The Betrayal of Bnter

We filmed this week’s Ask a VC on Tuesday, and I started out by asking Bijan Sabet of Spark Capital about the danger of venture capitalists investing in competitors. There was no ulterior motive on my part. It’s just a question I’ve seen coming up increasingly as dealmaking heats up and VCs invest across a bigger variety of company stages than ever before. And, I’d recently seen that Sabet did write a blog post on the topic.

Little did I know then the big drama that had been brewing between Spark and two competitive companies behind for months. Not investing in competitors of existing portfolio companies is great. Even better? Not offering one a term sheet after months of due diligence before you decide that they’re competitive.

TechCrunch has learned from three sources that Spark Capital reneged on a termsheet offered to a New York-based startup called Bnter, throwing the company into tumult and reportedly enraging its well-known angel investors who we’ve heard include Chris Dixon and Ron Conway.

According to three accounts, Spark principal Andrew Parker sought out Bnter’s founder Lauren Leto last December, impressed by the company’s beta messaging product and interested to invest. It was just a lean, two-person company at the time, and Leto had no immediate plans of fundraising. The company was gearing up for a big marketing push, and wanted to tap the market once it had better user feedback and growth. But when Spark– investors in such rock star companies as Twitter and Tumblr– came after Bnter, she and her partner were flattered. At the encouragement of existing investors and mentors, they took the train to Boston to pitch the partnership.

Spark loved it and negotiations continued for months. In March, the firm emailed her a termsheet, saying it wasn’t signed because the partner in question couldn’t get to a fax machine that moment, but said to consider it signed. Bnter was so star-struck by Spark, the company hadn’t widely pitched itself to other investors, but told the ones that it had talked to it’d be going with Spark.

Only then did it occur to the Spark team to check with Tumblr founder David Karp to make sure he wouldn’t view this as a competing company. From what we heard, neither Spark, Bnter nor the other angel investors had considered the two competitors, although there is some overlap with Bnter’s core service and the messaging part of Tumblr. But it’s hard to invest broadly in social media and not have small overlaps here and there.

According to sources, Karp was incensed, viewed them as clearly competitive and told Spark he wasn’t OK with the firm doing the deal. Fair enough. Whether anyone else agrees or not, Spark asked Karp his opinion and most ambitious entrepreneurs see their future markets as broader than they may look today. But what wasn’t fair was what Spark did next. The firm not only pulled the termsheet, but when existing Bnter investors cried foul, Spark refused to pay a $200,000 break up fee to help cover the expenses the lean company had started to take on as a result of having a signed term sheet and — it thought– $2 million on the way to its bank account. No one has argued Spark forced the company to take on those extra expenses and there’s a dispute about when the occurred, but the company clearly took them on thinking money was on the way.

The company had already hired an Android developer to get that version moving as quickly as possible– and now it was in a lurch. Some three months ago it was a hot, up-and-comer in the New York tech scene, backed by some of the biggest name angels in the business. It had no intention of fundraising this soon, but now that it had committed to the process and to growing the company more aggressively the rug had been ripped out from under it.

The company could find a way to cover the expenses: It has some deep pocketed angels and Leto has reportedly cut her salary to zero to help the make the company’s ends meet; she also has an existing profitable business that can help bootstrap Btner. The bigger fear is the stigma when it goes out to raise money of having a termsheet that a firm pulled. Raising money for a startup is like putting a house on the market: Just like sitting on the market for a long time makes people wonder what’s wrong with it, so too does a done deal that suddenly falls apart. We should note that no one has indicated that Spark pulled out for any reason other than Karp’s objections.

That’s why its incredibly rare that these things happen– particularly without a courtesy break up fee for the entrepreneur’s trouble. We polled a sample of VCs and some told us they’ve never seen this happen before, while others said they see these situations, at most, once a year, but almost always with a break-up fee paid out to the entrepreneur. This isn’t because of legal reasons, because a termsheet doesn’t legally bind investors to do the deal. And it’s not because VCs are altruistic. It’s because this is a small industry built around trust.

Sources say that Spark didn’t just hurt a tiny, two-person startup; it hurt the powerful investors behind that startup too. People close to the deal were simply agog that the firm wouldn’t offer to do anything to make the situation better– save offering to reimburse Leto for and legal costs and her train ticket to Boston.

We reached out to Bijan Sabet of Spark for comment, and he didn’t want to comment publicly aside from saying, “We have a different interpretation of what happened and we wish the company well.”

It remains unclear exactly why Spark– a firm known for treating entrepreneurs well– acted this way, and there’s enough he-said-he-said behind the scenes that we may be missing some details. But entrepreneurs should take a lesson from what Bnter went through: The deal isn’t done until the money is in the bank.