In the late 1960s and early 1970s tech boom, my best friend Peterâ€™s father left his law practice to be general counsel for a startup.
The company aimed to solve the nationwide affordable housing shortage through new tech modular housing. They mass-produced housing modules for sale at low cost to governments to assemble in multiple configurations. The problem would be solved.
Flashy brochures showcased the founders posing with the Secretary of Housing and Urban Development and offered detailed drawings of the assembly process. Mr. Newman, to his credit, said it was a speculation, but I wanted in. After the initial public offering (IPO), my Dad and I bought 10 shares for $170.
Around that time, Peter left our class for a local private school. He made friends with wealthy kids with famous local names, while I worked after school, played piano and competed in bridge tournaments. I watched the companyâ€™s stock price and my Dad and my growing paper profits.
But then, a few years later in high school, I was reading The New York Times. On the front page, above the fold, a headline blasted that Mr. Newman was indicted in connection with company misdeeds and fled to London. I didnâ€™t understand the articleâ€™s business jargon but sure as heck grasped the significance of my friendâ€™s fatherâ€™s name and “felonyâ€ together in the greatest paper in the world.
Later, the whistleblowerâ€™s wife wrote a book where we learned the sorry story.
In any boom, investors in new companies want sales growth now and figure the cash comes later. What investors in Mr. Newmanâ€™s company wanted, they got.
Meanwhile, inside the company execs saw that the demand not only didnâ€™t reach expectations but also was slowing. And as soon as they reported slowing numbers one quarter, Wall Street would torpedo the stock, along with their wealth.
Backed into a corner, the company kept on producing modules and growing unsold inventory. But they counted each new unsold module as a sale, even though they received no cash and had no reasonable prospect of doing so.
Business rules donâ€™t change. You either produce cash in excess of expenses or shut the doors. The companyâ€™s day of reckoning came soon, when the financial officer blew the whistle. As General Counsel, Mr. Newman was immediately suspected. He fled, returned, served time, and faded away, a devastated familyâ€”let alone stockholdersâ€”in his wake.
Peter left college to help care for his mother and younger siblings. After what I can only imagine to be years of struggle, he attended business school where, ironically, his fatherâ€™s companyâ€™s revenue recognition games became a case study.
Eventually, he grew wealthy through business success. Yet regardless of accomplishments, I bet neither Peter nor is siblings will ever forget the events that ended their youth.
The story is an example in Chapter 2 of John Del Vecchio and my book, where we hope it will serve as a warning. Fictitious revenues are as much a temptation today as they were thenâ€”and just as dangerous to investors.
Tom Jacobs is the Marfa-based Investment Advisor for Dallasâ€™s Echelon Investment Management. You may reach him at [email protected] and 432-386-0488.