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Virtual worlds economy

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Virtual worlds economy

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A definition of virtual world asset classes, the virtual worlds ecosystem and the attendant accounting, valuation, taxation and legal issues that arise in virtual world economics.

Audio: http://feeds.feedburner.com/BroaderPerspectivePodcast

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  1. Virtual World Valuation Accounting, valuation, taxation and legal issues in virtual worlds November 2007 Melanie Swan MS Futures Group melanieswan.com
  2. Virtual World Valuation 2 Valuation summary  Virtual worlds are becoming increasingly routine for business, academic and government use  Financial professionals and regulators are now getting involved; there is an opportunity for a leading accountancy to define and lead virtual world accounting and valuation practices  Demand for advisory services is growing along with strategic investment and M&A activity in all areas of the value chain  Doing business in a virtual world is similar to doing business in a foreign country
  3. Virtual World Valuation 3 Agenda  Virtual worlds  What are virtual worlds?  Who is using virtual worlds?  Second Life  Financial perspective  Accounting issues  Valuation issues  Tax issues  Legal and other issues  Industry leadership opportunities
  4. Virtual World Valuation 4 What are virtual worlds?  Definition: 3D online persistent world with a sense of presence and simultaneous experience in context  Examples (over 30 worlds):  Second Life  ActiveWorlds  BrandGames  Entropia Universe  There  Kaneva  MultiVerse  Club Penguin (pre-teen)  WebKins (pre-teen) Source: http://www.virtualworldsreview.com
  5. Virtual World Valuation 5  Game  World Virtual world vs. MMORPG Source: Linden Lab
  6. Virtual World Valuation 6 Who is using virtual worlds? IBM Dr. Dobbs Life 2.0 Conference Princeton International Spaceflight Museum US Congress Second Health Operating Theater Showtime “The L Word”CBS “CSI New York” Vodafone “Inside Out” SLCN “Metanomics”
  7. Virtual World Valuation 7 Second Life is the biggest virtual world  40,000 concurrency (at any time)  475,000 active users (last 7 days)  1.5 m active users (last 2 months)  11 m total accounts  2 m assets created per day  35 TB of user-created data  800,000 unique items sold or traded per month  500 events per day  15 m concurrent scripts  10 Gbps peak bandwidth Source: http://secondlife.com/whatis/economy-graphs.php Million Square Meters of Second Life Land Total User Hours (millions) Source: Linden Lab
  8. Virtual World Valuation 8 Diverse Second Life residents 0 5 10 15 20 25 30 35 40 18-24 25-34 35-44 45+ 0 10 20 30 40 50 60 70 18-24 25-34 35-44 45+  43% female  60% international  Top 5 countries: US, Germany, Brazil, Japan, UK Source: http://static.secondlife.com/economy/stats_200710.xls Resident market share by age tier Average monthly hours by age tier %
  9. Virtual World Valuation 9 Currency: Linden$  LindeX exchange operated by Linden Lab  Buy: USD $.30 transaction fee  Sell: 3.5% transaction fee  Monetary policy Sources: http://secondlife.com/whatis/economy-market.php, http://secondlife.com/whatis/economy-graphs.php, http://secondlife.reuters.com 270 L$ = $1 USD US$ Spent by Users (in Millions) US $ Exchanged on Lindex (in Millions)
  10. Virtual World Valuation 10 Economy  Reuters  Banking and credit  Stock markets  SL Capital Exchange (US, 20 listings)  World Stock Exchange (Australia, 15 listings)  VSTEX (Italy, 7 listings)  Ancapex (US, 3 listings) Source: http://secondlife.reuters.com
  11. Virtual World Valuation 11 Advisory firm presence in virtual worlds H&R Block Island BDO Stoy Hayward Island KAWG&F (Baltimore MD CPA firm), CPA Island Accenture
  12. Virtual World Valuation 12 Virtual world accounting issues  Asset and liability accounting  Precedent by analogy: software and websites  Revenue recognition  Currency related issues  Revaluations and gain/loss  International and regulatory issues
  13. Virtual World Valuation 13 Traditional accounting asset definitions  Asset  Any item of economic value owned by an individual or corporation, especially that which could be converted to cash  Tangible Assets  Assets having a physical existence, such as cash, equipment, and real estate  Intangible Assets  Identifiable non-monetary assets without physical substance  Examples: computer software, licenses, patents, brands and copyrights Source: International Financial Reporting Standards (IFRS)
  14. Virtual World Valuation 14 Are virtual world assets different?  Non-physical, like software  Multi-state / non-persistent  Specific risks of impairment, destruction, infringement  World disappearance  Economic disturbance  Ease of copying  International environment  Low transparency • Physical identity obscured, limited reporting infrastructure
  15. Virtual World Valuation 15 Virtual world asset and liability classification  Intangible assets  Land and real estate  Objects  Scripts and animations  Intellectual property • Patent, trademark, copyright  Liabilities  Loans payable, bonds
  16. Virtual World Valuation 16 Land is the most significant virtual asset  Purchase via auction or resale  Premium membership required ($9.95/mo)  USD $13 + $5 monthly for 512 sq m  USD $1,675 + $295 monthly for 65,536 sq m island Source: http://www.secondlife.com 200720052003 Available plots Available island areas Raw Land Growth of Second Life
  17. Virtual World Valuation 17 Real estate Anshe Chung Second Life real estate developer  Virtual homes, offices and meeting spaces
  18. Virtual World Valuation 18 Objects and scripts
  19. Virtual World Valuation 19 Asset recognition and measurement  An asset is recognized when it meets all of the following criteria  it is identifiable  the entity has control over the asset  it is probable that economic benefits will flow to the entity  the cost of the asset can be measured reliably  Initial measurement at cost of generation or acquisition or other assessment of fair value Holly Kai Golf and Country Club Sun Microsystems Pavilion
  20. Virtual World Valuation 20 Asset useful life, depreciation, disposition  Useful life  Shorter life  Amortization  Software: purchased vs. developed  Non-software: amortized over useful life  Impairment  More frequent reassessment  Retirement and disposal  Disclosure
