The Delaware Supreme Court last week upheld the dismissal of a lawsuit brought by the founder and an executive of Abbott (NYSE:ABT) acquisition IDEV Technologies against venture capital shops they accused of violating their fiduciary duties by diluting their economic and voting interests.
The plaintiffs in the case were Jeffrey Sheldon, who co-founded IDEV in 1999 and was CEO until 2008, and co-founder Dr. Andras Konya, who invented some of IDEV’s core technology and was a consultant to the company between 2000 and late 2012. Between them Sheldon and Konya owned a 3.75% stake in IDEV. Some 60% of the company was owned by a group of VC funds that included Pinto Technology Ventures, RiverVest Ventures and Bay City Capital as of 2009, according to court documents.
The next year the company changed management, restructured its sales force and focused on its core technologies. IDEV also hit the fundraising trail, aiming to bring in $40 million, setting the stage by converting preferred stock to common stock, executing a 1-for-100 reverse split and issuing new Series B-1 preferred shares that it eventually used to raise $27 million. Sheldon and Konya did not participate in the round, despite the firm’s warning that common shareholders who didn’t join would be significantly diluted; after the dust settled, they were left with a 0.012% stake in the company they’d founded, according to the documents:
“Sheldon and Konya claim that instead of the respective $15,000 and $7,500 they were actually entitled to from the Abbott acquisition, they would have received $7.75 million and $3.875 million, respectively.”
An initial case filed in Texas was dismissed on jurisdictional grounds, prompting Sheldon and Konya to bring the case to the Delaware Chancery Court, which dismissed it in January after finding that they failed to show that the VC firms banded together to control IDEV before the Abbott buyout. The duo appealed to Delaware’s high court, which ruled Oct. 4 that the lower court got it right.
“Appellants do not specify whether the venture capital firms invested through exclusive private placements, how many or which of them participated, what rights they obtained, when they occurred, or whether they agreed to vote together on any matters. Appellants also do not identify any instance in which all three venture capital firms participated in any investment,” the Delaware Supreme Court ruled. “The complaint does not allege that they held themselves out as a group of investors or that they reported as such to the SEC, nor does it explain how they coordinated their allegedly ‘long and close relationship of investing together for their mutual benefit.’ Rather, as the Court of Chancery concluded, ‘Plaintiffs’ allegations merely indicate that venture capital firms in the same sector crossed paths in a few investments.’ Moreover, it found that, ‘[o]ther investors participated in [the financing and prior financing rounds] and received the same securities, but are not alleged to be part of the control group.’
“Further, the complaint fails to allege facts or create a reasonable inference showing that the venture capital firms had anything but a ‘mere concurrence of self-interest.’ Viewing the allegations in the complaint in the aggregate, we agree with the Court of Chancery that it is not reasonably conceivable that the venture capital firms functioned as a control group. And because the appellants’ theory that their claims are partially direct hinges upon the existence of a control group, we cannot conclude on the record before us that the Court of Chancery’s conclusion was erroneous. It follows that the appellants’ standing was extinguished in the merger,” the court found.