You have a “million dollar idea.” You’ve done your homework. The market is ripe, and nobody is thinking what you’re thinking. All you need is a bit of cash to help you get started. And, that’s the hard part. Despite what you’d tend to believe from such high-profile disasters as the Bernard L. Madoff investment scam, it’s not all that easy to part fools from their money.
It’s a shame, really. Every year, countless great ideas never get off the ground because the funding isn’t available. Or, more accurately, the funding isn’t interested. As a result, wealth is not created. People don’t get rich. There’s a reason why a lot of companies aren’t able to secure the investment they need: They don’t know how.
By understanding where you can find sources of capital, how to approach them, and the information they are interested in seeing, you increase your chances of closing a deal exponentially. But, the odds remain stacked against you. Perhaps the greatest proof of this is the fact that none of my mainstream finance contacts would comment on the record for this story. This isn’t new. But, I’ve spent enough time with them to add insights to the background interviews I was given, and it should add up to information that you can use when you pursue investment capital.
As much as we’d like to think otherwise, institutional investors are still uneasy about investing in porn, but progress is being made, albeit slowly.
What Do Investors Want?
The big institutional investors that have the deep pockets of which you dream aren’t interested in investing $500,000 to make $5 million … or even $10 million. A consultant who helps companies raise venture financing — and is familiar with the adult industry and refuses to be named — says the small numbers don’t register with companies that have to put hundreds of millions of dollars or more into the market every year. “They want to invest $10 million and make $100 million back,” according to my source.
Institutional investors need to be enticed with the promise of substantial returns. Until this happens, the “making money on two people fucking” issue is irrelevant. The immediate problem is both obvious and well documented in the adult entertainment industry. There aren’t many adult businesses that have reached this threshold. Of those that have, few are run effectively.
Friend Finder and Playboy come to mind immediately among the companies with annual revenues above $100 million, and both seem to be trying desperately to turn large companies into small ones. Vivid is reported to have revenues at this threshold, a number which hasn’t changed in close to five years. Even if the company has maintained (rather than lost ground), this suggests an inability for growth once a business has gone from small to, well, not-so-small. After all, in the world of public finance, your company is small until it has attained a market value of $750 million.
This leaves only a handful of businesses that prefer to stay below the radar, behavior that can prevent unwanted scrutiny and at the same time make it virtually impossible to secure outside investment. But, if you were to give the money men a peek under the hood, would they ever invest?
Does Wall Street Invest in Porn?
We all know the answer to this question. Wall Street money does not come into the porn business. Sure, there are some exceptions, but they are rare, quiet, and riddled with caveats. Scott Coffman, from Adult Entertainment Broadcasting Network (AEBN), put it best. He can get a meeting with an investment institution, and he has. The owner of a diversified adult entertainment company, he’s spent time with hedge funds, pitching his ideas and looking for capital. RealTouch was among the ideas that were turned down.
Coffman has come close a number of times, he says. “It always happens at the top. Someone gets cold feet,” he explains, “and nothing happens.” The way he describes the dynamic, it almost sounds scripted. In reality, the situation has unfolded the same way so many times, that it must be hard to make the same story sound fresh. Institutional money may be interested in porn, but it is certainly afraid of commitment.
On a smaller scale, individual high-net-worth investors have put money into specific projects, but this really isn’t enough to change the landscape. I had front-row seats to the creation of RichRoc productions, which produced two adult films — one (Anal NYC) barely sold, and the other (Trust Fund Sluts) never made it to market. The investors fell prey to the notion that “sex sells.” This may be true, but selling does not always equate to profitability.
I’ve met several investors who have expressed an interest in putting money into individual film projects, which is a great way for them to gather porn “war stories” to share with their straight-laced friends, but in the end, the payout never comes. This sort of investment activity exists on the margins of the industry, though, and is unlikely to shape the business in any meaningful way. Rounding up $30,000 or so to make a low-budget flick isn’t all that hard. Finding $3 million to launch a new company, on the other hand, can be quite difficult.
Interestingly, the other extreme may show some promise. While private investments with lots of zeroes on the check are uncommon, publicly traded adult companies have attracted plenty of mainstream cash. A year and a half ago, the California Public Employees Retirement System (CALPERS) had a stake in gentlemen’s club chain – and now diversified adult entertainment company — Rick’s Cabaret. It turned out to be a hell of an investment, as CALPERS caught the wave of aggressive growth that CEO Eric Langan led before the company was beaten up by broader financial market conditions. Financial industry giants such as Fidelity, Goldman Sachs, and D.E. Shaw (among others) have owned shares of adult-oriented public companies, as well.
But, What About Zivity?
Small individual investments and large pension fund plays, however, are not what the adult industry has craved. We’re looking for the largesse of Silicon Valley to be visited upon the San Fernando Valley, with loose-walleted venture capitalists willing to invest in “a story” … as I remember from my days in the dot-com boom. Aside from Tim Draper’s $6.3 million investment in JimmyJane last year, there hasn’t been any noteworthy action … unless you count Zivity.
Zivity has secured a total of $8 million in capital from major venture capital investors, the “Sand Hill Road” guys, in that industry’s parlance. The adult entertainment industry was uniformly excited, because Zivity announced that it was in the “naked people business,” which is a step away from sex, many reasoned. This unfettered optimism, however, may have been misplaced. Zivity is a much different animal from the adult industry, and not merely because founders Scott and Cyan Bannister say that it is (though not in our most recent conversation, as Zivity declined an interview request).
The fact that hardcore sex — and even genital close-ups — are not permitted on Zivity reveals only a superficial difference from the adult entertainment industry. Look beneath the surface and you’ll find a well planned start-up operation from a management team that has founded, grown, and sold several technology companies. The last transaction they celebrated was the sale of IronPort (a centralized anti-spam company) to Cisco Systems for $830 million.
