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Lawsuits rarely ever happened in Silicon Valley’s venture capital community. The notoriously clubby circle of high-net-worth individuals who helped fuel the Internet boom of the ’90s has for years wielded too much power for unhappy entrepreneurs or investors to dare sue. But Jason Mendelson is proof those days are over. Mendelson is managing director of Mobius Venture Capital in Palo Alto, Calif. He is also the venture firm’s first general counsel, hired precisely because lawsuits targeting VCs have become nearly as common as the failed dot-coms that littered Silicon Valley after the bust. “Employment suits, investor suits, limited partnership suits — pretty much you name whatever lawsuits there are, and VCs have been sued for it,” Mendelson said. A co-investor sued the $1.2 billion venture fund in 2003 in a federal court in Philadelphia for violating the federal anti-racketeering statute. The complaint was based on allegations that Mobius partners conspired to run one of the companies in which they invested into the ground, so they could sell off the assets. “They made outrageous claims that we were racketeers,” said Mendelson, who convinced a judge to dismiss the case. “This was a shakedown lawsuit.” There’s not a lot of talk about the rise in suits against venture capitalists, but the litigation is happening. The growing list of venture funds with legal entanglements includes some of the big names in Silicon Valley. Benchmark Capital in Menlo Park, Calif., an early investor in eBay, has been sued at least twice in the last four years by the founders and former employees of two start-ups it funded. Menlo Park-based Lightspeed Ventures and Palo Alto-based ComVentures settled a suit last year brought by entrepreneur Aamir Latif, who founded Nishan Systems in San Jose, according to Private Equity Week. Sierra Ventures in Menlo Park is currently defending a $500 million suit in New York, filed by an angel investment firm from Silver Springs, Md., and a founder of a failed Internet radio start-up. And the most recent VC-related suit filed in San Francisco Superior Court involves the former executives and backers at Wine.com who are alleging New York VC firm Baker Capital passed on an attractive buyout offer for fear of having its own shares diluted. “Things have changed a lot from the days when the VC community was so small; entrepreneurs were reluctant to bring action against them for fear of damaging their chances of getting funding again,” said Michael Rhodes, the Cooley Godward partner heading the firm’s VC litigation practice. Today, with more new funds and larger players to hit up for seed money, Rhodes said, there are “a lot more people willing to blame others when things go wrong.” LOT OF WORK TO DO With the loss of de facto VC immunity, law firms with deep ties to the VC community are getting a ton of litigation work. Cooley has seen a steady increase in litigation matters since it started its VC litigation practice in 2003. “I am handling at least half a dozen litigation matters right now, and that doesn’t include the matters that my other partners in the practice are handling,” Rhodes said. The firm has litigated more than 50 venture-capital suits nationally. Many of the cases involve disaffected founders or early investors suing VCs over share dilution or control of the business. Cooley has mostly represented the VCs. Lawsuits challenging deals between private companies are also increasing. David Berger, a partner at Wilson Sonsini Goodrich & Rosati and head of the firm’s M&A litigation practice, says he is handling several VC-related cases. “Historically, my practice involves merger challenges between public companies,” Berger said. “What I’m seeing right now is a greater amount of litigation in private companies.” In 2004, for example, Berger represented Bellevue, Wash.’s WatchMark Corp. in a suit it brought against VC firm ARGO Global Capital and two other related funds. The wireless networking software company sought a declaratory judgment validating its new financing agreement, which would dilute the shares of ARGO’s investors. The VC firm countersued to prevent WatchMark from acquiring another software company that could double its sales revenues. ARGO argued that the company needed its consent to consummate the deal. “Five years ago, you would absolutely never see a lawsuit like this,” Berger said. Berger won the case for WatchMark, and he predicts many more lawsuits will be filed contesting business decisions. “Litigation has hit Silicon Valley, and it’s going to stay here,” Berger said. “It is going to be impossible to push this genie back into the bottle.” But it is not just litigators who are benefiting from the targets on venture funds’ backs. Transaction lawyers like William Schreiber, a partner at Fenwick & West, said his counseling practice has been very active of late. Schreiber, whose clients include mostly venture-backed start-ups and VCs, has been advising company boards on how best to structure financing deals to avoid litigation. “Questions come up all the time in board meetings, and all these are happening very real time,” Schreiber said. “Many of the laws are just being figured out by the courts, and you need someone to advise you on what you should do now or how to structure a deal.” The landscape has changed for VCs, and Mendelson says most VCs have prepared themselves by hiring in-house counsel. “The litigation and the growing complexity of the deals compel a lot of us to have a dedicated internal law group to help us do our work,” Mendelson said. “There is no more gentlemen’s agreement that exists, and there are a lot of plaintiffs lawyers out there.”

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