  21. Virtual World Valuation 21 Revenue recognition and currency issues  Services  Developer • Initial project • Maintenance / support  Other  Site allowance/stipend  Currency issues  Not different from high-risk international currencies IBM’s Forbidden City Sim
  22. Virtual World Valuation 22 Rapidly developing virtual world ecosystem Virtual World Providers Linden Lab/Second Life, ActiveWorlds, Entropia Universe, There, Kaneva, Muse, MultiVerse, vastpark, metaplace, Cybertown, Habbo Hotel, Whyville, Voodoo Chat, Taatu, Traveler, Sims Online, Club Penguin, WebKins, Hipihi, Uonenet, Noviking Virtual Businesses and Brands Anshe Chung Studios, DeCuir Creations, FairChang, Etopia, Hunter’s Cove, SL Boutique, Preen, House of Nyla, Second Life Cable Network, Rezzable, caLLie cLine, PeoplePool, Raven Pennyfeather, Lapointe & Bastchild Designs, InStyle, Vista Animations, Chai Skins, Acedia Albion, AV Puli Animations, Reel Expression, J&S Aviation, SZ Designs, Vindy Vindaloo, Esoterica Couture Virtual World Developers and Agencies Electric Sheep Company, Millions of Us, Rivers Run Red, CMP, Aimee Weber Studio, depo consulting, Forterra, Metaversatility, Wish Farmers, Virtual Worldlets, Icarus Studios, Proton Media, NGI Group 3Di, DAZ 3D, Code 4 3D Physics Engines and 3D Modeling Platforms Havok, Ageia PhysX, Unreal Engine, Open GL, Maya, 3D Studio, Croquet, SoftimageIXSI, Form Z, Strata 3D CX, RenderMan, Blender, Wings3D Investment transaction in 2007 or acquisition
  23. Virtual World Valuation 23 Virtual world valuation issues  Valuation situations  Asset transfer, purchase or sale  Internal accounting  Settlement: legal, estate, divorce, etc.  Valuation considerations  Ownership  Portability to other virtual worlds  Virtual business risks  Intangibles • Intellectual property • Brand value: reputation, management, innovation and human capital
  24. Virtual World Valuation 24 Virtual world valuation issues  Assets to be valued  In-world business: product, service  Brand: sim, business, avatar  Account: avatars/characters, assets  World, economy  Valuation techniques  DCF: emphasize near-term flows, low TV  Sales comparison: Second Life classifieds, stores, eBay  Recent transactions  Multiples: assets, sales, EBITDA, trading  Metrics: customers, contracts, sim and web traffic, conversion Motorati SpokesAvatar: caLLie cLine Coke’s virtual branding
  25. Virtual World Valuation 25 Virtual world tax issues  VAT, sales tax  Income tax  1099 contractors  Gains tax  Challenges of levying tax  Identity verification  Identification of activity  Monitoring, tracking and enforcement  Highly international environment
  26. Virtual World Valuation 26 Legal and other issues  Key rules  Linden Lab: Terms of Service Agreement, Community Standards, Privacy Policy, Digital Millennium Copyright Act Policy  Sim covenants  Dispute resolution  Metaverse Republic  Recent cases  Eros, LLC v. Doe (pending) • Copyright infringement (US $2,250)  Marc Bragg v. Linden Lab (Oct 2007) • Land acquisition via landbots (US $8,000)  Money laundering
  27. Virtual World Valuation 27 The future of finance and virtual worlds  Growth: participants, breadth, size  Formalization of the financial sector  Stock indices and mutual funds  In-world stock market crash  Third-party audit and analyst function  Regulatory initiatives  In-world GAAP  Explicit banking, securities and tax laws  Technical initiatives  Cross-world avatar portability
  28. Virtual World Valuation 28 Industry leadership opportunities  Provide industry leadership  Accounting and valuation white paper  Implement international GAAP / IFRS  In-world third-party audit infrastructure  Client earnings announcements  Audit, valuation, tax, SOX checklists  Support clients in the virtual medium  Accounting and business advisory, virtual dispute resolution  Facilitate internal initiatives  Recruiting, telepresence, collaboration
  29. Virtual World Valuation 29 Valuation summary  Virtual worlds are becoming increasingly routine for business, academic and government use  Financial professionals and regulators are now getting involved; there is an opportunity for a leading accountancy to define and lead virtual world accounting and valuation practices  Demand for advisory services is growing along with strategic investment and M&A activity in all areas of the value chain  Doing business in a virtual world is similar to doing business in a foreign country
  30. Thank you Melanie Swan MS Futures Group Palo Alto, CA melanieswan.com Slides: http//www.melanieswan.com/presentations/Virtual_World_Valuation.ppt Virtual World Valuation Provided under an open source Creative Commons 3.0 license http://creativecommons.org/licenses/by-nc-sa/3.0/
  31. Virtual World Valuation 31 Resources  Getting started in Second Life  http://sl.nmc.org/wiki/Getting_Started  Second Life SLURL Directories  http://nbhorizons.com/list.htm (companies)  http://npsl.wikispaces.com/Tenant+Directory (non-profit commons)  http://edumuve.com/tour/ (international locations)  Event listings  http://secondlife.com/events  http://metaversed.com/ *  http://www.metanomics.metaversed.com/ *  News, blogs, etc.  http://secondlife.reuters.com/ *  http://www.ugotrade.com/  http://www.virtualworldsreview.com/  http://www.metaversemessenger.com/  http://dwellonit.blogspot.com/ (most visited locations) * Finance and Economics

Editor's Notes

  • 51, 51, 153
  • 1000/1000 Virtual world economic activity is substantial (Second Life is over $1m USD/day)
  • Public or private worlds
    ActiveWorlds (supports 400 concurrent av present & chat; private label world platform; 47,000 active in their demo world; Tourist, Citizen, World Owner; can be accessed from FB (TEST VIA MOBILE)
    Entropia Universe – Swedish, 360,000 residents, MM virtual universe, own economy, sold banking licenses to RL banks
    Kaneva: only human avatars, completely modeled after the physical world
    In Aug, Disney acquired Club Penguin for $700m
  • Not MMORPGs because open-ended, no universal goals
    MMORPG examples: World of Warcraft, Ultima Online, Star Wars
    Games have structure, beginnings and endings, Second Life does not. There are many games within Second Life, but the platform and reason for being there is not the game. It’s about the community and knowledge that on the other side of every avatar is another human being.