These are seasoned venture capital veterans who have developed relationships, raised capital, and proven they can deliver a return. Consequently, the risk associated with investing in their companies is not as high.
And, they don’t come from porn.
That makes a difference. Venture capital funds are interested in making mainstream-caliber profits and they prefer to invest in ideas that come from people who have track records of generating results.
Homegrown Financing
Fuck the venture capitalists, right? They don’t “get” adult. In fact, we need them less than we did in the past, now that there’s a budding porn finance movement. To a certain extent, the “porn fund” concept is a no-brainer. You take an underserved market, aggregate capital, and choose who the winners will be. Investors can keep their anonymity and reap the returns … without having to do much work. And, the porn industry finally gains access to capital. It sounds great, but the results have been mixed (at best).
Last year, two porn funds sought to make the concept work: Adult Entertainment Capital and AdultVest.
Adult Entertainment Capital opened its doors in September and wasn’t around to see the ball drop over Times Square. It never gained much traction, didn’t seem to raise much money, and struggled to identify (and close) deals in what can only be described as a complicated market.
AdultVest has a more complex story. It’s been around longer than Adult Entertainment Capital and has completed some high-profile transactions (including those contributing to the iPorn platform). Yet, the company is surrounded by controversy, including rumors of litigation (which, in fairness, cannot be confirmed by a source that I consider sufficiently reliable).
According to an interview I conducted with founder and CEO Francis Koenig last November, the company has up to $50 million in assets under management and up to 20 clients. If AdultVest is at the upper ends of these ranges, that would make it perfectly sized to service an industry that does not need the mammoth amounts of cash used in large, mainstream private equity deals. But, Koenig keeps exact financials closely guarded and shares them only with investors.
As the sole survivor of the 2008 “shakeout” that destroyed half the adult finance industry (OK, feel free to chuckle), AdultVest is in the unique position to invest aggressively and grow its market share considerably. Without a major deal, though, it is hard to gauge the extent to which this is possible. iPorn, after all, involves the purchase of a domain name and launch of an operating company, which is not the same as passive investment that may also include the appointment of a CEO or members of the board of directors.
The adult finance business is clearly in its infancy, and we’ll need to see a few more players emerge – along with noteworthy transactions – before this can be considered a viable option for the future of the business.
The Money Right Under Your Nose
Even if the porn funds aren’t far enough along to change the adult entertainment industry, there is cash within our business. We just haven’t looked at it as possible investment capital. Last year, the mergers and acquisition (M&A) trend from 2008 accelerated, and it has continued this year. While you may not think these deals “count,” they are, in fact, quite real.
For the near future, M&A among ourselves is likely to be the most prominent and voluminous form of investment in the adult entertainment industry, and it is far from trivial. Many have experienced the urge to merge, and trying economic conditions will only yield more activity. If you are looking to sell your company or jumpstart a new venture, your acquirer or partner is most likely to be a company you currently call a competitor.
This is a good thing.
In addition to filling a financial void in the adult industry, company-financed investments will help us establish a track record. A company that is small by mainstream standards can become considerably larger through a steady diet of acquisitions. As it completes deals (and grows), the company will learn more about the intricacies of mainstream finance. The management team will become more familiar with financial structures, due diligence, and strategic planning. The lessons from each acquisition will be absorbed and applied the next time around. These are the tools of the mainstream finance trade, and mastery will make a difference in conversations with institutional investors down the road.
Consider a hypothetical company that has grown from annual revenues of $50 million to $150 million through both organic revenue growth and a busy M&A agenda over two years. It has healthy profit margins and a savvy executive team. Because the company learned the importance of financial statements, external audits, and integrating the acquired into the mother ship following the acquisition, the CEO will be able to show his scars to mainstream investors. Key leaders will be able to explain how invested funds would be applied and demonstrate — with examples — how it has executed a growth plan.
Today, most adult company executives can only say, “I intend to ….” After having mastered the art and science of M&A, these same industry leaders will be able to declare, “Well, this is what I did during my last three acquisitions, and it grew our top line by 25 percent without impairing profitability.”
See the difference? The venture capitalists sure do.
A Long Road, but it Leads Somewhere
I know I’m among the adult industry’s most brutal pessimists. Not only do I suspect that the broader financial crisis will persist for a while, I believe it’s going to be particularly tough for the adult business, which provides something more akin to a luxury item than a consumer staple. People will buy groceries before they buy porn.
Despite the challenges ahead, there are signs of hope. Adult companies are acquiring adult companies. The industry is maturing. These small steps will gradually attract the interest of mainstream financiers.
It’s going to take time for Wall Street to embrace adult. Investment in publicly traded porn businesses is a positive sign, and Draper’s investment in JimmyJane is a small step in the right direction. We’re far from a critical mass, but adult has moved from the financial hinterlands.
For now, the most profound development has been a change in attitude in our business. Two and a half years ago, finance was not on the porn industry’s mind. Efforts to secure financing may have been pursued in the shadows, but they were far from the headlines. Since then, we’ve moved to awareness to experimentation (with the likes of AdultVest and Adult Entertainment Capital) to action, with the wave of M&A that continues today. Adult entertainment has undergone decades of evolution, essentially, in the blink of an eye. The momentum will slow, as it must. But, the forward motion will continue.
The day will come when a porn company rings the opening bell at the New York Stock Exchange in celebration of its initial public offering. I, for one, can’t wait to see the celebration on the corner of Wall Street and Broadway.
This article originally appeared in the June 2009 issue of AVN Online. To subscribe, visit AVNMediaNetwork.com/subscribe
