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The ongoing struggle between one-time Internet star Bill Gross and the minority investors in his Idealab investment firm has taken a new twist. Disgruntled minority shareholders in Idealab filed a new complaint on Jan. 13 in California state court that includes snippets of e-mail and other embarrassing revelations about Gross and some of his fellow Idealab executives.
Among the disclosures: Gross, a onetime billionaire, defaulted on a $50 million personal loan from Bank of America in November, 2001. And in an e-mail dated March 16, 2000, Idealab President Marcia Goodstein told Gross "we are running out of cash. At your current deal rate, we're not running, we're hemmorrhage [sic], I can't even think of words strong enough to express how fast we are going broke."
That e-mail came at a time when Idealab still looked like a success, at least to outsiders. It had just raised $1 billion from private investors. The following month, the firm filed with the Securities & Exchange Commission to sell stock to the public. Idealab ultimately shelved that plan after the stock market collapsed.
DIVERSE GROUP. The Jan. 13 filing is part of a yearlong court battle between a group that now includes 40 Idealab investors. The investors, whose unhappiness was first reported by BusinessWeek Online, claim Gross, Goodstein, and six other Idealab officers and directors breached their fiduciary duties by misappropriating corporate assets (see BW Online, 12/21/01, "When an Incubator Goes Cold").
The 40 plaintiffs are a diverse group, consisting of sophisticated investment funds and wealthy individuals. They include the T. Rowe Price Science & Technology fund, Dell Computer's (DELL
) venture capital arm, Travelers Insurance Group, as well as Jeffery Berg, chairman of Hollywood talent agency International Creative Management, and Cindy Margolis, an E! Entertainment Channel show host and Internet pin-up queen. The plaintiffs are seeking a liquidation of Idealab, a removal of all of its directors, and a return of their $725 million in investments.
In an interview with BW Online, Goodstein, who is now married to Gross, doesn't denying writing the Mar. 16 e-mail. She says it came at a time when she was concerned about the rate at which the company was spending money. "Everyone was saying you can make 10 or 20 times your money," Goodstein says. "Investors were begging to give us their money."
TOUGH CASE TO PROVE. Goodstein calls the lawsuit a publicity stunt, designed to get Idealab to cough up more money to shareholders. In December, 2001, Idealab offered investors the equivalent of 10 cents on the dollar for their shares. The investors argue that the company still has $350 million in cash and marketable securities that could give them as much as 35 cents for every dollar they invested.
Goodstein counters that liquidating all of the firm's cash would be detrimental to Idealab's other shareholders, some of whom have been invested for years. "We run Idealab on behalf of all shareholders, and they deserve a return," Goodstein says. She says it has about 750 investors in all and manages a network of 25 companies, some of which have recently turned profitable.
Securities lawyers say the suing investors may have a tough case. "When you are a minority shareholder, your rights are limited," says Thomas Ajamie, a Houston attorney active in shareholder suits. "Judges give wide discretion to majority owners and management. Investors have to prove outright fraud."
GRIM PICTURE. Already, Los Angeles Superior Court Judge Ralph Dau has twice dismissed the investor's charges for lack of sufficient evidence. Plaintiffs' attorney Louis Miller says his clients had a hard time getting documents from Idealab and Bank of America to prove their case. "We didn't have all the details," Miller says. "Now we do."
Founded by longtime entrepreneur Gross in 1996, Idealab pioneered the concept of an Internet incubator -- a venture-capital firm cum office park, wherein fledging businesses were nurtured until they could be taken public. Idealab launched early Internet darlings like eToys, Carsdirect, and CitySearch. Gross poured more than $600 million into startup companies in early 2000 in preparation for Idealab's public offering. But many of those investments are now worthless.
The details disclosed in this latest filing don't paint a very flattering picture of Gross and his associates. According to the complaint, Gross's compensation has tripled to $766,000 in the past two years, even as Idealab investors saw the firm's overall value plummet. Goodstein's salary also soared, and her stock options were repriced, giving her a potential profit of $6.3 million, according to the suit. Gross's brother Lawrence, a former Idealab executive and board member, had a $618,000 personal loan forgiven.
KEEPING IT QUIET. Perhaps most damaging, the suit introduces a possible motive for why Gross may be resisting liquidating Idealab. He has $50 million in personal loans outstanding with Bank of America, according to the Jan. 13 complaint. His Idealab stock is pledged as collateral, so if those shares are ultimately worth less than $50 million, he might have to declare bankruptcy. Gross is Idealabs' largest shareholder, but the $1 billion raised in early 2000 was in preferred stock, which may have preferential claim to Idealab's assets if the firm were liquidated.
The suit details steps Idealab executives took to quietly resolve Gross's personal financial difficulties in 2001. An August 13, 2001 e-mail from Goodstein to Idealab executive and board member Robert Kavner emphasizes the need to keep Gross's loan troubles hush-hush. "That is a pretty large material fact to impact our business!" Goodstein allegedly wrote. "That is not something Bill is going to be comfortable disclosing publicly."
The suit also quotes an August 16, 2001, memorandum -- purportedly on file at Bank of America, according to the plaintiffs -- in which Goodstein offers to have Idealab buy Gross's personal loan at a discount with company funds. Goodstein says Idealab explored that option only because it might have benefited by allowing the firm to acquire Gross's shares at a discounted price. According to the suit, and later confirmed by Goodstein, Gross ultimately renegotiated the loan with Bank of America in exchange for $300,000 in cash and $1.4 million worth of Idealab stock.
NO GARY WINNICK? Goodstein says her compensation and that of other Idealab execs increased because management successfully restructured the company, closing four offices, laying off more than one-third of the staff, and cutting monthly losses from $10 million to $2 million. Gross's large personal debt, she says, was not due to extravagant personal spending, as the suit implies, but instead is the result of his having personally invested $42 million to buy Idealab stock.
"This isn't like the Gary Winnicks of the world," Goodstein says, referring to the former Global Crossing chairman who sold $600 million of his telecom's stock before the company declared bankruptcy. "Bill was putting money in, not taking it out."
Idealab's angry investors may have a tough time proving their case in court, but Bill Gross's defense isn't like to polish his already tarnished reputation, either.
Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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