your stock with someone else, the buyer implicitly states that your stock is worth more than theirs. Losing deal.
Would you marry someone you didn't trust? No. Then why would you swap your baby for theirs?
Certain return with someone you trust is 10x better than a "certain" return from a flaky agent.
Nullify any agreements that don't put cash in the bank and give you more risk than reward. Take the breaker clause. Or lose everything.