If you're a founder and you think you can get away with selling your founder shares at the expense of a major shareholder, think again. They will come after you with a lawsuit.
The most-likely candidates for such lawsuits are those involved in active secondary market securities, wild swings in valuations, and a complex cap table that looks like a Chinese menu. Remind you of anyone? Facebook comes to mind. But this story isn't about Facebook.
WPP Group, NY-based advertising giant, has filed a lawsuit against LA-based Internet ad agency Spot Runner, and fellow VCs, alleging the sale of $54 million of their own shares at the expense of WPP and other Spot Runner shareholders. WPP Group is trying to recoup $11 million.
The high-profile defendants in the case include Bob Pittman, Spot Runner co-founder and former AOL chief, Battery Ventures and Index Ventures.
Spot Runner has raised over $110 million from firms like Battery Ventures Index Ventures, WPP Group, Allen & Co., The Interpublic Group, Tudor Ventures, Daily Mail & General Trust, Grupo Televisa, Legg Mason Capital Management and Groupe Arnault/LVMH, according to peHub.
Some interesting highlights from the filing include:
“The defendants operated the company from its inception
for their own benefit instead of the best interests of the company and
its stockholders. Rather than working to make Spot Runner a successful
and profitable venture, they perpetuated a “pump and dump” scheme in
which they aggressively promoted the company to new investors (often by
promoting that WPP was an investor in and supporter of the company) and
then sold new investors large quantities of their own secondary shares
at ever-increasing valuations. Such secondary sales were accomplished
surreptitiously and without the disclosures to investors required by
the controlling investor agreements or the federal and state securities
laws.” (As reported by peHub)
"On this occassion, WPP was given notice of the proposed March 2008 secondary share sales by the Founders, the Directors and Battery and Index, and was offered an opportunity to sell shares pro rata with the Founders at the time. But WPP was given not notice at the time that the same insiders had previously sold amost $40 million in Company stock, or that the financial condition of the Company should have precluded such sales."
"On May 21, 2007, Alexander Barry, counsel to WPP, e-mailed Peter Huie, general counsel of Spot Runner, to inquire about the share sale notice in the May 10 letter. Huie was specifically asked: "Is there an existing investor and/or founder selling existing shares related to this offering? If so, who is selling shares and how many shares are they selling? WPP as assured by reply e-mail from Mr. Huie that same day that "[t]his offering does not involved the sale of any existing shares. It is an entirely new issuance by the Company." Relying on Mr. Huie's representation that no existing Investors or Founders were selling shares, WPP decided to purchase additional shares of Spot Runner stock to maintain its percentage shares of the Company's stock. On or about May 24, 2007, WPP purchased 383,111 shares of common stock from the Company at $4.66 per share for a total investment of $1.785,297 in this round."
Now, while this is certainly a boatload of money that the founders and some VCs took off the table, it's quite possible that within those few days between the emails and the purchase, the founders decided to sell their shares.
Essentially, it's possible that WPP shares some of the blame for not having adequate oversight or active participation in this investment, not just during May 2007, but throughout its involvement.
Moreover, there is nothing fundamentally wrong with founders and existing investors selling shares in the secondary market. After all, many founders work for years without getting paid for all the work they've put into their startup.
The question is will WPP hurt its ability to work with other Silicon Valley investors, after spending so many years making inroads as an investor in early-stage startups?
Here's the complaint, which was filed April 9: