PeHUB Redux

Welcome to the first installment of peHUB Redux, where we reprint the juciest posts on www.peHUB.com from the prior month. If the discussions continue to be as heated as they were in November, we expect to bring you this feature on a monthly basis. —Dan Primack, Editor, peHUB

Hey, Lightspeed: Do the right thing

Posted Nov. 2

Limited partners usually look forward to stock distributions from their general partners. It’s not quite the liquidity of a cash distribution, but still superior to the erethral dryness of a printed IRR. But there are exceptions to any rule—and sometimes they are large enough that an LP will call me to say: “We got screwed.”

This is one of those exceptions.

Last Thursday night, Lightspeed Venture Partners distributed over $100 million in Riverbed Technology (Nasdaq: RVBD) stock. The deal was tagged with around a $42.22 per-share distribution price, which was based on the five-day trading average prior to distribution. This is also the mark that Lightspeed used to determine its carried interest, as specified in its limited partnership agreements. No official harm or foul.

Unofficially, however, the distribution was a show of bad faith. Riverbed stock had mostly traded above $40 for months, even surpassing $50 in mid-day trading a few weeks ago. But that all came to a crashing halt last Wednesday, following the release of disappointing earnings. Riverbed stock last Wednesday sunk more than 28%, to close at just $34.61 per share. Things got even worse the subsequent day, with a $32.67 per share close.

It was at this point that Lightspeed decided to make its distribution, using a five-day average that included three high days and two low days. In other words, LPs were told to pay carry on over $42 per share, on the very day that the stock is trading at under $33 per share? Simply unfair.

There are plenty of times when a stock spikes or tanks after a distribution, in which case either the GP or LP is honestly chagrined. But that is not what happened here, as the tank had already occurred. Lightspeed knew that the distribution price would be significantly higher than what LPs could actually sell the stock for, which would be particularly tough for those LPs who are mandated to sell distributed shares immediately.

Lightspeed declined to comment, but perhaps would argue that the tank is precisely why it distributed on Thursday, under the premise that Riverbed would not regain its past glory. Get in those three good days. Fine, but then it should amend its LP agreements and take a lower carry. Not because it has to, but because it’s the right thing to do.

It’s also the best strategic move. Lightspeed plans to raise another fund (likely next year), and LPs tell me that they’ll remember this incident when due diligence comes back around. All it takes is a few sour LPs to sour the bunch.

It’s not too late, Lightspeed. Do the right thing. Do the smart thing. —Dan Primack

Reader Reaction

(Edited for length and clarity.)

“This is a highly unsophisticated viewpoint on a very routine transaction in the venture world. Lightspeed had a director and was unable to distribute. It certainly appears that they distributed first chance they could (48 hours after earnings release, right?). Their LP agreement is not only industry standard, but considered superior to other agreements which allow same-day pricing (rather than five- to 10-day averaging).”— Alexis Lakes

“Alexis: You’re right about when they can distribute, but Dan wasn’t arguing that they should have distributed 10 days earlier. He was saying that the GP is receiving more in carried interest than is actually deserved, based on what the LPs received. As you write, they had a director. If that director is worth anything, he should have told his GP to keep the shares until the firm improves (which he could theoretically help it do). Just because this may be standard doesn’t make it ‘right.’” —an LP

“I hear you on Lightspeed, but that is why we have agreements. LPs should have negotiated an agreement that was the five-day trading average not to exceed the last day price. Otherwise, this will always happen (just mathematically) any time the stock is trading down. Here it is accentuated, because of the big drop, but that could have easily been seen by the mechanism before.” —Jason

“The bottom line here is that Lightspeed made a conscious decision to make that particular distribution because of what had happened to Riverbed stock two days before. And they knew that decision was to screw the LPs and pay themselves more money than they deserved for a stock that had tanked. All they had to do was to wait three more days when the five-day trading average reflected Riverbed’s true price.” —Joe S.

