The startling turn of events came just three days after CEO Konrad Hilbers and co-founder Shawn Fanning, along with other high-ranking execs, resigned their jobs to protest the refusal of Napster's board to approve Bertelsmann's buyout (see BW Online, 5/15/02, "Napster's CEO Splits on a Sour Note"). Napster appeared to be headed for bankruptcy court. Now it has a new lease on life with an international entertainment giant.
LOAN FORGIVEN. The about-face, say insiders, was prompted in large part by the Napster executive walkout, as well as a Delaware judge's decision to throw out a bizarre lawsuit that pitted Napster board members against each other. In addition, Napster board members Hank Barry and John Hummer, venture capitalists who had put more than $12 million into the upstart, dropped their demands that Bertelsmann indemnify them against any liability stemming from the upstart's troubles with the recording industry, insiders say.
The deal will see Bertelsmann forgive an $85 million loan it made to Napster and make $8 million available to pay off the outfit's creditors. It also reunites the Napster team, including Hilbers, Fanning, and others. In a statement, Hilbers expressed a readiness to get on with developing a legal, subscription-based service. Said Hilbers: "While this has been a very unusual week, I'm pleased that I and my colleagues can move forward and give our full attention to Napster's future."
All parties expressed relief to have finally resolved their differences. "We are very committed to providing artists the best possible distribution opportunities for their work, and to providing consumers more choice and control," says Joel Klein, chairman and CEO of Bertelsmann. "Creating new ways of doing business is never easy, but Napster will be at the forefront of finding business models that respect copyright, reward artists, and deliver entertainment value to consumers."
Whether Napster will be able to deliver on its vision is far from certain. It still needs to settle lawsuits brought by the recording industry as well as produce a service that's compelling enough to bring back customers who have defected to other sites.
SNARLS AND STALEMATES. The mere fact that Hilbers and his team will be able to confront that challenge is remarkable, given the ups and downs of the recent dealings with Bertelsmann. As Napster's cash dwindled, it had been in talks with Bertelsmann for months. Then, in early March, an offer from the media giant seemed to be on the fast track. Hilbers championed the deal as a way to prevent further layoffs and possible bankruptcy.
An internal feud among Napster's board members scuttled the purchase when John Fanning, uncle of co-founder Shawn Fanning, filed suit on Mar. 25 against the company and board members Barry and Hummer. Fanning asked a judge to remove the duo from the board and validate a new one. Bertelsmann wanted unanimous approval for its offer. Suddenly, a pact that seemed imminent was taken off the table, insiders say.
The buyout came back into play weeks later, and a deal seemed closer than ever. The only sticking points revolved around liability. Insiders say Hummer and Barry, partners at Hummer Winblad Venture Partners, wanted a right to sue Bertelsmann if the recording industry went after the venture firm or its partners. Bertelsmann apparently balked at the demand, and the two sides were at a stalemate once again. Barry declined to comment for this article.
MESSAGE DELIVERED. That's when Hilbers and his team decided to walk. On the morning of May 14, Hilbers resigned. By the end of the day, Shawn Fanning and other senior execs had done the same. In an e-mail, Hilbers told staffers: "I am convinced that not pursuing the offer is a mistake and it will lead the company to a place where I don't want to lead it."
The message apparently got through to Napster's board. Talks with Bertelsmann resumed almost immediately, ending with the May 17 announcement. Now, Napster and Bertlesmann will have to show that this surprise second act can bolster the bottom line by providing a music-delivery system that consumers want.
Editor's Note: Remarks critical of Napster's board, written in an e-mail to company insiders by Napster investor Ron Conway and reported in an earlier version of this story, were retracted by Mr. Conway on Friday, May 17, BusinessWeek Online has learned. By Linda Himelstein in San Mateo