“I have never seen anything like this” said a corporate law partner at a large silicon valley law firm. He was referring to the undoing of a $17 million venture round at BitTorrent and subsequent recapitalization that we reported yesterday.
In one board action, $10 million was removed from the company’s bank account and the valuation slashed from $177 million to just $35 million.
Recapitalizations, where existing stockholders are crammed down to near zero equity in anticipation of a new round of financing at a lower valuation, are common. Particularly in down markets. Old investors are forced to put in new capital to maintain their ownership. New stock options are awarded to current employees. Anyone who’s left the company, even founders, are left with nothing. Even though they’ve often paid hard cash to exercise stock options.
Recaps are the only way to make bloated startups that have run out of cash healthy again. But they only happen when a company is desperate for cash and has no other options. The reason is clear – the board of directors has a fiduciary duty to protect stockholders. Recapitalizations are not good for existing stockholders, and can only be approved when the company has no other choice.
But what happened at BitTorrent wasn’t a standard recapitalization. Nothing about the BitTorrent reorganization was standard, in fact. The company, which laid off more than 2/3 of staff (65 to 19 employees), had over $20 million in the bank before this transaction, says a source close to the company. They weren’t generating much revenue from toolbar and device installations – just $5 million or so annually – but at least the company had plenty of runway left.
In other words, the fiduciary duty of the board of directors to the stockholders of BitTorrent was almost certainly disregarded.
The letter to stockholders said that “DAG claimed that the Series C financing should be substantially renegotiated.” But our sources say that Accel was the firm to insist on the change, forced the decision on everyone else, and let DAG take the fall. Why did DAG allow that to happen? The firm’s whole investment thesis is to follow top tier firms like Accel and Sequoia, investing in later rounds at higher valuations. They have to keep these top firms happy. As a result, they are effectively a whipping boy when someone has to be held publicly responsible for unpopular actions.
But the real question about the recap is why the board of directors let it happen. The board has a strict fiduciary duty to protect stockholders. That didn’t happen here, since all existing stockholders were effectively wiped out by the recap.
So why did the board vote for this extraordinary transaction? Two of the board members, Ping Li (Accel) and David Chao (DCM), are investors in the company and stood to gain financially from the rescission and recap. CEO Erik Klinker is an Accel man, having previously worked at Accel-funded Internap. That leaves founder Bram Cohen, founder Ashwin Navin and outside director Brad Templeton.
Navin voted against the transaction. Templeton voted for it, but refused to comment when I asked him why he felt this was in the best interest of the company and it’s stockholders. Cohen also voted for the transaction, and as the majority holder of common stock he was a necessary vote. Without him, the transaction would not have happened.
So why did Cohen agree to vote for the transaction? Speculation abounds, but one aspect of the transaction is suspicious. The term sheet calls for $750,000 to be spent buying back shares from common stock holders. That mostly means Cohen, who is reportedly getting the lion’s share of the 30% of the company put aside for current employees. Cohen, who has recently had highly publicized financial troubles, may have simply been bought off.
There’s no other reason for the stock buyback. If the company is in a dire enough financial situation to warrant an unprecedented rescission of a $17 million financing, then money that’s left sure as hell shouldn’t be spent in payouts to founders.
BitTorrent and Accel will not respond to requests for comment. Everyone is keeping quiet. For now.
Capital H on the first “he!”
I really do not know how this shit could happen. I myself usually track my 20 dollar when it goes out. What about those VCs not even tracking their Millions. Three questions here:
1- Is it a fraud, if Yes, by whom-when-how?
2- Is it bad planning, by whom-why?
3- Are there some backdoors of both the company and some VCs personnel?
The overall discourse is open for interpretation. Feed it guys.
This always happens in a VC downturn. The only difference this time is that you are finding out about it.
Cram downs always do happen. This is unusual because it involves a recision offering that only benefited a single class of stock. Keep in mind that preferred stock is considered a debt under the U.S. constitution. They might have run afoul of lending laws, whereby they “bait and switch” lending money intentionally to take over a company, then cramming everyone else out.
Your comment is ridiculous to the point of stupidity: the US Constitution does not govern company debt and equity.
These are governed by the laws of the state in which the company was incorporated.
You clearly have no idea whatsoever what you are talking about.
yeah, that comment is just complete bullshit.
@Michael,
I wouldn’t say recaps make bloated startups “healthy again”, recaps ensure the startup continues as an ongoing concern with a better chance at future financing if needed.
Just my $.02.
Best,
Curtis
The board has a fiduciary duty to the shareholders, but the shareholders, at least under Deleware law, might not. However, there are also issues of unjust enrichment and self dealing, which could be just as problematic as any breach of fiduciary duty. Another consideration is fraud, which is one possibility on both sides, though it sounds like it might be on the investor side of this deal.
