Conglomerate

February 01, 2005

The Epinions Shareholder Lawsuit

If you have ever gone to Epinions to help decide what consumer product to buy, then you may be interested in this new lawsuit. The fact pattern is pretty involved, so bear with me. I've gotten most of the facts from the complaint and from a former employee/shareholder, but more facts may come out once the answer is filed. The crux of it is that in a merger with DealTime (Shopping.com) that preceded last Fall's successful IPO, the Epinions common got washed out, and now they are fighting mad.

Epinions was founded in March 1999, and financed its operation with three rounds of venture capital financing over the next two years, totalling $43 million. Various financial firms were involved, but the largest two were able to nominate three directors to the five member board. Even with this financing, Epinions tumbled with the rest of the market between 2000-2002 and experienced large layoffs. The VCs were getting a little nervous that they would not get paid back. The details of their preferred stock stipulated that in the event of a merger or liquidation, the first $45 million went to the preferred. Epinions had two acquisition offers (from Google and Yahoo), but the offers were half of that nut or less. The board eventually agreed to an acquisition by DealTime in late 2002. The offer was for less than the $45 million, so only the preferred would get compensation for the shares (some cash and stock in the new company), but the common would not get anything. But, the common stock had to vote (60%) for the merger. The stock was well concentrated, so really only one or two people had to be convinced that the merger was in the best interest of the company. The board assured the common stock owners that this was the best deal that they were going to get and keep the company as a going concern. Some of the common shareholders affected were employees, but some were not. The deal went through in April 2003. The preferred stockholders were given stock or vested options in the new company.

In October 2003, the new company changed its name to Shopping.com, and on March 23, 2004, this company announced its IPO, which closed on October 24. The complaint alleges that the vested options given to the preferred stockholders was then worth $250 million.

The shareholders have multiple theories of recovery relating to alleged breaches of fiduciary duties by the board. The shareholders allege that the board knew of certain information that would make the company more profitable in the near future, but did not communicate that to them. We will have to see how that plays out. The shareholders also allege that the valuation of the company below $45 million was wrong, but I'm not sure that their analysis is valid. The plaintiffs base their valuation on the valuation of the combined company. For example, if Epinions was 35% of the resulting company, and the resulting company was worth X, then Epinions was worth .35X. However, the value of Epinions must be calculated by looking at Epinions standing alone, without looking at the resulting company. Theoretically, the merger should create value and make .35X be greater than the value of Epinions. Again, I'll be interested to see how that plays out.

Posted by Christine at February 1, 2005 04:16 PM | Fiduciary Duties