In the world of venture-funded companies, not much surprises industry observers. Yet a new strategy employed by one privately held company might have founders and venture investors wondering if it’s a maneuver worth replicating.
What happened: The U.S. subsidiary of a venture-backed Berlin-based search optimization company called Searchmetrics just filed for Chapter 11 bankruptcy protection in Delaware.
Why it’s interesting: Sources close to Searchmetrics say the company was forced to file to escape a longstanding battle with venture-backed competitor BrightEdge, based in Menlo Park. Specifically, Searchmetrics alleges that BrightEdge stole its intellectual property, then filed for patents around it. (Searchmetrics says it had patents on its technology in Europe but failed to secure similar patents in the U.S., which created an opening for BrightEdge to exploit.)
Here’s how Searchmetrics’s chief restructuring officer, Wayne Weitz, describes the companies’ rivalry in a letter he submitted to the court today: “One of the [Searchmetrics’s] primary competitors in the U.S. market is BrightEdge Technologies [which] sought to acquire or merge with Searchmetrics in or about October of 2013. During acquisition discussions, BrightEdge became privy to Searchmetrics’ confidential, proprietary, competitive information and business practices, including its business model and growth plans. Ultimately, Searchmetrics and BrightEdge could not agree on terms and the acquisition discussions fell apart.
“Unbeknownst to Searchmetrics, whilst in the midst of the acquisition discussions, BrightEdge developed a campaign to eliminate [Searchmetrics’s] presence in the U.S. market. BrightEdge started by engaging in a smear campaign designed to lure the Debtor’s customers and prospective customers to BrightEdge by making false and disparaging statements about Searchmetrics’s products, and then initiated vexatious, baseless, and prolonged litigation against [Searchmetrics] on two fronts. This Chapter 11 Case was initiated to bring [this litigation] to an expeditious and cost-effective end to permit the Debtor to reorganize, failing which, [Searchmetrics] will be liquidated.”
Searchmetrics employees 250 people altogether; its U.S. subsidiary employs 40, mostly marketing and sales staff who are located primarily in San Mateo, Ca.
One source tells us that with the exception of “one or two people,” the company’s U.S.-based employees are paid on salary and commissions, so aren’t at risk of seeing their equity impacted by the filing. (Typically, in such a proceeding, there’s little to nothing left for shareholders once more senior creditors are paid. In this case, BrightEdge would be considered a creditor, though Searchmetrics is hoping to pay it a whole lot less than BrightEdge might win in a patent suit.)
The move is far from certain to work. Richard Kanowitz, a New York attorney who specializes in bankruptcies on behalf of Cooley, notes that, “With bankruptcy, there’s an automatic stay, but whether that stay holds is another story.” (We should add we merely asked Kanowitz whether he thought it was unusual for a venture-backed company to file for bankruptcy protection to spare itself from a patent lawsuit. He wasn’t aware of the companies involved at the time.)
Stephen Lubben, an expert on bankruptcy who teaches corporate governance and business ethics at Seton Hall Law School, meanwhile observes that yes, bankruptcy filings by venture capital-backed companies are rare, particularly in California, where the strong preference is to do an “assignment for the benefit of creditors” that allows backers more say in how to save their investments.
But also speaking generally and not specifically about these two companies, Lubben says that bankruptcy filings solely to address a single piece of litigation are “dicey. The court might dismiss the filing as being in bad faith. The company will have to show some other reason for needing to reorganize, and that it’s not just trying to stiff a single creditor.”
Asked for a comment about its Chapter 11 strategy, a Searchmetrics spokesman wrote in an email to us that the “U.S. subsidiary cannot invest properly in growing its business despite longstanding customer approval of our Searchmetrics products, a deep pipeline that brings new innovations in online content marketing, and a great relationship with our parent company,” while trying to fend off BrightEdge.
Meanwhile, asked for his reaction, BrightEdge founder and CEO Jim Yu said via email: “BrightEdge does not comment on the substance of pending litigation.”
Ten-year-old Searchmetrics has raised roughly $32 million from investors, shows Crunchbase. Its backers include Holtzbrinck Digital, Iris Capital and Kreos Capital, among others.
BrightEdge, also founded 10 years ago, has raised around $62 million, according to Crunchbase. Its investors include Illuminate Ventures, Insight Venture Partners, Intel Capital, Altos Partners and Battery Ventures.
You can read through Searchmetrics’s court filings here.