The Mystery of 38 Studios Demise

First and foremost, the news that 38 Studios has laid off all employees is an economic disaster for Rhode Island and a personal tragedy for the individuals and their families affected. Employment-wise, Rhode Island is in much worse shape than Massachusetts, ranking 50th (out of 51) in unemployment rate at 11.2 percent. Massachusetts is 14th at 6.3 percent.

And this is a big layoff for that state, with 288 employees laid off in-state and another 91 laid off out-of-state (primarily in Maryland). Over the past 10 years, Rhode Island has averaged 63 “mass layoff” events per year, at an average of 134 employees laid off per event. So 38 Studios demise is roughly twice that.

One really puzzling aspect of this for me is how dramatically the company missed. This is the not the case of needed a few more months of runway. 38 Studios was a cash-burning machine — with some back-of-the-envelope stats and assumptions — it appears that the company’s salary and benefit costs alone were close to $3.4 million per month. Given that they had at least another year of development to go, if not more, then you can see the funding challenge. The notion that a few more million in tax credits was the solution is not rational.

There still seems to be a disconnect here — it’s obvious from the financials and timeline that additional funding was needed, but Curt Schilling was reportedly unwilling to part with a substantial equity stake. Something had to give in this scenario, and it finally did.

Lastly, it’s increasingly clear that we should be skeptical, hugely skeptical, when public funds come in and try to change the laws of financing. Absent the state of Rhode Island, an appropriate follow-on investor (after Schilling’s initial investment), was a equity investor who would be willing to take a large risk for the chance at substantial reward in the future. The fact that none has surfaced over the past six months suggests either an unwillingness to part with equity or the perception of the potential for the reward in the end was not widely shared.

Instead, Rhode Island stepped in with a loan and demanded a modest return for a dramatic risk. And of course, Schilling took the loan — it preserved his ownership stake at incredibly low cost.

There’s a functioning market with rules for different types of financing for different types of assets. States trying to change those rules do so at the peril of their taxpayers.

Crossposted at Pioneer Institute’s blog.