    Another difference is that the content in games is created by large teams of developers and “consumed” by the customers. In Second Life, the customer creates all of the content and shares it with others in a variety of ways.
  • Variety of individuals and organizations, many people are familiar with the recreational uses, but there is perhaps just as much serious or professional activity
    1000 businesses and 1000 academic institutions; no analyst firm officially following this yet
    Millions of ‘residents’
    Entertainment
    Enterprise: Traditional physical world business migrates in-world + In-world emergent brands
    Academic and educational organizations: Extension of existing eLearning mechanisms
    Science: Intl spaceflight museum, AFM demo, molecule, weather, plane traffic, data visualization platform=google earth
    Government: info, personalized face, modeling disease spread
    Non-profit: Etopia eco-sim with water treatment plant replica
    Using virtual worlds to collaborate, create, interact, enjoy, experience, recruit, demonstrate, prototype
  • SL: the world SL grid: the underlying platform
  • Create an avatar, a visual representation of your presence. This is how you will appear to others in the world.
    Who uses the virtual world? Ordinary people
    Context re: TV hrs/month
  • The only tool is monetary policy
    http://www.benchmark.com/news/sv/2006/10_16_2006.php
  • Banks been around 3 yrs; mostly failed or reorganized; related to casino gambling
    My Second Bank.com
    “Unable to pay depositors, Ginko ceases banking operations”
    The bank, which as of last week claimed to have 18,000 accounts worth a total of L$190 million (US$700,000), said it would issue what it called a “Ginko Perpetual Bonds,” a security on the World Stock Exchange, in an attempt to compensate depositors.
    A gambling ban, insider theft at the World Stock Exchange and a bank run on Ginko Financial within the past week have combined to threaten confidence in the integrity of the Second Life financial sector.
    Financial exchange platforms
    Anshe Chung: Second Life, Entropia exchange
    Stock markets
    Completely unregulated
    Nothing qualifying SL stocks for a registration exemption
    Accounting, valuation and tax issues
    1099 issue, depreciation (software, website precedents)
  • Presence to hold meetings, consultations with clients/potential clients
  • Conceptually, like doing business in another country; the usual risks are higher, there are additional risks. There are currency issues.
  • Different conceptually not fundamentally; we account for them in the same way but with a deeper application of risk, like foreign country
    Not yet fully proven that these are “real assets” though implicitly standing up as so in US legal cases. Not universally tested worldwide. \ Multi-state / non-persistent
    Ones and zeros stored on a computer server
    Chinese MMORPG case re: physical world murder over an uncompleted VW transaction
    Non-persistent / multi-state
    Virtual asset = pixels, ones and zeros stored on a computer somewhere, in a different “un-asset-like” format until rezzed on someone’s screen
    Similar examples: webpage is also stored one way & rendered another; also digital pic sharing sites like flickr. Is a website an asset if no one visits it?
    Non-physical, like software
    Specific risks of impairment, destruction, infringement
    World disappearance, market disappearance
    Easily copied, like software
    Difficult to identify physical entity that is the creator/owner; 1:many avatars (alts)
    Enforcement mechanisms more challenging massively international
    Low transparency: frail reporting infrastructure, anonymity of Paypal, difficulty/lack of recordkeeping,
  • Issues: 1) VW asset = an asset? 2) Tangible or intangible?
    Could have accruals, wouldn’t be any different in the virtual worlds application
  • Looking at an example: Land & RE market: 75 yr / 6 mo; 5000 yr / 450 mo; 13/mo = 150 /yr
    Reserved; moved to eBay enabled auction system mid-Sept 3 mo grace period then reservations lapse
    Island is about 16 acres
    Develop the sim
    Structures, landscape, FF&E, functionality
    Development firm, independent contractor(s), self-develop
    Anything else to place the asset into servicee
  • Homes and offices
  • Appearance more important b/c area for exploration, fun, personalization, more emphasis and expectation b/c can change it
    Shop.onrez.com
    Group: shopping emergency
    Blogs: SL Men, ??
