alarm:clock

Venture Capital - Wednesday, January 26, 2005

VCs Deceived, Lawsuit Charges

The NY Times runs a cautionary tale about the ways VCs communicate with entrepreneurs. 3 of the 5 founders of Epinions filed a lawsuit against Benchmark Capital's Bill Gurley and August Capital's John Johnston as well as another Epinions founder, Nirav Tolia, charging them with withholding information that cheated them out of tens of millions of dollars. According to one source, the founders may be driven by bitterness that the VCs and Tolia ended up making millions from Epinions. By contrast, "the three co-founders left almost $18M in stock options of @Home, Yahoo, and AOL to start epinions.com and took the company to funding stage in a record 12 weeks from the idea."

The story is long and hairy but in short it focuses on a 2003 merger between Epinions and DealTime at a time when Epinions fortunes had sunk and the founders who brought the lawsuit were out of the company. The four had the power to have scuttled the merger but they assented. They say they later found out that the financial situation at Epinions was a lot better than they were led to believe by Gurley, Johnston, and Tolia. For one thing, they say that they were not told that Epinions had a deal in place with Google that was expected to increase profits 1500%. The fine print, as the Times describes it is that "The four owned enough shares to scuttle the merger but gave their blessing, even though it meant valuing those shares at zero. At the time, investors holding preferred shares, including Benchmark and August Capital, had claim on the $45 million they had invested collectively. The four founders, the suit says, were led to believe that the company was worth $23 million to $38 million, making common stock worthless." Had they been given this information, they contend they wouldn't have agreed to the merger, rather they would have waited for their shares to increase in value.

This could have happened to hundreds of companies - its amazing this is so rare. An interesting aside to the story: the documents reveal that Google was interested in acquiring Epinions but passed when it learned that defendant Tolia had lied that he was a McKinsey consultant and Stanford grad.

Read- Founders of Web Site Accuse Backers of Cheating Them (New York Times)