City’s loan for convention software firm keeps growing

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Area residents who pay sales taxes in Minneapolis might not know it, but they’re supporting a high-tech Internet-based for-profit start-up company. The city’s Convention Center account, which collects several city sales taxes, lends money to a company called internet Destination Sales System (iDSS), a for-profit company that the Greater Minneapolis Convention and Visitors Association (GMCVA) started about two years ago.

The company sells Internet-based computer services to other cities’ convention and visitors associations. The associations use the system to manage and manipulate data on their area’s hospitality offerings so convention planners can quickly see what’s available and when. And, scheduled to begin next month, iDSS will offer online convention and hotel registration services.

The city established a $2.5 million credit line for iDSS in January, 2004; extended that to $5 million in July, 2005; and, last week, extended it to $10 million. According to City Finance Officer Patrick Born, the money in the Convention Center accounts can only be used for center-related expenses, and cannot be used for “general fund” expenses such as public works and police and fire protection.

To fund the Convention Center account, the city collects a 0.5 percent sales tax on any city purchases subject to Minnesota’s sales tax, plus a 3 percent citywide large-hotel tax and 3 percent downtown-area restaurant, bar and entertainment taxes. That was about $55 million in 2005; Convention Center revenues contributed another $16.2 million. Including interest revenue and after center-related expenses, the fund produced a $6.2 million surplus in 2005, Born said. However, that’s not the case every year. In slow-economy years, when sales tax collections are down, the fund sometimes loses money.

Who’s who here, and is it for profit or not?
GMCVA is not directly a part of the City of Minneapolis, but it’s an independent nonprofit corporation that has a very special relationship with the city. Part of its mission is to “sell” Minneapolis to convention and meeting planners who can bring large numbers of people to Minneapolis to rent the Convention Center’s facilities, fill up downtown hotel rooms and spend money at downtown restaurants.

The mayor and six Minneapolis City Council members sit on GMCVA’s 43-member board of directors. And the city uses the Convention Center account to contract with GMCVA for about $7 million a year (GMCVA’s total annual budget is about $9 million).

The startup company, iDSS, is a for-profit firm, but the nonprofit GMCVA, which gets most of its money from the city’s sales taxes, owns all of its shares.

And, while GMCVA is nonprofit and government-funded, most of its members represent profit-making businesses, and if GMCVA does its job, it will increase profits for Minneapolis-area hospitality businesses.

Does the city have collateral?
The answer is, yes and no. The city has claim to any assets iDSS has and any profits it makes, as long as the loan money is outstanding. However, according to a Nov. 30, 2005 iDSS balance sheet provided by the City of Minneapolis, iDSS only had $419,806 in assets, and owed the city almost $5 million.

As of Nov. 30, iDSS had no profits; it had lost almost $4.5 million.

And, the city’s claim to assets and profits makes iDSS unattractive to private investors, who aren’t likely to put their money in without being promised a “piece of the action” when and if the company becomes profitable. And that would weaken the city’s financial position in the company.

If iDSS doesn’t pay back the loan money, the city can take it out of the money it appropriates for GMCVA. That provides some security for the $10 million line of credit; however, city officials point out that if the city takes that money from GMCVA’s appropriation, it will hinder GMCVA’s ability to do the work the city wants it to do.

Some history
GMCVA President and Chief Executive Officer Greg Ortale said that several years ago, GMCVA was looking for a software program for its operations. They looked at everything that was available in the market, he said, and none of the programs provided what GMCVA needed.

In 2002, GMCVA hired Eutech Cybernetics, a Singapore firm, to develop a custom software package. “It worked very well,” he said, and they continued developing the software in 2003. Then, he said, “we started to realize that it was going to be very expensive,” and proposed a joint venture with Eutech, to not only develop the software but to market it to convention and visitors associations elsewhere.

GMCVA people also saw the enterprise as a way to make GMCVA less dependent on city tax dollars. City officials had asked GMCVA to find ways to become more self-sufficient.

So why isn’t it making any money?
The joint venture, iDSS, started in January, 2004. Later in 2004, however, problems developed. Ortale said Eutech had “staffing issues [that were] causing problems for the company.”

Kevin Cattoor, iDSS president and chief executive officer, said Eutech was developing multiple structures for manipulating clients’ data, which made software upgrades cumbersome and time consuming. GMCVA preferred a single data-handling structure.

Cattoor became president and CEO in September 2004, and began “positioning GMCVA to own 100 percent of the company,” he said. GMCVA and Eutech parted in January, 2005, he said, which left the new iDSS, now completely owned by GMCVA, to develop the software from scratch.