  • These parts are the same
    Initial measurement…plus placing in service
  • Software (sophisticated programming languages):
    Shorter lives from the risk and pace of change of the medium; given the lack of precedent, slot virtual world sim costs in the annual $108,000 Section 179 write-down
    The useful life of an intangible asset:
    Is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.To an entity shall be based on an analysis of all pertinent factors, in particular:        o   The expected use of the asset by the entity.        o   The level of maintenance expenditures required to obtain the              expected future cash flows from the asset (for example, a material level of             required maintenance in relation to the carrying amount of the             asset may suggest a very limited useful life).Shall be considered indefinite, if no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset to the reporting entity.  The term indefinite does not mean infinite.   
    Externally purchased software; 3 or 5 year; external website designer who guarantees the product; 3 year
    Internally developed sw, including website dvpt, can be expensed under R&D
    In audit or SOX work, need to be asking about virtual world sim presence, internally/externally developed and maintained.
    For some companies its just a virtual office (non-software) but others (Eolus) use it as a data platform (software); scripts make it sw
    3 yrs, longer for government or non-profit organizations
    Disclosure
    Lower threshold
  • Talked a lot about virtual world assets – services are another large chunk of the economy but more straightforward from an accounting standpoint
    Life cycle issues with software in perpetual betas, still have significant releases
    Depreciation – when you are outfitting your virtual office with some PP&E, FF&E….depreciate it?
  • http://www.news.com/8301-10784_3-6161999-7.html (Feb 2007 CBS invests $7m in ESC)
    http://secondlife.reuters.com/stories/2007/10/11/omnicom-buys-stake-in-millions-of-us/
    Intel acq Havok Sep 2007 (gaming, movies) trend to high-end chips, graphics processors
  • World longevity risk: technical, M&A or fad, migration from the Sims Online to SL
    Ownership: of what is being valued, of the world
    Reputation, knowledge & skills
    Sim brand (virtual laguna beach, the l word, csi)
    Internal accounting purposes (initial measurement when placing in service, re-assessment, disposition)
    Overall valuation of a virtual economy
    Difficult to size, no vetted published metrics
    Difficult to know full activity: transaction mix of local currency/Linden$ and PayPal
  • X $’s now plus a % of forth-coming profits over the first six months with more emphasis on the % of profits portion
    Software as part of a business purchase: Finally, let's say you buy a business and, as part of the purchase, you get software. This software is likely to be considered a Section 197 intangible (yes, Section 197, not Section 179 — again, go to the IRS Web site). That means it is either not generally available to the public, is subject to an exclusive license, or has been substantially changed. In this case, you have intangible property. And the property will have to be amortized over not 36 months or 60 months, but 15 years.
    Usual business valuation methods
    No problem with an entity valuation; WACC
  • Virtual world owner imposes VAT (at the source)
    When a web development shop builds a website for the NY Times do they charge sales tax? No
    Identification of activity – sex related
    Current status – congress and IRS comment summary
    Monitoring – attractiveness as a money laundering platform
    Taxing Linden-denominated transactions would just shift the activity to PayPal/surrogates
    Identity verification (1:many avatars)
  • http://secondlife.reuters.com/stories/2007/10/25/eros-lawyers-id-john-doe-avatar-youth-denies-hes-catteneo/
    Robert Leatherwood, 19, of North Richland Hills, Tx., as Second Life avatar “Volkov Catteneo.”
    Sold 50 copies illegally obtained of Stroker Serpentine’s EROS LLC SexGen bed with 150 sex animations (L$12,000; USD $45
    Alderman’s team subpoenaed Linden Lab and PayPal for Catteneo’s Internet Protocol addresses, and then subpoenaed Internet service providers AT&T and Charter Communications to determine the real-world billing addresses associated with the IP information.
    Taney, lawyer for Alderman. He said Leatherwood has 20 days to reach a settlement agreement, or he’ll move forward with discovery, where legal depositions will be collected from members of the two households that Catteneo’s IP addresses trace to.
    Linden Lab ejected Bragg from Second Life after he allegedly used an exploit in the real estate auction system to purchase land below market value, and Bragg sued in response. The case recently settled out of court. Terms were not disclosed. LL’s TOS ruled not legally binding. 5 land bots currently operating.
  • Analyst – both market research and securities analyst
    Growth: like eBay, more people will earn supplemental and eventually replacement income
    Formalization of banking, securities and insurance sectors
    Reuters/other to develop stock index
    Virtual worlds index mutual fund (in-world and physical world listings)
    First widespread in-world stock market crash
    Third-party verified digital identity systems; Secure identity identification mechanism (though still waiting for this on the web)
  • Accounting and business advisory services
    International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB).
    Provide industry leadership
    White paper: accounting, valuation and tax issues
    Implement IFRS / international GAAP in virtual worlds
    Setup in-world independent third-party audit infrastructure
    In-world client earnings announcements, analyst conferences: short-term wins; Reuters, others will cover it
    Virtual worlds items included on audit, valuation and tax checklists
    Support clients in the virtual medium
    Accounting, audit, tax, valuation, securities advisory, consulting, SOX compliance, virtual dispute resolution, security
    Facilitate internal initiatives
    Recruiting, conferences and events
    Internal collaboration, teleconferencing substitute
    Accounting, audit, tax, valuation, securities advisory, consulting, SOX compliance, virtual dispute resolution, security
  • 1000/1000 Virtual world economic activity is substantial (Second Life is over $1m USD/day)
  • When a web development shop builds a website for the NY Times do they charge sales tax? No
  • Description

    A definition of virtual world asset classes, the virtual worlds ecosystem and the attendant accounting, valuation, taxation and legal issues that arise in virtual world economics.

