What Just Happened With OnLive?

Disclaimer: I’m not an investor in OnLive and I know nothing about the specifics of what happened. I’m just speculating, but it’s informed speculation based on my experience.

I read a few articles over the weekend about OnLive potentially going out of business, potentially screwing its employees, and a few other things. The first articles were weirdly hostile with a focus on how OnLive just laid all their employees off in preparation for a sale in order to enrich the founders/investors at the expense of the employees. By the end of the weekend the reporting was more thorough and balanced.

Companies fail – all the time. It’s part of entrepreneurship. It’s painful and sucks when you are part of a company that fails (I know from experience – I’ve been there many times) – whether you are a founder, employee, or investor. But failure is part of it and at the moment of acceptance of failure, a good founder and board look for the most graceful path forward, however messy and yucky that might be.

One of those approaches is something called assignment for the benefit of creditors (ABC). If you were around during the collapse of the Internet bubble, you’ll remember this. It’s a lot easier and quicker than a formal bankruptcy (via a Chapter 11 filing) and allows the assets of a company to quickly be sold to a new owner. In some cases this is just for cash to pay off creditors; in other cases it’s a way to sell the company to a new owner and keep the business operating.

OnLive looks to me like the second case. The news is coming out that it has a new owner, that many of the employees have already been offered jobs post ABC, and that the service will continue to operate and customers won’t be negatively impacted.

The key thing to understand in an ABC is that 100% of the equity is wiped out and deemed worthless. The founders equity, the investors equity, and the employees equity. When a company goes into ABC, it’s almost always because the value of the liabilities far outweighs the perceived value of the assets. No buyer was found that was willing to take on the liabilities while giving the equity holders any economic value. So – an ABC effectively “cleans this up” for the new owner – compartmentalizing the liabilities in the ABC process and using the proceeds from whatever asset sales come out of ABC to pay off some portion of the liabilities.

Occasionally investors will get something in an ABC because they are creditors. If the last round (or rounds) have been in convertible debt, or just straight debt, the investors (whoever holds the debt) will be creditors. They can often be pretty high up in the creditor stack and sometimes recover some or all of their debt. But their equity will almost always be worthless.

In a situation where the company is immediately purchased out of ABC (which is what it looks like happened in OnLive’s case) many of the employees will be rehired by the new owner. While their stock options will be worthless (as is all equity) they are often immediately offered new stock option packages. Usually the vesting clock resets completely; sometimes a new owner will be extra generous and offer a shorter vesting term.

In OnLive’s case, it feels like the company simply ran out of options and couldn’t find a new investor or a buyer who would take on the company outside of ABC. Rather than shut down, they found a buyer / investor (which could be a subset of the existing investors) who would recapitalize the company and keep it going as long as he didn’t inherit the liabilities. Hence, the ABC process.

Rather than screwing the employees to enrich management, this feels to me like a pretty employee friendly approach. Hopefully the stories this week will clear this up, rather than end on “it looks like the investors and the founders screwed the employees.”

Don’t ever forget that failure is part of the process.

  • Hmm, still, despite being ’employee friendly” I am sure it’s rather demoralizing for most employees with options to be fired, then re-hired and starting from scratch with new options. They was likely a better way for Perlman to handle of this.

    • Maybe and as I said I’m just speculating. But many ABC’s work this way – it’s an artifact of corporate law. The fact that people are fired and rehired is simply “the ABC process” since they are being hired by a new entity.

    • What would that better way be? I can’t see one. The only way of being more ’employee friendly’ I can think of in this situation is to shorten vesting on the new stock as a gesture of goodwill from the new investors.

  • I am a restructuring guy by trade, so I work on bankruptcies and wind-downs all the time. Brad is exactly right here – there is almost certainly no value to the company’s equity, so it’s not like the employees lost anything. 5% of $0 is still $0. If there was money left over after satisfying all creditors and preferreds, they will get their pro rata share of it, so I don’t understand how an ABC is “unfair” to employees. The number that got to keep their jobs is staggering to me – the trend in restructurings these days is liquidation, not reorganization, which means everyone loses their job and may not even get their last paycheck.

    Furthermore, they might end up being better off if they get options in NewCo at a much lower (and more realistic) valuation, assuming the company ends up a success. Employees who joined OnLive back when it was valued over $1bn needed a gigantic exit to give value to their options. If you get options in the same company but with a valuation some fraction of that, how are you not much better off?

  • James Mitchell

    With ABCs, I thought the issue was that every creditor has to assent to the ABC, and if not, the company needs for file for bankruptcy. (In bankruptcy, the creditors do not have a choice but to assent to the court’s jurisdiction.) Am I right about ABC?

    • You are correct – all of the creditors have to consent to the ABC. However if you use a credible firm like Sherwood Partners (http://www.shrwood.com/) it’s much less expensive than going through bankruptcy. As a result, most creditors realize it’s a negotiation and would rather get more of the money faster (as most ABCs work out faster and cheaper than bankruptcies).

  • While it’s possible to do the ABC, the way this seems to have been handled was at least inconsiderate, if not outright unethical.

