Alibaba, the large Chinese company that owns Yahoo China, is preparing to file another hard-hitting suit against competitor Qihoo and its leader, Zhou Hongyi (pictured above).

Yahoo China has already filed one suit against Qihoo, saying the search engine start-up’s software notifies users that Yahoo’s toolbar is malware and prompts deinstallation, and that it’s hurt Yahoo’s market share.

The coming suit, which VentureBeat learned about early this week, will go much further. It will attempt to take out the man at the center of the stand-off: Zhou Hongyi. He is the founder of Qihoo, and is backed by the aggressive venture capital firm, Sequoia Capital. Zhou embittered Yahoo China since he was forced out of that company last year. Yahoo China will claim that Zhou has embezzled from Yahoo China and defrauded it, according to a source familiar with the lawsuit being prepared.

This isn’t helping Qihoo, which is reportedly trying to raise another round of funding at a high valuation of about $80 million. Its main backer, Sequoia Capital, had a few conflicts in China too. Sequoia was a big backer of Google, which is now a competitor to Qihoo. It was also an original backer of Yahoo. However, it’s not clear how much the U.S. Sequoia team is involved in the Qihoo deal. Sequoia’s Chinese office has been the main liaison with Qihoo.

Meanwhle, a separate source says Yahoo’s co-founder Jerry Yang is actively seeking to dissuade investors from backing Qihoo. A Yahoo spokeswoman declined comment. VentureBeat has contacted Qihoo, but was unable to reach Zhou by the time of this writing (Update: See our story here for Zhou’s response). A spokesman for Yahoo China did not respond to a request for comment.

Qihoo’s Zhou is controversial. He was the founder of 3721, China’s first search engine, which Yahoo bought for $120 million in 2003 to help it gain a significant foothold that had eluded it in China since it entered in 1999.

But 3721’s software had become popular by lodging itself in computers as spyware. It introducing pop-windows, bedeviling its users — and some would say it introduced spyware into China.

Things went down hill after Yahoo’s acquisition. Zhou, who took over Yahoo China’s operations came to loggerheads with Yahoo’s US headquarters. Zhou has subsequently blamed Yahoo China’s arrogance for the fallout. But Alibaba’s suit will claim Zhou initiated illegal behavior long before he was pushed out. Yahoo China says it first became upset with his performance: He refused to hire English speaking employees, and had become distant from his U.S. owner. Meanwhile, he was biding his time until he qualified for the earnout under the Yahoo China acquisition contract.

Then, last year, Yahoo invested $1 billion into Alibaba. Alibaba, under that agreement, took over the operations of Yahoo China. Alibaba’s leader Jack Ma forced out Zhou. Zhou then vowed to some his executives that he’d do anything he could to make sure Yahoo China never succeeded, according to the suit to be filed.

Yahoo China will claim Zhou was already using his position before the Alibaba acquistion to steal partnership and investment opportunities away from Yahoo China, preparing the groundwork for his exodus to Qihoo. He also offered money to key Yahoo China staff if they left the company, the suit will allege. He even launched press releases through front PR firms, saying in one case that a Yahoo China deal with MSN had expired when in fact it hadn’t, the suit will claim.

Qihoo is now reportedly raising another round, asking for a $80 million pre-money valuation. Our source said Sequoia’s Michael Moritz planned to meet Yahoo’s Jerry Yang this week to sort things out, something VentureBeat wasn’t able to confirm. Sequoia did not respond to a request for comment. According to the rumor, Qihoo wants to raise $10 to 20 million and is projecting $3 million in revenue for 2006, and $18 million for 2007.

In Qihoo’s first round, Sequoia joined CDH Investment and IDG Ventures to invest $20 million.

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