    Audio: http://feeds.feedburner.com/BroaderPerspectivePodcast

    Transcript

    1. Virtual World Valuation Accounting, valuation, taxation and legal issues in virtual worlds November 2007 Melanie Swan MS Futures Group melanieswan.com
    2. Virtual World Valuation 2 Valuation summary  Virtual worlds are becoming increasingly routine for business, academic and government use  Financial professionals and regulators are now getting involved; there is an opportunity for a leading accountancy to define and lead virtual world accounting and valuation practices  Demand for advisory services is growing along with strategic investment and M&A activity in all areas of the value chain  Doing business in a virtual world is similar to doing business in a foreign country
    3. Virtual World Valuation 3 Agenda  Virtual worlds  What are virtual worlds?  Who is using virtual worlds?  Second Life  Financial perspective  Accounting issues  Valuation issues  Tax issues  Legal and other issues  Industry leadership opportunities
    4. Virtual World Valuation 4 What are virtual worlds?  Definition: 3D online persistent world with a sense of presence and simultaneous experience in context  Examples (over 30 worlds):  Second Life  ActiveWorlds  BrandGames  Entropia Universe  There  Kaneva  MultiVerse  Club Penguin (pre-teen)  WebKins (pre-teen) Source: http://www.virtualworldsreview.com
    5. Virtual World Valuation 5  Game  World Virtual world vs. MMORPG Source: Linden Lab
    6. Virtual World Valuation 6 Who is using virtual worlds? IBM Dr. Dobbs Life 2.0 Conference Princeton International Spaceflight Museum US Congress Second Health Operating Theater Showtime “The L Word”CBS “CSI New York” Vodafone “Inside Out” SLCN “Metanomics”
    7. Virtual World Valuation 7 Second Life is the biggest virtual world  40,000 concurrency (at any time)  475,000 active users (last 7 days)  1.5 m active users (last 2 months)  11 m total accounts  2 m assets created per day  35 TB of user-created data  800,000 unique items sold or traded per month  500 events per day  15 m concurrent scripts  10 Gbps peak bandwidth Source: http://secondlife.com/whatis/economy-graphs.php Million Square Meters of Second Life Land Total User Hours (millions) Source: Linden Lab
    8. Virtual World Valuation 8 Diverse Second Life residents 0 5 10 15 20 25 30 35 40 18-24 25-34 35-44 45+ 0 10 20 30 40 50 60 70 18-24 25-34 35-44 45+  43% female  60% international  Top 5 countries: US, Germany, Brazil, Japan, UK Source: http://static.secondlife.com/economy/stats_200710.xls Resident market share by age tier Average monthly hours by age tier %
    9. Virtual World Valuation 9 Currency: Linden$  LindeX exchange operated by Linden Lab  Buy: USD $.30 transaction fee  Sell: 3.5% transaction fee  Monetary policy Sources: http://secondlife.com/whatis/economy-market.php, http://secondlife.com/whatis/economy-graphs.php, http://secondlife.reuters.com 270 L$ = $1 USD US$ Spent by Users (in Millions) US $ Exchanged on Lindex (in Millions)
    10. Virtual World Valuation 10 Economy  Reuters  Banking and credit  Stock markets  SL Capital Exchange (US, 20 listings)  World Stock Exchange (Australia, 15 listings)  VSTEX (Italy, 7 listings)  Ancapex (US, 3 listings) Source: http://secondlife.reuters.com
    11. Virtual World Valuation 11 Advisory firm presence in virtual worlds H&R Block Island BDO Stoy Hayward Island KAWG&F (Baltimore MD CPA firm), CPA Island Accenture
    12. Virtual World Valuation 12 Virtual world accounting issues  Asset and liability accounting  Precedent by analogy: software and websites  Revenue recognition  Currency related issues  Revaluations and gain/loss  International and regulatory issues
    13. Virtual World Valuation 13 Traditional accounting asset definitions  Asset  Any item of economic value owned by an individual or corporation, especially that which could be converted to cash  Tangible Assets  Assets having a physical existence, such as cash, equipment, and real estate  Intangible Assets  Identifiable non-monetary assets without physical substance  Examples: computer software, licenses, patents, brands and copyrights Source: International Financial Reporting Standards (IFRS)
    14. Virtual World Valuation 14 Are virtual world assets different?  Non-physical, like software  Multi-state / non-persistent  Specific risks of impairment, destruction, infringement  World disappearance  Economic disturbance  Ease of copying  International environment  Low transparency • Physical identity obscured, limited reporting infrastructure
    15. Virtual World Valuation 15 Virtual world asset and liability classification  Intangible assets  Land and real estate  Objects  Scripts and animations  Intellectual property • Patent, trademark, copyright  Liabilities  Loans payable, bonds
    16. Virtual World Valuation 16 Land is the most significant virtual asset  Purchase via auction or resale  Premium membership required ($9.95/mo)  USD $13 + $5 monthly for 512 sq m  USD $1,675 + $295 monthly for 65,536 sq m island Source: http://www.secondlife.com 200720052003 Available plots Available island areas Raw Land Growth of Second Life
    17. Virtual World Valuation 17 Real estate Anshe Chung Second Life real estate developer  Virtual homes, offices and meeting spaces
    18. Virtual World Valuation 18 Objects and scripts
    19. Virtual World Valuation 19 Asset recognition and measurement  An asset is recognized when it meets all of the following criteria  it is identifiable  the entity has control over the asset  it is probable that economic benefits will flow to the entity  the cost of the asset can be measured reliably  Initial measurement at cost of generation or acquisition or other assessment of fair value Holly Kai Golf and Country Club Sun Microsystems Pavilion
    20. Virtual World Valuation 20 Asset useful life, depreciation, disposition  Useful life  Shorter life  Amortization  Software: purchased vs. developed  Non-software: amortized over useful life  Impairment  More frequent reassessment  Retirement and disposal  Disclosure
    21. Virtual World Valuation 21 Revenue recognition and currency issues  Services  Developer • Initial project • Maintenance / support  Other  Site allowance/stipend  Currency issues  Not different from high-risk international currencies IBM’s Forbidden City Sim