“We basically had to start over,” he said, and they had another problem: The company’s 12 customers were using the Eutech product, and iDSS had to continue serving them while the new software was developed.

“We probably lost a year…over a year,” he said. And, “we underestimated what it was going to take to develop [the new software] and convert the charter customers.”

In addition to the lost time, iDSS paid Eutech $250,000 to buy out its interest.

Cattoor said he isn’t certain when iDSS will become profitable, and acknowledged that one of the major risks the company faces is “being able to ramp up the revenue fast enough.” He said it will probably be sometime between mid-2007 and mid-2008 before the company starts making money. And, he added, unexpected delays and expenses are very common when a technology-based firm is starting up.

He said competition from other software vendors is “not my biggest risk…because of the effort involved” to create a product suitable for iDSS clients. “It’s a niche system,” he said. “I don’t think any other outside party would want to take this on,” he said. “[But] turn that around…the success we have [with a difficult-to-develop product] will make it attractive for acquisition.”

Because the system is entirely Internet based, customers don’t have to buy special computers or software to use the iDSS system, and they can use it from any computer that can connect to the Internet. When all systems are up and running, Cattoor said, customers will pay iDSS between $500 and $5,000 per month, depending on how many people in the customer organization have access to iDSS programming.

He said the company now has almost 40 customers, including the convention and visitors organizations in London, England and Sydney, Australia.

Cattoor said iDSS can be successful for GMCVA and the city in two ways: It can become profitable and create a revenue stream, or it can be sold to a private operator with the proceeds going to GMCVA, making it less dependent on city funding.

Where has the money gone?
Financial statements from Nov. 30, 2005 indicate that iDSS had less than $20,000 in revenue in November; less than $370,000 for the first 11 months of 2005. The company had more than $1,985,000 in losses before 2005.

November expenses were more than $248,000; with more than $147,000 in salaries and benefits and more than $19,000 in professional service fees to non-employees.

For the first 11 months of 2005, expenses were more than $2,625,000, with more than $1,266,000 in salaries and benefits and more than $550,000 in professional service fees to non-employees.

Cattoor said attorney fees related to a lawsuit from a previous software provider (not Eutech) that was settled out of court; and contracting out some software development work; caused higher-than-normal professional service expenses in 2005.

Cattoor said the company has 19 employees, including nine software developers, two administrators and two sales people. The rest work in client services, he said.

What are the city people saying?
Born, the city’s finance officer, said the city’s relationship with GMCVA is the only one the city has in which an independent nonprofit corporation operates “basically as agents of the city.” Across the country, however, this kind of arrangement is a “very common way” for cities and convention centers to promote themselves.

The financing arrangement iDSS has is “very unique, very unusual,” he said.

“We do make loans to other groups, other nonprofits,” he said, and “occasionally we dabble [in selling software] we have developed…hardly ever with any success.”

In all of the city’s financing operations, however, there’s “nothing that I can think of that would be anywhere near the financial commitment that we have in this case.”

“It has taken more money to commercialize this software than was anticipated,” he said. Also, some of the company’s operations didn’t meet with city officials’ approval.
“The pricing models and marketing models were incomplete and needed a lot of work,” he said, and when the second $2.5 million credit line was approved, city officials told iDSS to “hire an expert” and get that work done. “That’s taken longer than we thought also,” he said.

Born said iDSS and GMCVA officials thought private equity capital would be available to fund the most recent $5 million credit line, and a private equity offer was received. But Born said the proposed arrangement made city officials nervous.

“It was unclear how much governance control we and GMCVA would have to waive” to gain access to the private capital, he said, but it would likely have meant the city would “give up a considerable amount of the up side [potential profits] and about all of the down side protection that we now have.”

1st Ward Minneapolis City Council Member Paul Ostrow, who chairs the council’s Ways and Means/ Budget Committee, said the city did the right thing under the circumstances in extending the iDSS line of credit, but that it’s “legitimate [to question] how we got to that point.”

“We expressed some discomfort at being in the position of bankers,” he said.

Ostrow and Ortale noted that the latest $5 million is not merely an open line of credit. It can only be drawn periodically, and iDSS has to keep the city better informed on how it’s meeting its revenue projections and other benchmarks in its business plan. Ortale said that if the $5 million credit line (which increased iDSS’ total credit line with the city to $10 million) were to be “maxed out,” that would not happen until some time in 2010.

Ostrow also said that he doesn’t know of any similar city financing situations. “There are other situations where we’ve taken risk, but not this kind of risk,” he said.

“We had to rely on our own people,” he said. “Our own technical people said this is a good product. They believe this product will succeed.”

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