Why a haphazardly made venture capital deal may cost a successful entrepreneur her company.
Back in the early days of Discovery Toys, founder Lane Nemeth accepted $100,000 from Phil Greer's VC firm. Ten years later the deal may cost her the company
The adversaries in these events would tell you this is a story about dishonesty, or the clash of a company builder's vision with an investor's self-interest, or the principle of fairness. But it isn't. It's about money. And, like all stories about money, it's about greed.
More particularly, it's about what can happen when one small deal is haphazardly made. In this case, the result was a fight that will determine the future of hugely successful Discovery Toys Inc. And if the fight's outcome is still unclear, the stakes are not. Though Lane Nemeth founded it, runs it, and with her husband owns more than two-thirds of its privately held stock, she may lose her company.
When you talk to Nemeth these days you get the impression that this potential consequence hasn't yet sunk in -- that it strikes her as all too, well, inconceivable to actually happen. It's easy to see why.
Having started Discovery 12 years ago with a $5,000 loan from her family and a love for quality toys, Nemeth now finds herself with a profitable, $70-million direct-sales toy company -- all without the benefit of a background in business. From humble beginnings in her garage -- her then-baby daughter, Tara, crawling among the boxes -- Nemeth built Discovery into one of the nation's top-grossing companies of its kind, joining an elite group that includes Avon, Tupperware, Mary Kay, and World Book. In the process the 43-year-old Nemeth has become a touted female entrepreneur and working mother, the subject of countless inspirational tales about having it all.
But next month Nemeth's tale could be about losing it all instead. On August 20, she's scheduled to go to court to battle a lawsuit brought against her by eight Discovery minority shareholders. The suit threatens to dissolve her company or force her to pay dearly to keep it; even an out-of-court settlement could prove too costly for Discovery to bear.
Ironically, Nemeth's considerable trouble stems from vexing Philip Greer, the very investor who saved her from near-ruin a decade ago. His firm, Weiss, Peck & Greer (WP&G), an investment management, venture capital, and buyout firm with offices in San Francisco, put $100,000 into Nemeth's company when it was flirting with insolvency in 1980. The cash infusion originally bought WP&G 20% of the toy concern. The firm later sold between 2% and 3% to an outside investor, leaving it with a 17.46% share. Nemeth and her husband, Ed, own about 68%.
In the decade since the deal, Discovery has become successful and Greer -- as any venture capitalist would -- has been waiting to cash out his position. But WP&G did not specifically contract for a way to liquidate its holdings, and Discovery hasn't paid out a dime either as a return or as a dividend. Nemeth's compensation, meanwhile, has risen exponentially -- from $32,000 in 1981 to $750,000 in 1989 -- serving to irk the peeved Greer even more.
Last August WP&G took its gripe to the courts, charging the entrepreneur with treating herself better than the company's minority shareholders, and so abusing their minority rights. Nemeth and Discovery countersued, alleging Greer engaged in a pattern of greenmail, harassing and badgering Discovery for an exorbitant price for the stock. In February Weiss, Peck & Greer asked for an involuntary dissolution of Discovery -- possibly the first time that a venture capital firm has sued to dissolve one of its own portfolio companies, but nevertheless Greer's only legal avenue for liquidating his firm's position. By May more barbs were flying. All but 3 of Discovery's 11 minority owners had become parties to the suit. Two of the 3 not suing are insiders: Nemeth's husband and Michael Clark, the company's chief operating officer.
That the minority should gang up on the majority -- especially in a private company whose founder owns the bulk of the equity -- is not unique to this feud. Suing for dissolution is a common cure in several states for irreconcilable shareholder disputes, particularly those springing from closely held and family-owned businesses. What's more, the courts have grown increasingly willing to favor minority shareholders and actually dissolve a company, sending a stern message to business owners who believe they can ignore those investors and enrich themselves instead.
Before California Superior Court Judge Ellen S. James weighs the issues, she'll have to wade through considerable court files. Indeed, in the past year, the battle between Discovery and WP&G has become so hostile that the lawyers for each have clogged the court with motions for sanctions and evidence of every sort, laying bare the entire history of a 10-year relationship now on the rocks.
Those documents suggest that Nemeth and Greer, acting more like star-struck sweethearts than business partners, got into a legally binding relationship without first agreeing on what they wanted to get out of it. They neither discussed common goals for the company, nor contracted for them. The court papers make plain that Greer, while a savvy venture capitalist, did not act like one when he invested in Discovery, leaving too much -- particularly his exit strategy -- to chance. And the record shows that Nemeth took the venture money despite never liking the strings attached to it. In short, Greer struck a deal that was careless in ways he would later regret. Nemeth cut one she didn't want even then, and likes less now.
Obscured by the lofty legal claims is what the two are really after. What Greer wants is money -- his financial due. He wants WP&G's stake made liquid, and the suit for dissolution is his way to force that end. If it works, WP&G could get as much as a $12-million return on its 1980 investment of $100,000.