“As far as doing the right thing, we have numerous GPs that have willingly chosen (with little LP influence or coercion) to act in a manner inconsistent with the LPA. For example, one GP waived management fees on a 1999 fund post-investment period that was performing poorly. Another GP chose to escrow deal-by-deal carry because they foresaw some future write-downs or potential write-offs in non-realized portfolio companies. These are not fly-by-night GPs. These are brand name firms whose LPs occasionally grant them LPA and other flexibility because they trust the GP to ‘do the right thing.’” —Anonymous

“Anyone who has worked with the Lightspeed board member (and I did for almost two years), Chris Schaepe, would tell you that he is a class act. He is a strong supporter of his portfolio companies (above and beyond when other investors would have thrown in the towel and gone home), dedicated board member, hard-working honest, and ethical. It would be highly improbable to see Chris doing something with the malicious intent to LPs as described in this column.” —Michael C.

“As a Lightspeed LP, [I’m] sorely disappointed in the GP on this whole Riverbed distribution…. They had the benefit of hindsight on when to choose to distribute the stock (and thus lock-in their carry)—and you are fooling yourself if you don’t think a GP thinks about that constantly when they are holding several hundred million dollars of a single stock—and they consciously chose a time that was highly advantageous to themselves and highly disadvantageous to their LPs.” —Will

Lightspeed does right

Posted on Nov. 6

Lightspeed Venture Partners has (belatedly) done the right thing, vis-à-vis its distribution of Riverbed Technology stock. The Silicon Valley firm yesterday posted the following comment here at peHUB:

“Lightspeed Venture Partners is an LP-friendly firm that operates according to high ethical and professional standards. We prefer not to comment publicly about limited partner matters. However, given the discussion here surrounding our recent stock distribution of Riverbed, we felt it was important to set the record straight.

The distribution of Riverbed stock was issued upon the opening of the directors’ trading window with a distribution price calculated according to our LP agreement. The General Partner did not receive any carried interest distribution. Subsequently, as the stock settled out at a significantly lower price than the distribution price, we made an adjustment to compensate our LPs for the difference.”

I followed up with Lightspeed partner Jeremy Liew, for clarification on the issue of the GP not receiving any carried interest distribution. He responded with the following:

“To answer your question, as you know, there is often a difference between when GP carry is earned and when it is paid. The GP was not paid any carry on this distribution. Furthermore, we made an LP-favorable adjustment to GP carry earned. The feedback we’ve heard from LPs has been extremely positive.”

In other words, the fund is either (a) underwater, (b) around water-level, but the GP is still over-distributed or (c) above water, with the GP building in some cushion in case of subsequent losses.

But that doesn’t really matter. The important thing is that the issue has been resolved fairly. Kudos to all involved. —Dan Primack

Reader reaction

(Edited for length and clarity.)

“I have known and invested in the Lightspeed team for many years and continue to think of them as a high integrity team with a history of doing the right thing for their LPs. This was an unfortunate situation which stems from the terms of the LP agreement, not the integrity of the team. They addressed the issue quickly and professionally and that should be the end of the story.” —Lightspeed LP

“I have several issues with your Lightspeed articles. One of the most glaring is your use of the word ‘belatedly,’ which is simply wrong. Lightspeed has a history of soliciting input from their LPs before making important decisions. They moved very quickly in this case to present and implement a very equitable position. In brief, we have tremendous respect for the Lightspeed team, which has a history of doing the right thing for its LPs.” —Longtime West Coast LP

“Lightspeed didn’t consult with their LPs before they decided to cut themselves an extra $8 Million check. And they only decided to give that back once they were vilified in the press. I wonder if they’ll still take credit for the $42 distribution price in their track record for future marketing.” —Jeff

“I’m glad you followed up with another article clarifying the resolution to the distribution of Riverbed stock and an end to this story. The team responded promptly and fairly to offer its LPs a full offset for the lower price of the stock. As to the issue of when a GP can take carry, your implication is misguided. This particular fund is well above break-even, but, as several other posters have outlined, waterfall mechanics impact timing of carry distributions.” —LP