Rapt co-founders sue Accel & Levensohn for playing hardball

September 6, 2006 | Matt Marshall | Comments | |

Two co-founders of Rapt have sued the company’s chief executive and venture capital backers, Accel Partners and Levensohn Venture Partners for breach of fiduciary duty and fraud.

Rapt is a San Francisco company that provides software to help companies find the right price for their goods to maximize profits.

It is another one of those stories we are getting familiar with in the valley — where start-up founders get washed out of their ownership holdings, while venture firms bolster their stake at more favorable terms. The case is similar to those of Epinions, Nishan Systems and Wine.com before it (you can search for stories about these cases here at VentureBeat). Rapt raised money during the boom times, but then struggled through hardships — and when the company was forced to raise more money, it did so in a way that pissed off guys who put in early sweat labor.

We’d heard about the suit a few days ago, but hadn’t gotten very far in confirming it. Now the team over at PE Week have gotten a copy of the complaint and spilled all the details. We’ve emailed Accel’s Jim Breyer again, and called Rapt, but nothing back so far.

Dan Primack of PE Wire has done a good job in summarizing it, so we won’t repeat it all here. We agree with his assessment that it is unlikely to go to trial. This is something that venture firms don’t like doing, because it can hurt their reputation as an entrepreneur friendly firm. At least in the Nishan and Epinions cases, settlements were reached. The Wine.com case rages on, however, that one concerns an East Coast firm, Baker capital, which presumably is less concerned about its reputation among entrepreneurs out here (it has also tended to invest in later stage companies). Regardless of the merits of all these suits, the cases are significant because entrepreneurs have until recently avoided suing VCs — once perceived a powerful clique that could gang together and blacklist a noisy entrepreneur.

There is also one other anecdote worth mentioning, since the two co-founders are blaming a third, Tom Chavez, who is now chief executive for effectively changing the rules of the game on them. Chavez not long ago became known for his Rapt presentation called: “It’s a whole new ballgame, and the winners are changing the rules,” adorned with pictures and references from Michael Lewis’ best-selling book, MoneyBall. Don’t mean for this to be a cheap shot; it’s just that he was giving this presentation around the same time the firm was negotiating its 2005 round of capital — the one where the two co-founders say shareholders weren’t solicited for their input on what would become a massive dilution of their shares.

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  • CleanBiz
    To recap a relevant case, ten years ago a judge in Alantec vs its VCs set precedence by ruling against the VCs. The VCs had washed out the founders and other shareholders and later profited enormously on a small investment in a washout/recap round. Amongst other findings were violations of fairness, inside dealing (the washout round was by existing investors, not all of whom participated), and breaches of fiduciary duties. The VCs fought that and lost out very badly. They then threatened to blacklist the founders and complained in the press about how this will cast a chill over Silicon Valley (oh yeah?), and have since resisted going to trial as any judge or jury will condemn and penalize them for their rapacious behavior, including taking advantage of founders and other shareholders. Nishan vs TCV/etc. is another recent another egregious example.

    There’s a reason why some existing investors drop out of recap rounds. They would rather make money some other way than engage in fraud, misrepresentation, and other behavior that is likely to breach fiduciary duties and end up in court. Explains better (than Dan's analysis) why Summit dropped out of Rapt's recap round.

    A new investor in a recap round doesn’t mean all is clear. The other (existing) investors usually have ties to the new investor and there is a quid pro quo between them. Invest in this round to save my butt and I'll do you a favor later.

    Incentives for current employees is a good thing but it crosses over into breach of fiduciary duties when it is at the cost of diluting prior shareholders disadvantageously. Giving carveouts to current management is nothing but bribery to buy compliance (to wipe out prior management/shareholders).

    Expect more of these to surface. Most venture investments made 1998-2002 are down the toilet. Expect the VCs to milk hard and run dry the few cows that survived that period. When they have nine failures out of ten, why wouldn’t they rape and plunder and engage in every trick in the books, known or unknown, legal or illegal, to extract the last penny out of their one surviving deal? If nobody catches them they get away. If they get caught, they settle and still make out better than if they had stayed straight.

    It’d be worthwhile to list firms/partners that are known to engage in this practice. Right at the top will be some firms/partners with poor track records whose LPs already pulled out and have few entrepreneurs to speak for them.
  • great comment cleanbiz (I hope Dan adds this point of view tomorrow) . . . also to add to the laundry list of entrepreneur vs. VC lawsuits, no one should forget the mess that is ArsDigita (Philip Greenspun vs. General Atlantic) . . . not in the valley but even more dramatic. . .

    Carveouts are evil . . .:)
  • Josh
    VCs (except for the ones that succeed) take advantage of any divisions within a company to strengthen their ownership. The worst ones even foster or exploit crises so they can swoop in under the pretext of saving the company, wipe out the existing shareholders, change the capital and shareholding structure, all to their advantage.

    This problem has become even more prevalent now for reasons explained earlier. The few companies that survived the Great Freezeout are glad they escaped and then find they are ripe and ready to be exploited by their own investors.

    Several quality LPs, on learning certain venture firms had a predisposition for such unconscionable and bordering on illegal practices have pulled back their support of those funds. It didn't help that these firms were also the worst performing in returns. Which explains why some firms had trouble raising money and are shutting down.
  • Chase Williams
    Accel Partners – A worse partner to entrepreneurs can be found nowhere else.

    When searching for investments startups are looking not only for money, but for a partner that they can trust. My experience with Accel Partners has been so bad that I had to comment about it.

    Many VC firms are very busy and it is only natural that they limit the time spent talking on the numerous new deals that come in. However, communicating with Accel is like talking with your long distance company when there has been a mistake on your bill. Long holds, dispassionate voices, constant transfers. I couldn't even speak to an assistant and constantly was put into voicemail, not the partner’s voicemail, the assistants.

    To contrast, Sequoia and Charles River Ventures, who must be much busier than Accel very responsive in getting back to me in a timely fashion and in making me feel like, whether or not my deal was something they were interested in, they at least gave it due consideration. On the other hand, even though I visited Accel Partners in person (which I didn't for Sequoia and CRV) I couldn't even get confirmation that my proposal was received.

    So while I haven’t worked closely with Accel Partners I feel there are many better choices in the Menlo Park area, and I would advise entrepreneurs not to waste their time with Accel, because Accel will not waste any of their time on you.