Looks like a juicy lawsuit, if the common stock and Series A and B holding plebes are up for it.
Nice to have Techcrunch back!
This is the type of news and reporting we expect from TC. Please enough of the childish nonsense and bickering about European conferences and about twitter clones.
This is great stuff, and there is a lot more news here (and lawsuits abound). TC, your job in this downturn is to turn the heat on the VCs, because if you do not no one else will. We look to you to break these stories and to find out the Madoffs of the VC world before anyone else.
It seems clear that Accel and the other VC board members were not looking after shareholder interests.
Excellent! For the first time in a long time, I am proud to be a TC reader.
Totally agree.
AFAIK, Michael is a (former?) lawyer that’s why he excels at this kind of journalism.
Agreed. First article in a long time that I read all the way through.
Nice. More!
You guys know where we can find more VC inside stories & goodies?
We need VC’s to scale but we really don’t need to be abused by them either.
Founders: Beware of VCs.
Entertaining yet educating. Great article Mike.
ooops, meant edukashional.
Excellent reporting. Thanks.
I was just about to make a comment similar to what Chris wrote. This is quality journalism that we all appreciate.
In regards to the transaction, it looks like the vultures are out. Private equity and venture capital funds are really struggling right now, however, they continue to attract investors. Why? It’s simple – they are going to continue performing transactions like this and take larger shares of their portfolio companies. I guess it’s just a form of dollar cost averaging. When the market turns around, their investments will benefit from these transactions.
after 2 years i’m still courius about their acquisition of utorrent in 2006, how much they spent?
just a few million, in cash.
Which realistically is the most valuable thing they have right now.
I feel sorry for Bram – he invented a very cool, very useful technology. But sadly it’s near-impossible to monetize, certainly not unless you get much further up the stack into realms where licensing would normally occur (which is also impossible given BT is Open Source).
Selling movies and content was a logical route to try, but average joes don’t care about the technology being used so they will always go to the vendor of their playback device (ie Apple) or brands they are already familiar with (eg Netflix).
Also, if I’m paying for a movie, why do I want to also participate in the distribution of it to other buyers (which costs me in terms of bandwidth?). BitTorrent was never able to give a valid reason to that.
vc’s are so shaddy, founders beware!
Not sure how uncommon this is, but the structure of the deal (if the assessment is correct) is clearly evidence of a tense and complex negotiation.
Investors probably wanted to shut down the company and get their cash back. New money in at a new (lower) pre-money valuation was located; and in order to placate an on-staff founder, a payoff was organized to make sure he’d never have to be placated again (minority stake).
totally agree w/ Chris. TC has gotten so so boring – but this article is great – do more of these, where there is actually something interesting to read!
techcrunch is never boring.
Boring is not the right word, but sometimes it does read more like a teenage girl’s diary than a serious tech blog.
I agree this was a great article though.
michael, to be honest, if all your site does is to give us the “latest startup” then it’s really no different from many others.
& we’ll tend to skim over the article to just get the names we need to follow. if even that. we’ll just as likely go elsewhere.
this was a great article and really kept my attention from start to finish. i haven’t done that in months here.
need more of these — and the excellent Swisscom article yesterday (though some thought it was about LeWeb).
i agree aswell with Chris
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Any aspiring CEO who cares about not getting their lunch eaten by VCs needs to join TheFunded.com.
There is an active discussion there on BitTorrentGate. 10 years ago, before the Internet, this would have been kept hush hush. We’ll see how some transparency and light can make a difference, although in that case, I’m not sure if either side is clean.
Mike,
In your opinion, are there any grounds for a minority shareholder lawsuit against the board for breaking the fiduciary duty?
Also, any idea where Bittorrent Inc. is incorporated? I’m guessing Delaware…
Dave
it sure looks that way to me, but I don’t know who’d be doing the suing. Instead of litigation, the former investors are choosing to talk instead.
Mike,
I think you’re right. But all those employees that were axed and many of those that stayed surely lost a lot of options in this mess. Also, Ashwin surely lost a lot too! He could organize something, I’m sure.
Dave
Shady financing deals need to be exposed. Last thing any VC ever wants is there name in the marketplace under such circumstances. I hope the common shareholders sue everyone of the board members.
This is very similar to the shopping.com epinions ebay lawsuit. It would be good to see how they are related from people who understand this like Arrington.
One driver could be if the investors in the last round felt like they had been mislead in the funding round. In other words, they argued the last deal was invalid because of fraudlent statements in the fund raising process
There is no possible way that they had $20mm in hand when they did the original round with DAG. They only raised $33mm up until that point, spend millions on building TEN, content licensing fees, acquiring uTorrent and paying a staff of 65 for years. I also have serious doubts that they are doing $5mm on the toolbar income. With only 18 employees that should be breakeven. The letter from Klinker even says that the $7mm should allow them to operate for 12 months. I suspect they were nearly broke when they did the $17mm deal and the $2mm that DAG is putting in was money already spent, but I am speculating.
Mike, you got a great scoop here but now I think the “source” is spreading misinformation or just isn’t that well informed.
no. the $20 million in the bank was just prior to the rescission, so it included the $17m.
Unless the’re was a secret 2 1/2 round before the 3rd which was just undone, there is 0% chance of bittorrent having $20M in the bank. I don’t think they were on their last pennies, but i’m certain they were getting closer. Don’t forget all those agreements with the Hollywood studios didn’t come cheap, and those kinds of content deals have draconian guarantees that escalate over time. Bittorrent had to do the round.
see above.
So they did $5m and were valued at $177m — a mere 35 times revenue?!? Outrage! Honestly, even 35m at 7x sounds rich to me. I hope nobody is complaining, ’cause I’d take it guys, considering where a lot of public companies are sitting right now.
I would be surprised if they did $5MM for the year. The old ‘new CEO’ was fired because he didn’t meet the promised projections (which were in that general $5M range). I’m not sure what bittorrent was making on licensing deals, but a large chunk of revenue was ad based, check out the traffic trend for bittorrent on alexa. $5MM is fiction.
fascinating stuff — this is where mike really shines!
I say it again:
Why would you agree to a rescindable deal? Yes, I know, “you had to,” because you’re investors, who probably called themselves your “partners” when they were wooing you, saw your weakness and forced you into the bathroom stall, bent you over, and showed you who they really were.
Why did your lawyer not demand whatever clause let this happen be removed, even if you had to trade something for that to happen? Because they are conflicted too. You can bring them one deal, but the VC can bring them many. Who do they want to please? Right.
Yes, I’m over-simplifying, exaggerating, and possibly mischaracterizing, but this story is yet another lesson for entrepreneurs, yet another reason why you should bootstrap if you can. Otherwise, most of the time, you’re just asking to be taken advantage of.
Sure, sometimes you get some benefit from taking VC money before you have revenue and positive margins, just like sometimes you get some benefit (at least it looks that way for a while) from taking the devil’s money. In the end, though, most of the time, you will get screwed (sometimes justifiably so, maybe, such as if it was your own greed that drove you to the deal). Why? I leave you with my favorite version of a famous fable:
Once upon a time, a woman was picking up firewood. She came upon a poisonous snake frozen in the snow. She took the snake home and nursed it back to health. One day the snake bit her on the cheek. As she lay dying, she asked the snake, “Why have you done this to me?” And the snake answered, “Look, bitch, you knew I was a snake.” -NBK
I don’t think five million annual revenue is unrealistic for Bittorrent at all. They do have a huge install base, thanks to uTorrent, and probably make some good money with browser toolbars.
Just as a quick comparison: DivX networks made 14 million distributing the Yahoo toolbar in the first nine months of 08 alone, according to SEC filings. Of course that deal just fell apart, ending in a lawsuit and a bunch of lay-offs, but that’s a different story.
i wonder who’s going to be ratcheted to death next. anyone knows who raised a round with Accel & DAG except bittorrent?
probably any company losing a lot of $$ + raising a round right now is prime for this sort of thing..
The article mentions “highly publicized financial troubles”. Where were they publicized?
I want to know the same how could Bram Cohen possibly be in financial trouble. I mean he hasn’t been investing his own money.
I would also like to know about this, first I heard of it was in this article.. anyone have a link? there should have been a reference link in the post.
I agree.
Consider that Bram’s been told his company is worth $100MM+ and expected to be much more in the future and assume he owns a significant chunk of the common (which is 50%+ of total shares). Given those expectations, isnt it reasonable that he’s been spending some of those expected dollars, so that now when they’ve been sizably reduced he’d be feeling a little less than secure.
This is a good story but we probably don’t have 100% of the facts … obviously whatever happened, the Board reviewed it with their corporate counsel (mentioned in last article) and got their blessing one way or another.
I suspect at the end of the day it was just a tough choice between liquidation to return cash (something the VCs probably have a right to do), or restructure.
isn’t Bram’s website bitconjurer.org
look who’s selling their TV
http://tinyurl.com/6×65fv
That’s really Bram’s selling tv because he need money? Please somebody tell me that isn’t true
bram runs around the office complaining about his 2 houses being in foreclosure..
adsf