business

When an Incubator Goes Cold

The tech goldrush drew high-profile investors to Idealab! Now that things have turned sour, bailing out is proving to be another matter

At one time, Bill Gross could do no wrong. The 43-year-old entrepreneur popularized the concept of an Internet "incubator." Since 1996, