Thursday Throw-Back


The sun is shining, the entire HP board should have followed Tom Perkins’ lead and the hand-me-down Volkswagen has decided to mimic the once-trusty Pontiac. In other words, it’s time for Thursday Throw-Back. 

First up was yesterday’s discussion of the lawsuit filed by two co-founders of Rapt Inc., against venture capital firms Accel Partners and Levensohn Venture Partners. The plaintiffs argued that their Rapt shareholdings were unfairly diluted, and I suggested that they’ll do better in conference than in a courtroom. Many of you strongly disagreed with my assessment. 

Ian: “I would disagree that a strong case can be made for incentivising current employees at the expense of minority shareholders, whether those minority shareholders are former employees or not. If the majority shareholders of a public company decided to issue a massive number options to management along with a rights offering to themselves at a steep discount, while leaving the minority shareholders out in the cold, they would (justifiably) get sued and probably lose. The only issue is whether the valuation on the Series D was appropriate or not.” 

VC L: “All common stock holders aren’t just former employees.Some are former board members, vendors, customers, and angel investors.The board has a fiduciary duty to all stockholders and therefore is barred from screwing some just to reward others. I know that this kind of a recap is common, but I would not be so sure that it is legal.VCs are riding a slippery slope to jail if they keep acting as if they are not subject to the law.” 

George: “Motive does not much matter, but it does if a transaction will have a disproportionate adverse impact on one group of stockholders as compared to another. I believe a court would not apply the business judgment rule (i.e. deferential standard of review) to a board decision having such a disproportionate adverse impact if it found the decision was motivated by revenge (i.e. lacked a proper business purpose). It doesn’t take much to satisfy the proper business purpose test these days, but proof that the primary motive was revenge would, I believe, clearly be a problem… If what the investors got was purely pro rata based on their investment in the new D round — or pursuant to anti-dilution protection in the terms of the existing preferred — then that is probably OK. But if the board selectively chose to protect one group of stockholders from the effects of a transaction (other than just a grant of more equity to current management) and not another, that is clearly a problem. 

John: “I agree with your conclusions on Rapt, but if the plaintiffs have actual evidence that the Rapt principals did the transaction for the purpose of hurting them, all bets are off.The Alantec case was essentially lost based upon a paralegal’s notes of discussions in a board meeting.” 

*** Jennifer was one of five readers to suggest that I had ulterior motives in writing that some private equity firm should buy embryonic stem cell company ACTC: “Are you by chance being paid by ACTC to make such statements? Are you an investor in this company?” No and no. Moreover, it’s an offensive suggestion. I didn’t realize this was needed, but: I pledge to always disclose any personal holdings in a company on which I’m opining. This should be fairly easy since I own relatively little stock (in large part to avoid such potential conflicts). 

*** Quiz Answer Six of you correctly answered the following question: Can you name the commercial finance firm (focused on PE-backed lower-middle-market companies) that is about to sell new equity to a private equity firm? Hint: It’s in the middle of the race. The answer was Churchill Financial. Today it announced that it has sold a stake to Centre Partners, as part of a deal whereby Churchill is acquiring CDO manager Centre Pacific LLC.