    22. Virtual World Valuation 22 Rapidly developing virtual world ecosystem Virtual World Providers Linden Lab/Second Life, ActiveWorlds, Entropia Universe, There, Kaneva, Muse, MultiVerse, vastpark, metaplace, Cybertown, Habbo Hotel, Whyville, Voodoo Chat, Taatu, Traveler, Sims Online, Club Penguin, WebKins, Hipihi, Uonenet, Noviking Virtual Businesses and Brands Anshe Chung Studios, DeCuir Creations, FairChang, Etopia, Hunter’s Cove, SL Boutique, Preen, House of Nyla, Second Life Cable Network, Rezzable, caLLie cLine, PeoplePool, Raven Pennyfeather, Lapointe & Bastchild Designs, InStyle, Vista Animations, Chai Skins, Acedia Albion, AV Puli Animations, Reel Expression, J&S Aviation, SZ Designs, Vindy Vindaloo, Esoterica Couture Virtual World Developers and Agencies Electric Sheep Company, Millions of Us, Rivers Run Red, CMP, Aimee Weber Studio, depo consulting, Forterra, Metaversatility, Wish Farmers, Virtual Worldlets, Icarus Studios, Proton Media, NGI Group 3Di, DAZ 3D, Code 4 3D Physics Engines and 3D Modeling Platforms Havok, Ageia PhysX, Unreal Engine, Open GL, Maya, 3D Studio, Croquet, SoftimageIXSI, Form Z, Strata 3D CX, RenderMan, Blender, Wings3D Investment transaction in 2007 or acquisition
    23. Virtual World Valuation 23 Virtual world valuation issues  Valuation situations  Asset transfer, purchase or sale  Internal accounting  Settlement: legal, estate, divorce, etc.  Valuation considerations  Ownership  Portability to other virtual worlds  Virtual business risks  Intangibles • Intellectual property • Brand value: reputation, management, innovation and human capital
    24. Virtual World Valuation 24 Virtual world valuation issues  Assets to be valued  In-world business: product, service  Brand: sim, business, avatar  Account: avatars/characters, assets  World, economy  Valuation techniques  DCF: emphasize near-term flows, low TV  Sales comparison: Second Life classifieds, stores, eBay  Recent transactions  Multiples: assets, sales, EBITDA, trading  Metrics: customers, contracts, sim and web traffic, conversion Motorati SpokesAvatar: caLLie cLine Coke’s virtual branding
    25. Virtual World Valuation 25 Virtual world tax issues  VAT, sales tax  Income tax  1099 contractors  Gains tax  Challenges of levying tax  Identity verification  Identification of activity  Monitoring, tracking and enforcement  Highly international environment
    26. Virtual World Valuation 26 Legal and other issues  Key rules  Linden Lab: Terms of Service Agreement, Community Standards, Privacy Policy, Digital Millennium Copyright Act Policy  Sim covenants  Dispute resolution  Metaverse Republic  Recent cases  Eros, LLC v. Doe (pending) • Copyright infringement (US $2,250)  Marc Bragg v. Linden Lab (Oct 2007) • Land acquisition via landbots (US $8,000)  Money laundering
    27. Virtual World Valuation 27 The future of finance and virtual worlds  Growth: participants, breadth, size  Formalization of the financial sector  Stock indices and mutual funds  In-world stock market crash  Third-party audit and analyst function  Regulatory initiatives  In-world GAAP  Explicit banking, securities and tax laws  Technical initiatives  Cross-world avatar portability
    28. Virtual World Valuation 28 Industry leadership opportunities  Provide industry leadership  Accounting and valuation white paper  Implement international GAAP / IFRS  In-world third-party audit infrastructure  Client earnings announcements  Audit, valuation, tax, SOX checklists  Support clients in the virtual medium  Accounting and business advisory, virtual dispute resolution  Facilitate internal initiatives  Recruiting, telepresence, collaboration
    29. Virtual World Valuation 29 Valuation summary  Virtual worlds are becoming increasingly routine for business, academic and government use  Financial professionals and regulators are now getting involved; there is an opportunity for a leading accountancy to define and lead virtual world accounting and valuation practices  Demand for advisory services is growing along with strategic investment and M&A activity in all areas of the value chain  Doing business in a virtual world is similar to doing business in a foreign country
    30. Thank you Melanie Swan MS Futures Group Palo Alto, CA melanieswan.com Slides: http//www.melanieswan.com/presentations/Virtual_World_Valuation.ppt Virtual World Valuation Provided under an open source Creative Commons 3.0 license http://creativecommons.org/licenses/by-nc-sa/3.0/
    31. Virtual World Valuation 31 Resources  Getting started in Second Life  http://sl.nmc.org/wiki/Getting_Started  Second Life SLURL Directories  http://nbhorizons.com/list.htm (companies)  http://npsl.wikispaces.com/Tenant+Directory (non-profit commons)  http://edumuve.com/tour/ (international locations)  Event listings  http://secondlife.com/events  http://metaversed.com/ *  http://www.metanomics.metaversed.com/ *  News, blogs, etc.  http://secondlife.reuters.com/ *  http://www.ugotrade.com/  http://www.virtualworldsreview.com/  http://www.metaversemessenger.com/  http://dwellonit.blogspot.com/ (most visited locations) * Finance and Economics

    Editor's Notes

  • 51, 51, 153
  • 1000/1000 Virtual world economic activity is substantial (Second Life is over $1m USD/day)
  • Public or private worlds
    ActiveWorlds (supports 400 concurrent av present & chat; private label world platform; 47,000 active in their demo world; Tourist, Citizen, World Owner; can be accessed from FB (TEST VIA MOBILE)
    Entropia Universe – Swedish, 360,000 residents, MM virtual universe, own economy, sold banking licenses to RL banks
    Kaneva: only human avatars, completely modeled after the physical world
    In Aug, Disney acquired Club Penguin for $700m
  • Not MMORPGs because open-ended, no universal goals
    MMORPG examples: World of Warcraft, Ultima Online, Star Wars
    Games have structure, beginnings and endings, Second Life does not. There are many games within Second Life, but the platform and reason for being there is not the game. It’s about the community and knowledge that on the other side of every avatar is another human being.
