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Follow UsIt just keeps getting worse for war-weary Napster Inc. The online-music
pioneer, already paralyzed by assaults from the recording industry, now faces a
nasty conflict within its ranks. On one side is an early backer of the company.
On the other side are Napster and two board members. If they don’t resolve
their dispute, it could derail a buyout offer by Bertelsmann AG, leaving the
onetime Internet highflier in dire financial straits.
According to a lawsuit filed on Mar 25, board member John Fanning, is suing
fellow directors John Hummer and Hank Barry. His claim: The two venture
capitalists are no longer directors because shareholders voted them out on Mar
24. Fanning also claims that Napster’s preferred stock, which Hummer and Barry
hold, was converted into common stock on Mar 11.
In the unusual lawsuit, Fanning asks the Delaware Court of Chancery to
validate the new board so it can consider pressing issues facing Napster,
including a buyout offer. Business Week has learned that Bertelsmann has made a
$15 million bid for the company. The media giant, which already has loaned
Napster $85 million, wants to buy the company to gain full control before
committing any more money, say the sources.
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A new cash infusion is critical to Napster, since the startup is running low
on cash, says an insider. That’s one reason why Fanning is rushing into court.
His complaint states: "Any delay in determining the validity
That time is of the essence is the sole thing the two sides agree on. Napster
CEO Konrad Hilbers rejects Fanning’s claims that the board’s makeup has
changed and the preferred stock was converted. "The allegations in the
lawsuit are legally groundless," says Hilbers in a statement.
One thing that’s clear is the dispute could prompt Bertelsmann to abandon
its buyout offer. Instead, the music giant may choose to call the $85 million
note, which could prompt Napster to consider radical steps, including bankruptcy
protection, say analysts. BMG has been hoping to avoid a public and costly
bankruptcy proceeding. But it may prefer that outcome to becoming embroiled in
an internal war at Napster. "With all the online services being launched
right now, Bertelsmann is under immense pressure to make its Napster deal pay
off," says one record-industry executive.
Exactly who capitalizes on a buyout is at the heart of the dispute. If
Napster goes into bankruptcy, the company’s investors, and founders, including
the Fannings, could end up with zilch. Typically, the last investors in a
startup get their money back first because they pay a higher price for a smaller
share of the company. By contrast, the earliest investors get paid back last
because they receive a lot of stock on the cheap. At Napster, venture firms
Hummer Winblad Venture Partners and Angel Investors LP put in about $15 million
in May 2000. Since that was the last financing, they may well be entitled to
most of the $15 million Bertelsmann is offering. Fanning’s class of stock is
likely among the last in line.
And that’s the rub. According to his lawsuit, all of Napster’s preferred
stock has been converted into common stock, which would put Fanning alongside
other shareholders when they divvy up any proceeds from a buyout.
This latest conflict comes at a terrible time. Napster is making progress in
settling its beefs with the record labels. And the company is testing a new
online subscription music service that would be undermined if the fracas dragged
on. Worse, now it looks like Napster’s undoing could come down to a few
million dollars instead of anything related to the company’s business.
By Linda Himelstein in San Mateo, with Tom Lowry in New York
in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc