High-tech incubator Idealab fights for survival

Posted: Friday, May 03, 2002

PASADENA, Calif. (AP) -- Big-dreaming entrepreneur Bill Gross once personified the giddiness of the Internet economy as he hatched both clever and kooky startups at Idealab, his business incubator.

Now Gross hopes to avoid becoming a destitute symbol of the dot-com bust. Just two years after becoming a billionaire on paper, he is deeply in debt and fending off a lawsuit filed by high-powered investors who accuse him of turning Idealab into his personal piggy bank.

The case in Los Angeles Superior Court is developing into a litmus test for investors' rights as the wealth created during the dot-com boom morphs into devastating losses.

Many investors who entrusted billions of dollars to venture capitalists during the good times are now having second thoughts.

While these investors -- also known as limited partners -- can't recover the losses of the past two years, many want to retrieve some of the money still in the hands of venture capitalists.

About $43 billion in venture capital has yet to be invested, according to VentureOne, an industry research firm. Even if they don't invest all that money, venture capitalists can prosper by collecting management fees that range as high as 2.5 percent of the portfolio.

''A lot of limited partners are asking why venture capitalists should be allowed to hold on to their money when they could using it to invest in bonds or something else,'' said Dave Barry, a vice president with VentureOne.

The second-guessing is a dramatic change from the late 1990s ''when limited partners were almost throwing themselves at venture capitalists'' Barry said.

Dozens of investors poured in $1 billion for a 10 percent stake in Idealab at the height of the Internet craze in early 2000.

Nearly all of them now allege that Gross is keeping a brain-dead incubator alive to stave off personal bankruptcy and support an extravagant lifestyle with his fiancee, Marcia Goodstein, Idealab's president.

Gross, 43, denies the allegations, describing them as the sour grapes of greedy investors who sought quick profits from Idealab's planned initial public stock offering. The IPO got shelved in 2000 amid the dot-com wipeout.

By March 2000, the investors now suing the company had valued Idealab at $10 billion, making Gross' then-41 percent stake in the Pasadena-based company worth about $4 billion.

Their rich opinion of Idealab represented a ringing endorsement of its unusual business formula. Founded by Gross in 1996, Idealab pioneered the concept of high-tech incubators -- entrepreneurial communes where workers share office space and inspiration.

Gross still provides almost all the ideas at Idealab and tries to bring them to life by drawing from the talent at the California Institute of Technology, where he got a bachelor's degree in mechanical engineering.

''Bill Gross is a very creative guy, a good builder who just got caught in a complicated situation,'' said Robert Roeper, managing director of VIMAC, a venture capital fund in Boston.

While he was still in high school, Gross launched his first business, a solar energy supplier. After graduating from college, Gross founded and sold two software companies.

Goodstein was the first person Gross hired at Idealab.

A Pomona College graduate, Goodstein, 37, previously worked in marketing for a software company called Enfish. Gross promoted Goodstein to chief operating officer in 1998.

Encouraged by the rapid expansion of the Internet economy, Gross once planned to open his business labs all over the country.

He opened offices in the Silicon Valley, Boston, New York and London and expanded Idealab's payroll from 18 employees in January 1999 to 250 workers in mid-2000.

The Boston incubator is the only satellite office still open and Idealab's work force has been cut to about 100.

Other companies, such as Andover, Mass.-based CMGI Inc. and Wayne, Penn.-based Internet Capital Group, followed Idealab's lead, forming incubators that launched skyrocketing IPOs before their stocks plummeted in the dot-com crash.

As publicly held companies, CMGI and Internet Capital are among the few venture capitalists that have had to open their books for the world to see. CMGI lost a total of $6.76 billion in its last two fiscal years. Internet Capital's losses during 2000 and 2001 totaled $3 billion.

Idealab, which remains private, spawned several dot-coms that investors embraced. Early successes included online retailer eToys, ad-driven search engine Overture and free Internet service provider NetZero.

Many Idealab-backed startups, including online beauty site Eve.com and online retailer petsmart.com, flopped long before reaching the stock market. Of the companies Idealab took public, only Overture is still worth more than its IPO price.

Etoys was Idealab's most spectacular failure, but the incubator made out all right. Before eToys tanked, Idealab made $193 million selling shares in 1999. Gross says several of the investors now suing Idealab also made huge windfalls on eToys and Overture.

The dot-com crash then mired Idealab in losses that the dissident investors say exceed $500 million.

Gross got hurt by the reversal of fortune, too.

The suit alleges that Gross has a negative net worth of more than $40 million -- one reason investors say he lobbied Idealab's board to raise his annual salary from $250,000 in the year ending in January 2000 to $766,667 during the past year. Idealab also raised Goodstein's salary from $190,000 to $616,667 during the same period.

Idealab said the raises reward the two top executives for guiding the company through difficult times.

And while Gross acknowledges he owes Bank of America $50 million on a loan backed by Idealab stock, he denies he is near bankruptcy.

After a painful reorganization that lowered Idealab's annual expenses from $200 million to $52 million, Gross and Goodstein say the incubator is in great shape, with $360 million in cash and other liquid assets as well as a batch of promising high-tech startups.

''These companies are going to make the world a better place,'' Gross said, flashing the hyperbole that helped make him a dot-com icon.

''We went through some tough times and made a lot of mistakes, but we learned from them,'' Goodstein said. ''We are now a five-year (investment) play instead of a six-month play and that seems to have caused a tremendous amount of ire.''

Idealab's prospects look dismal to the dissident investors -- a list that includes Dell Computer's venture capital arm, Moore Global Investments, Kline Hawkes and T. Rowe Price's science and technology fund.

''The company is dead. It was a product of the Internet bubble,'' said Louis ''Skip'' Miller, a Los Angeles attorney representing investors.

Gross said Idealab has offered to buy back the shares of the dissident investors at a 90 percent discount. The investors are fighting to recover as much as 50 percent of their original investments.

Some venture capitalists, like Josh Fidler of Boulder Ventures in Owings Mills, Md., view the strife at Idealab as an aberration.

''Everybody has to adjust their expectations and that is starting to happen,'' said Fidler, who has no stake in the Idealab fight.

Others suspect similar melodramas will land in court.

''If a big fund with a lot of money to invest doesn't do the logical thing by returning some of it, then the limited partners will be watching the venture capitalists like the media watches a Washington politician,'' Roeper said.


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