    Another difference is that the content in games is created by large teams of developers and “consumed” by the customers. In Second Life, the customer creates all of the content and shares it with others in a variety of ways.
  • Variety of individuals and organizations, many people are familiar with the recreational uses, but there is perhaps just as much serious or professional activity
    1000 businesses and 1000 academic institutions; no analyst firm officially following this yet
    Millions of ‘residents’
    Entertainment
    Enterprise: Traditional physical world business migrates in-world + In-world emergent brands
    Academic and educational organizations: Extension of existing eLearning mechanisms
    Science: Intl spaceflight museum, AFM demo, molecule, weather, plane traffic, data visualization platform=google earth
    Government: info, personalized face, modeling disease spread
    Non-profit: Etopia eco-sim with water treatment plant replica
    Using virtual worlds to collaborate, create, interact, enjoy, experience, recruit, demonstrate, prototype
  • SL: the world SL grid: the underlying platform
  • Create an avatar, a visual representation of your presence. This is how you will appear to others in the world.
    Who uses the virtual world? Ordinary people
    Context re: TV hrs/month
  • The only tool is monetary policy
    http://www.benchmark.com/news/sv/2006/10_16_2006.php
  • Banks been around 3 yrs; mostly failed or reorganized; related to casino gambling
    My Second Bank.com
    “Unable to pay depositors, Ginko ceases banking operations”
    The bank, which as of last week claimed to have 18,000 accounts worth a total of L$190 million (US$700,000), said it would issue what it called a “Ginko Perpetual Bonds,” a security on the World Stock Exchange, in an attempt to compensate depositors.
    A gambling ban, insider theft at the World Stock Exchange and a bank run on Ginko Financial within the past week have combined to threaten confidence in the integrity of the Second Life financial sector.
    Financial exchange platforms
    Anshe Chung: Second Life, Entropia exchange
    Stock markets
    Completely unregulated
    Nothing qualifying SL stocks for a registration exemption
    Accounting, valuation and tax issues
    1099 issue, depreciation (software, website precedents)
  • Presence to hold meetings, consultations with clients/potential clients
  • Conceptually, like doing business in another country; the usual risks are higher, there are additional risks. There are currency issues.
  • Different conceptually not fundamentally; we account for them in the same way but with a deeper application of risk, like foreign country
    Not yet fully proven that these are “real assets” though implicitly standing up as so in US legal cases. Not universally tested worldwide. \ Multi-state / non-persistent
    Ones and zeros stored on a computer server
    Chinese MMORPG case re: physical world murder over an uncompleted VW transaction
    Non-persistent / multi-state
    Virtual asset = pixels, ones and zeros stored on a computer somewhere, in a different “un-asset-like” format until rezzed on someone’s screen
    Similar examples: webpage is also stored one way & rendered another; also digital pic sharing sites like flickr. Is a website an asset if no one visits it?
    Non-physical, like software
    Specific risks of impairment, destruction, infringement
    World disappearance, market disappearance
    Easily copied, like software
    Difficult to identify physical entity that is the creator/owner; 1:many avatars (alts)
    Enforcement mechanisms more challenging massively international
    Low transparency: frail reporting infrastructure, anonymity of Paypal, difficulty/lack of recordkeeping,
  • Issues: 1) VW asset = an asset? 2) Tangible or intangible?
    Could have accruals, wouldn’t be any different in the virtual worlds application
  • Looking at an example: Land & RE market: 75 yr / 6 mo; 5000 yr / 450 mo; 13/mo = 150 /yr
    Reserved; moved to eBay enabled auction system mid-Sept 3 mo grace period then reservations lapse
    Island is about 16 acres
    Develop the sim
    Structures, landscape, FF&E, functionality
    Development firm, independent contractor(s), self-develop
    Anything else to place the asset into servicee
  • Homes and offices
  • Appearance more important b/c area for exploration, fun, personalization, more emphasis and expectation b/c can change it
    Shop.onrez.com
    Group: shopping emergency
    Blogs: SL Men, ??
