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Napster's CEO Splits on a Sour Note

Napster CEO Konrad Hilbers has had enough. On May 14, the man charged with spearheading a turnaround at the once red-hot music-sharing site resigned from his job in protest after Napster board members refused to go along with a $16 million buyout by German media giant Bertelsmann.

Hilbers' resignation seemed to spark an all-out mutiny. Within hours, Napster co-founder Shawn Fanning, the technological wunderkind who created the service as a teenager, also turned in his resignation. And by the end of the day, virtually all of Napster's remaining 70 employees had headed for the exits. Insiders say the exodus was a group protest to the board's decision to reject Bertelsmann's offer. They say all of the employees' jobs would have been saved if the buyout had been accepted.

Now, however, it's all but certain that Napster will fall into bankruptcy -- and the company that has changed the music industry forever will never be the same. "Because of [the board's] behavior, we get nothing, our investors get nothing, and innocent people who worked hard lost their jobs. Shameful," wrote early Napster investor Ronald C. Conway in an e-mail sent to board members and other senior Napster insiders.

"I think we could have saved this company," Hilbers told BusinessWeek Online in an interview. "I proposed a deal to the board that would have guaranteed people employment and would have restructured the company. But the majority of the board opted not to pursue the deal."

NO INDEMNITY. The latest setback has been weeks in the making. According to insiders, the sticking points for the board, which includes venture capitalists Hank Barry and John Hummer, centered around liability. Specifically, Barry and Hummer, partners at Silicon Valley venture firm Hummer Winblad Venture Partners, wanted a promise from Bertelsmann that it would indemnify the firm and its partners from any liability stemming from Napster's feud with the recording industry -- a request that Bertelsmann was apparently unwilling to make.

In an e-mail response to questions from BusinessWeek Online, Barry declined to elaborate on the board's decision. He would comment only on Hilbers' resignation. "We are sorry that Konrad has resigned. He made great contributions to the company as CEO," Barry wrote.

In a statement, Napster similarly expressed appreciation for Hilbers, adding, "We deeply regret that we have not yet been able to find a funding solution that would allow Napster to launch a service to benefit artists and consumers alike."

"A MISTAKE." Napster's future now depends on a quick cash infusion or finding a new suitor, since it's coming dangerously close to running out of money. Unless another buyer comes along or a new cash source is found, Napster will likely be forced to let go of its remaining employees and to file for bankruptcy protection, according to insiders.

Clearly, Napster is already considering further downsizing: "We will be looking at additional steps in the coming week to further reduce expenses," the company said in its announcement. In a statement to Napster employees, Hilbers lashed at the board's decision. "I am convinced that not pursuing the offer is a mistake, and it will lead the company to a place where I don't want to lead it," he wrote.

Bertlesmann has loaned Napster $85 million and hoped to buy out existing Napster shareholders. In a prepared statement, Bertlesmann expressed "regret" that Napster shareholders were unable to reach an agreement regarding the offer. Indeed, Bertelsmann CEO Thomas Middelhoff has made no secret of his desire to own and control Napster so his company could continue its quest in the online music arena.

"WE ARE HOPEFUL." Middelhoff might still get his wish, since Bertelsmann is likely to be Napster's largest creditor in the event of a bankruptcy. What's more, Bertelsmann has made clear that it believes there's a way to make a legal -- and profitable -- business out of selling songs on the Web. "We are hopeful that Napster's brand and technology will be able to realize its potential as a compelling consumer proposition," Bertlesmann said in its statement.

Napster has been dormant since last July when the labels forced its shutdown due to claims of copyright infringement. The launch of a subscription-only site, expected in March, has been delayed while Napster pursues settlements with the record companies.

Beyond the liability issues, it has also been embroiled in a bizarre internal battle. Another Napster board member, John Fanning, the uncle of co-founder Shawn Fanning, sued Hummer, Barry, and Napster in Delaware court in March. His argument: That Hummer and Barry should be ousted from the board and that all Napster shareholders should be treated equally in the event of a buyout.

STILL VALUABLE? That would mean the Hummer Winblad firm, which invested more than $12 million in Napster in May, 2000, would lose its right as a preferred shareholder to get its money out of a sale before anyone else. The two venture capitalists, along with Napster, disputed Fanning's claims.

This issue is now moot, though, since Fanning's suit was dismissed on May 14. What's clear is that this latest turn in Napster's fortunes isn't a chapter that anybody wanted. "It's sad that Napster has to continue to lose employees and momentum, since none of its investors can seem to get along," says Ronald C. Conway, a founder of Angel Investors, which put $2 million into the startup.

Despite all the wrangling, don't count Napster out. Hilbers says it still has a lot of value in its technology, its brand, and its business. "Somebody will do something with these assets," he predicts. "There's a future for this name and this business." It'll just be a future without Konrad Hilbers. By Linda Himelstein in San Mateo, Calif.

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