The disgruntled investors who sued Idealab Inc. on Friday seeking to liquidate its assets and recoup at least some of their money are unlikely to win in court, according to legal experts.
Dell USA, T. Rowe Price Science & Technology Fund and others were part of a $1-billion investment group that bought 10% of the Pasadena-based Internet "incubator" at the height of the dot-com frenzy.
Now that the bubble has burst, the investors accuse Idealab founder Bill Gross and other executives at the once highflying company of keeping it alive solely for their personal gain, and they want it dissolved before the remaining assets are frittered away.
But legal experts say that these preferred shareholders should not get their money back simply because they made a bad bet on the future of Internet stocks.
"Corporations are meant to be permanent economic organizations, not ones in which the minority investors can demand their money back because market conditions have turned sour," said John Coffee, a Columbia University law professor who specializes in corporate governance and securities law. "They knew the risks."
The key argument in the lawsuit is that Idealab's executives treated the investors unfairly by using the money to "feather their nests" instead of returning it once it became clear the market for new Internet companies had dissipated, said Skip Miller, the attorney representing the investors in their lawsuit, which was filed in Los Angeles Superior Court.
It has been clear for more than a year that the dot-com boom is over, and yet privately held Idealab continued to pour millions of dollars into new start-ups that have little hope of success, Miller said. If Gross and his cohorts really had the best interests of the investors at heart, they would wind down the incubator and return the remaining cash, he said.
"It comes down to inherent fairness," said Miller, a partner at the Los Angeles firm Christensen, Miller.
But fairness is not a legitimate basis for this kind of shareholder lawsuit, legal experts said. The investors are entitled only to the protections specifically laid out in their shareholder agreements and nothing more.
"As a general matter, judges tend to be reluctant to give preferred stockholders rights beyond the contractual terms they agreed to," said Henry Hu, a corporate law professor at the University of Texas at Austin who has not read the complaint. "The preferred shareholders want to just cut their losses and take their money, but that's not the deal they negotiated. The judge is going to be reluctant to in effect renegotiate the deal."
Since they represent less than 10% of Idealab's shareholders, a judge is even less likely to be sympathetic.
"It's very hard for minority shareholders owning only 10% of the company to convince the court that it should overrule the majority and the board of directors," Coffee said. "This is a fairly weak argument."
The investors have tried to assert in private negotiations with Gross that they are entitled to a majority of the company. They argue that Idealab is worth little more than the $1 billion they invested in March 2000.
They first approached Gross in November 2000 with a proposal to take over 80% of the incubator and leave him with some of Idealab's start-ups. Gross refused.
They returned last Wednesday demanding a 90% stake in the company "or else," said Marcia Goodstein, Idealab's president and chief operating officer. After they were rebuffed again, they filed their lawsuit.
The best that Idealab has offered is to return 10 cents on the dollar, a deal that several investors accepted in recent weeks.
Gross' main strategy has been to appeal for patience. Despite the freefall in Internet stocks and demise of Idealab fledglings such as online toy seller EToys Inc., Gross insists the incubator is still viable. "The climate is picking up," he said.
Idealab has pared its operations in the last two years. Three of the four satellite offices have closed, and its work force has been cut from 230 in October 2000 to 93 today. The prospect of IPO riches, once tantalizingly close, is now years away at best.
Idealab has $360 million in liquid assets and is incubating nine start-ups, including a broadband venture and a robotics firm. With annual operating costs of $24 million and a $12-million investment budget, the company has the resources to stay in business for five to 10 years, Gross said.
Goodstein said the company's assets, although far smaller than before, are growing, and that the investors have benefited from that growth since the time of their first divestiture demand.
"At the time, if we had given them all of the cash and assets, they would've gotten 6 cents on the dollar," said Goodstein, who is engaged to Gross. "Now what we have is 36 cents on the dollar in cash. If you include the other assets, it's 50 to 60 cents on the dollar."