  • These parts are the same
    Initial measurement…plus placing in service
  • Software (sophisticated programming languages):
    Shorter lives from the risk and pace of change of the medium; given the lack of precedent, slot virtual world sim costs in the annual $108,000 Section 179 write-down
    The useful life of an intangible asset:
    Is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.To an entity shall be based on an analysis of all pertinent factors, in particular:        o   The expected use of the asset by the entity.        o   The level of maintenance expenditures required to obtain the              expected future cash flows from the asset (for example, a material level of             required maintenance in relation to the carrying amount of the             asset may suggest a very limited useful life).Shall be considered indefinite, if no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset to the reporting entity.  The term indefinite does not mean infinite.   
    Externally purchased software; 3 or 5 year; external website designer who guarantees the product; 3 year
    Internally developed sw, including website dvpt, can be expensed under R&D
    In audit or SOX work, need to be asking about virtual world sim presence, internally/externally developed and maintained.
    For some companies its just a virtual office (non-software) but others (Eolus) use it as a data platform (software); scripts make it sw
    3 yrs, longer for government or non-profit organizations
    Disclosure
    Lower threshold
  • Talked a lot about virtual world assets – services are another large chunk of the economy but more straightforward from an accounting standpoint
    Life cycle issues with software in perpetual betas, still have significant releases
    Depreciation – when you are outfitting your virtual office with some PP&E, FF&E….depreciate it?
  • http://www.news.com/8301-10784_3-6161999-7.html (Feb 2007 CBS invests $7m in ESC)
    http://secondlife.reuters.com/stories/2007/10/11/omnicom-buys-stake-in-millions-of-us/
    Intel acq Havok Sep 2007 (gaming, movies) trend to high-end chips, graphics processors
  • World longevity risk: technical, M&A or fad, migration from the Sims Online to SL
    Ownership: of what is being valued, of the world
    Reputation, knowledge & skills
    Sim brand (virtual laguna beach, the l word, csi)
    Internal accounting purposes (initial measurement when placing in service, re-assessment, disposition)
    Overall valuation of a virtual economy
    Difficult to size, no vetted published metrics
    Difficult to know full activity: transaction mix of local currency/Linden$ and PayPal
  • X $’s now plus a % of forth-coming profits over the first six months with more emphasis on the % of profits portion
    Software as part of a business purchase: Finally, let's say you buy a business and, as part of the purchase, you get software. This software is likely to be considered a Section 197 intangible (yes, Section 197, not Section 179 — again, go to the IRS Web site). That means it is either not generally available to the public, is subject to an exclusive license, or has been substantially changed. In this case, you have intangible property. And the property will have to be amortized over not 36 months or 60 months, but 15 years.
    Usual business valuation methods
    No problem with an entity valuation; WACC
  • Virtual world owner imposes VAT (at the source)
    When a web development shop builds a website for the NY Times do they charge sales tax? No
    Identification of activity – sex related
    Current status – congress and IRS comment summary
    Monitoring – attractiveness as a money laundering platform
    Taxing Linden-denominated transactions would just shift the activity to PayPal/surrogates
    Identity verification (1:many avatars)
  • http://secondlife.reuters.com/stories/2007/10/25/eros-lawyers-id-john-doe-avatar-youth-denies-hes-catteneo/
    Robert Leatherwood, 19, of North Richland Hills, Tx., as Second Life avatar “Volkov Catteneo.”
    Sold 50 copies illegally obtained of Stroker Serpentine’s EROS LLC SexGen bed with 150 sex animations (L$12,000; USD $45
    Alderman’s team subpoenaed Linden Lab and PayPal for Catteneo’s Internet Protocol addresses, and then subpoenaed Internet service providers AT&T and Charter Communications to determine the real-world billing addresses associated with the IP information.
    Taney, lawyer for Alderman. He said Leatherwood has 20 days to reach a settlement agreement, or he’ll move forward with discovery, where legal depositions will be collected from members of the two households that Catteneo’s IP addresses trace to.
    Linden Lab ejected Bragg from Second Life after he allegedly used an exploit in the real estate auction system to purchase land below market value, and Bragg sued in response. The case recently settled out of court. Terms were not disclosed. LL’s TOS ruled not legally binding. 5 land bots currently operating.
  • Analyst – both market research and securities analyst
    Growth: like eBay, more people will earn supplemental and eventually replacement income
    Formalization of banking, securities and insurance sectors
    Reuters/other to develop stock index
    Virtual worlds index mutual fund (in-world and physical world listings)
    First widespread in-world stock market crash
    Third-party verified digital identity systems; Secure identity identification mechanism (though still waiting for this on the web)
  • Accounting and business advisory services
    International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB).
    Provide industry leadership
    White paper: accounting, valuation and tax issues
    Implement IFRS / international GAAP in virtual worlds
    Setup in-world independent third-party audit infrastructure
    In-world client earnings announcements, analyst conferences: short-term wins; Reuters, others will cover it
    Virtual worlds items included on audit, valuation and tax checklists
    Support clients in the virtual medium
    Accounting, audit, tax, valuation, securities advisory, consulting, SOX compliance, virtual dispute resolution, security
    Facilitate internal initiatives
    Recruiting, conferences and events
    Internal collaboration, teleconferencing substitute
    Accounting, audit, tax, valuation, securities advisory, consulting, SOX compliance, virtual dispute resolution, security
  • 1000/1000 Virtual world economic activity is substantial (Second Life is over $1m USD/day)
  • When a web development shop builds a website for the NY Times do they charge sales tax? No
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