Technology

Skype Founders Pull Out the Stops


The men who launched the Internet-calling service are redoubling their legal efforts after a failed last-minute bid to buy back the eBay unit

Skype's founders aren't letting go of their brainchild without a legal fight. Turns out they mounted a formidable financial battle, too.

At the end of August, Skype founders Niklas Zennstr?m and Janus Friis submitted an 11th-hour bid for the Internet-calling business, BusinessWeek.com has learned. The pair, who had sold Skype to eBay (EBAY) in 2005, offered to buy it back for $2.1 billion, according to three people familiar with the situation. The offer was made in conjunction with private equity firm Elevation Partners, one of the people says.

Friis and Zennstr?m were trumped, of course, by a rival bid that valued Skype at $2.75 billion, but their efforts show how far the pair are willing to go to retain control of what makes Skype valuable.

Ratcheting Up Pressure

Having lost the bidding tussle to a group of investors led by Silver Lake, Skype's founders redoubled their fight in courts. The pair allege that Skype infringes on copyrights owned by their company, Joltid, and filed lawsuits in hopes of forcing Skype to stop using the technology. The lawsuits are not likely to scupper the sale, but they ratchet up pressure on Skype to reach a settlement or find another way of delivering Internet calling, legal experts say.

On Sept. 18, Zennstr?m and Friis took aim at Mike Volpi, a partner at Index Ventures, also part of the group that bought 65% of Skype for $1.9 billion and $125 million in debt. The lawsuit alleges breach of fiduciary duty, saying Volpi was aided in the successful buyout of Skype by information he obtained while he was CEO of Joost, a company also founded by Zennstr?m and Friis.

Two days before that lawsuit was filed, Joltid filed a lawsuit against the Silver Lake-led group of investors and eBay, alleging copyright infringement.

Growth Remains Notable

Volpi and representatives for Skype, Silver Lake, and Index declined to comment, as did representatives of Joost and attorneys for companies run by Zennstr?m and Friis. Alan Marks, a spokesman for eBay, says the company is "focused on closing the deal" and expects it to be finalized by year's end.

The Skype stakes are high. In the second quarter, Skype's user base jumped 42% from a year earlier, to 480.5 million people, and its sales rose 25%, to $170 million. While growth has slowed from previous quarters, eBay still expects the company to achieve $1 billion in annual sales by 2011. The new owners aim to accelerate growth by putting Skype on a broader array of mobile devices and pushing it deeper into businesses. "The potential of this company is underestimated," Mark Wiseman, senior vice-president of private investments for the CPP Investment Board, which also invested with Silver Lake, told BusinessWeek.com soon after the purchase was announced.

The founders may not be appeased by a financial settlement and instead may be holding out for a stake in the company, if not a leadership role, says Nitzan Shaer, a managing director at venture fund High Star Group who previously managed Skype's mobile efforts. "They'd like to lead the acquisition themselves," he says. "Now, it's a battle for who controls and leads [Skype]." Joltid and Joost are being represented by Skadden, Arps, Slate, Meagher & Flom.

Technical Obstacles for New Owners

Though the legal contest will be hard fought, it's not likely to derail the deal. If Silver Lake and its fellow investors walk, they'd have to pay eBay $300 million. For its part, eBay has agreed to take on 50% of any potential damages from litigation. And Skype's founders had alleged copyright infringement before the deal was clinched, so it's not like the bidders weren't aware of the potential legal hurdles.

But Skype's new owners also face technological obstacles. Since the 2005 acquisition, eBay licensed Skype's core technology from Joltid, which terminated the license in March. Since then, eBay has been scrambling to devise a workaround that would let Skype quit using Joltid's technology altogether. A viable workaround would be an important lever in negotiations with Joltid, which says it's suffering damages of $75 million a day. "If they can do a complete workaround, then things become materially different," says Randolf Katz, partner at law firm Baker & Hostetler.

With his deep technology expertise, Volpi may be instrumental in developing different approaches to calling. "Clearly, there are other services like Skype out there," says Joyce Kim, chief marketing officer at Web-calling technology company Global IP Solutions, whose customers include networking giant Cisco Systems (CSCO), where Volpi used to be chief strategy officer. "Certainly, there are other ways to do what they are doing."

Settlement Is Possible

Skype could even modify its service so it works similarly to Web-calling rival Vonage (VG), experts say. It could develop the technology in-house, or even buy a Web-calling startup, such as damaka. Volpi left his CEO position at Joost to join Index Ventures in June. While at Cisco, he helped the networking giant acquire more than 70 companies. "Skype isn't out of options," says Jeffrey Lindsay, an analyst at Sanford C. Bernstein. "It's not a hopeless case by any means."

What's more, Skype will have months more to finesse the workaround. The lawsuit made public Sept. 16 "is unlikely to get to trial until a year or two from now," says Rod Dorman, a partner at Hennigan, Bennett & Dorman, which represents Joltid. The lawsuit against Volpi and Index is tricky, and could take time as well, as proving breach of fiduciary duty and resulting damages is typically more difficult than proving copyright infringement, Katz says. The parties could still settle before then; one possibility is that Skype may be offered an option to acquire Joltid, with the founders getting a piece of the equity in Skype in exchange.


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