Arrington Fires FilmLoop Flap

FilmLoop co-founder and company Chairman Prescott Lee says ComVentures, one of his startup’s backers, forced the short-order liquidation of his startup, did not adequately shop it around to potential acquirers and rolled it up into one of its other portfolio companies at the founders’ and employees’ expense. But he does not claim any laws were violated or even that the investors acted unethically.

The FilmLoop flap began earlier in the week, when TechCrunch editor Michael Arrington wrote a vitriolic rant about FilmLoop’s demise—– including the charge that ComVentures had committed an “evil” act.

The events are unusual, but what follows is not the story of an “evil” VC jonesing to break the back of a hard-working entrepreneur, as Arrington would have you believe. Instead, it’s the swan song of a startup, inflected with a “somebody done somebody wrong” song melody from the startup’s founder and counterpoint from its investor. You may enjoying listening to it, but be assured, it is in a minor key.

Palo Alto, Calif.-based FilmLoop was having problems. Its product, a service that allowed you to share a revolving set of digital photographs, had good customer adoption, Lee says, but lacked a stickiness that could be translated into revenue. It was working to overcome those problems and redesigned its service last fall.

Lee says Roland Van der Meer, the ComVentures partner responsible for the deal, met with him at the beginning of November to discuss the redesign. Van der Meer said positive things about it, Lee recalls.

Then, at the end of the month, Van der Meer came back to Lee and called for the company to be shut down, Lee says. “He did a complete right turn where he said he wanted to sell the company by the end of the year,” Lee says of Van der Meer. The founders were not pleased with this turn of events. “We thought it was kind of ridiculous to try to sell the company in the month of December,” he says.

Lee immediately cut costs, reducing his staff from 30 full time employees and contractors down to 10. The company could have run for another year, even before the layoff, based on its burn rate at the time and the cash it had on hand at the time, Lee says.

But ComVentures wanted to shut it down, Lee says. Van der Meer convinced Globespan Capital Partners, the other venture firm associated with the deal, to vote its preferred shares in favor of ComVentures proposal to shut down the company. Guy Kawasaki was invested as well, through Garage Ventures, but only had a limited stake, Lee says. The partner who initiated Globespan’s investment in FilmLoop had left earlier last year; a factor Lee says may have played a part in Globespan’s acquiescence to the shut down proposal.

FilmLoop’s founders were reluctant to sell. They might have been able to block the move as board members. But after discussing the matter with their lawyers, Lee says they felt they had a fiduciary duty to vote in favor of the preferred shareholders: the VCs. The preferred shareholders did not own a majority of the shares, Lee says. But the common shareholders were bound to vote in the same direction because of preferred shareholder drag-along rights, Lee says.

The FilmLoop founders were forced to look for a buyer after losing the board vote. Van der Meer was adamant about getting the deal done before the end of the year, Lee says. The rush precluded some potential acquirers from doing the deal and led to a poor valuation of the company, Lee says. “There were a number of interested parties who said they wouldn’t close before the end of the year,” Lee says.

The startup fielded two bids, Lee says. One came from ComVentures portfolio company Fabrik, which sells a service for storing digital media online. The other was a bid by management, led by Lee, he says. San Mateo, Calif.-based Fabrik offered more money and subsequently got the company. It extended employment offers to the 10 remaining FilmLoop employees, but not one took a position, Lee says. “They [the FilmLoop employees] didn’t believe in their [Fabrik’s] vision or their ability to execute,” Lee says.

Roland Van der Meer, a partner at ComVentures, has a different story. “We are only one of five board member and we were not the largest share holder,” he says. “We were one of many in a process that is orderly and legal. It’s an unfortunate outcome because we really believed in the team.”

Van der Meer says he did not call for the company to be shut down, nor did he even suggest it. Anther board member first floated the idea, he says. He won’t say who it was.

The VCs were not interested in funding the company until it ran out of money, Van der Meer says. The company had enough time to meet with between 10 and 15 potential strategic acquirers before it signed with Fabrik, Van der Meer says.

“We believe in the entrepreneur and we’ll back them all the time,” Van der Meer says. “You have to work through problems. We didn’t force anything. This all happened.”