    What about employees who are not hired back? They can’t buy their vested options (not that they should have any confidence in option value).

    Why was this handled all at once rather than as a progressive, orderly reorg?

    It seems to me that the company had plenty of capital at some point, but was so poorly managed that it was beyond the cliff. It’s not as though the CEO had no idea about the runway.

    The manner in which it was handled was incredibly–and unnecessarily–disrespectful to the employees.

    From what we can tell, anyway (including from employee comments at HN)

    • 1. Vested options: They are worthless so there is no reason for anyone to buy them in any case.

      2. Progressive orderly reorg: I don’t know the details but often a new investor or buyer will only fund contingent on an ABC in downside situations like this. So there is no other option.

      3. Plenty of capital: I don’t know enough about the company to have a judgment but often companies that are well capitalized burn a lot of cash quickly with the hope of raising more in the future. In this case it looks like the only way they could do it was to do an ABC.

      I don’t get the incredibly / unnecessarily disrespectful part of this.

      • You walk into work one day, and you’re told that you’re fired, there’s going to be a new company and you might be rehired, but many of you won’t. The timing alone is disrespectful.

        Capital–the company had a few hundred employees and operations over several years. So they had capital, and a burn rate, but managed into a crisis shutdown that left employees stunned and unemployed.

        Options–new options will be issued to the founder and rehired employees. Fired employees contributed to the assets. Let’s say with the new, leaner company and a responsible manager that they flip it in 12 months. Everybody makes money, except the employees who participated in building the assets that carried the new company forward.

        Just feels wrong to me.

        • So that’s not an OnLive problem. That’s an “any company that goes splat” against the wall problem that gets bailed out by a new investor. In many cases, they want to incent some set of people going forward, which could include the original founder. Recognize that all of the equity up to that point is likely worthless, regardless of how hard people worked. So it’s a tough balance but the new investor views it objectively – I’m going to incent people from this point forward.

          • Yeah, I get it. I guess it was the manner in which it was delivered. Thanks for replying.

      • Neither do I. I imagine the management was in a box.

  • I was active in the game tech market when OnLive and Gaikai were demoing at the E3 conference. OnLive blew huge amounts of cash on booths, staff, kit, and so on. They talked a lot about cloud gaming, but had precious little product to show. Gaikai rented a hotel room suite that the two founders and their new CEO Dave Perry used to give one of the best tech demos I’ve ever seen. Mitch Lasky from Benchmark invested soon after. I left the games industry, and didn’t follow the two companies too closely, but I wasn’t at all surprised to see that only six weeks before the OnLive debacle, Gaikai sold to Sony for $380m.

    Failure is part of capitalism, but conserving capital, hiring right and getting smart people on your board are three good ways of preventing it happening to you.

    • That is a very correct statement!

    • Failure is part of capitalism, but conserving capital, hiring right and getting smart people on your board are three good ways of preventing it happening to you.”

      This is brilliant and I think we all need to be reminded of this more often. The best companies in the world are the ones that are incredibly mindful of their capital and choose to spend it wisely.

      Thanks @twitter-2267:disqus

  • Excellent balanced analysis.

    I would be in favor of sweeter vesting because if you have bought at a good price why not start off on the right foot with your new/old employees, but others may legitimately disagree. It’s a judgement call.
    I few comments have been to the effect that employees should have been kept more in the loop etc etc. I very much doubt that would have been possible or even in the interests of the employees who got to stay. Leaks would have made negotiations harder, morale would have suffered etc. It is similar to cuts, if you are going to do it cut hard then manage the pain.

    • Well said on more communication prior to the ABC event. It’s also my experience that there’s still a teeny bit of hope until the moment the board decides to go ABC.

      • For sure. ‘Hope springs eternal…’ And of course the founder(s) is being wiped out too.

  • What are the IRS tax consequences to ABC for the investor? Are you able to write off the loss even though the company has technically not gone through formal bankruptcy? Economically and via accounting, your equity is wiped out so you have no chance of getting anything back. Seems obvious that you should be able to write off the loss, but you never know!

    • Yes – you can write off the equity as a tax loss if the company goes through ABC.

  • Today’s SJ Merc has an article that says OnLive owed creditors $30m-$40m and was days away from a “hard shutdown.”


    • I was just about to post this. It also speculates a recovery of $0.05 – $0.10 to creditors, which means anyone higher up in the capital stack got wiped out. No idea what their balance sheet would have looked like, but if all $40mm is unsecured and they forecast a 10 cent recovery, the cash portion of the purchase price from the new buyer couldn’t have been more than $5mm or so. The enterprise value of NewCo will be higher because it probably took over some leases and other liabilities from OldCo, but total capitalization of NewCo is probably under $20 million.

      Which, if you are an employee and get stock in NewCo, is great news for you. Get back to that $1bn valuation and whatever stock you got now is up 50x!

  • Pingback: North Brunswick()

  • Pingback: - Speedy 20()

  • Pingback: cheap auto insurance las vegas()