“This was a good team,” he says. “They had a good business model but it didn’t work. They tried again and again and it didn’t work. The board, at large, had to ask, do we have a value proposition that is viable. If it is, then you work like crazy to make all the pieces in place to make that happen. These guys did that for a long time, they were a diligent team. They worked hard.”

But it was obvious that it wasn’t working, Van der Meer says, and the investors had no interest in running it into the ground. “People downloaded it and never used it again,” he says. “I believed all those downloads meant something—until they didn’t.”

“The big lesson for this genre of company is: even though you have fantastic download and initial sign-ons, you have to really watch the burn and demonstrate that you can get to revenue,” Van der Meer says. “It’s something very intuitive. Be very judicious about expanding burn until you have the revenue growth to accelerate.”
Concerns about ComVentures

TechCrunch, a popular technology weblog, broke the news of FilmLoop’s fire sale last week, asking if FilmLoop was “betrayed” by its investors. Blog editor Michael Arrington, implied, through his editorial-style post, that ComVentures was “ethically challenged” and that its actions were “evil.”

Arrington’s post raised questions in some peoples’ minds about the health of ComVentures. Arrington wrote that ComVentures was “…under pressure from its own limited partners to clean up its portfolio and discard any unprofitable startups.”

Sources familiar with the situation contacted by PEHub.com echoed Arrington’s claim but were unable to provide any support to prove their assertion.Van der Meer denies this statement. “Limited partners, in my experience, have never interfered with the portfolio management of any venture firm,” he says.

The firm raised a $300 million fund in 2005, so it’s hard to imagine its limited partners being too anxious for the firm to wrap up its unprofitable startups. In fact, one might expect the majority of its portfolio companies to be unprofitable.

But ComVentures limited partners may have some reason to be nervous. The firm has been plagued by instability. It lost Partner Jim McLean last spring, who was one of five general partners to leave since the Palo Alto, Calif.-based firm began in 1997. The other partners to leave were Paul Vabakos, David Helfrich, Perry Wu and firm co-founder Cliff Higgerson. Higgerson remained involved with the firm during part of 2006, but finally severed his ties in favor of a position as venture partner at Walden International.

The firm has had little in the way of successful recent exits. It sold two companies in 2006, according to Thomson Financial (publisher of PEHub.com). It sold business communications company Ascendent Telecommunications, which had raised $20 million from VCs, for an undisclosed value in March and FilmLoop in December.

ComVentures sold three companies in 2005, according to Thomson Financial. It sold Kagoor Networks, which had raised $40 million from VCs, for $67.5 million. It sold RLX Technologies, which had raised $99 million from VCs and Sarvega, which had raised $23.5 million from VCs, each for undisclosed amounts. Van der Meer confirmed these sales.

But the dearth of recent exits doesn’t necessarily mean the firm is in trouble. The firm has four companies in its portfolio with revenue over $100 million, Van der Meer says: fixed wireless voice and data products-maker Axesstel (AMEX: AFT), Fabrik, Internet market research company MarketTools and digital archiving service provider Zantaz. High-bandwidth transmission systems company Aurora Networks, another ComVentures portfolio company, is doing $95 million in revenue per year Van der Meer says.

Perhaps the most telling detail is the firms ComVentures does the most deals with. Van der Meer is quick to point out that these partners are more representative of ComVentures’ previous ten years of investing rather than its current operations. But the firm’s top three partners are Sevin Rosen Funds, which it has invested next to in 22 rounds, Crescendo Venture Management, which it has invested next to in 19 rounds and Worldview Technology Partners, which it has invested next to in 18 rounds, according to Thomson Financial.

Sevin Rosen announced it was not going to raise its next fund last fall. Crescendo has yet to close a new fund, despite jumping through several hoops to make its offering attractive to investors. Worldview gave up on its fifth fund last year due to its poor returns.

Still, FilmLoop’s failure isn’t going to sink ComVentures and Arrington’s reach isn’t going to poison the Web2.0 world against the firm. Silicon Valley is littered with the corpses of failed startups. That’s part of the charm of the region. It’s a place where failure is an accepted part of the culture, a place where you can swing for the fences and a place where people still play hardball. Serious entrepreneurs understand that. Arrington should too.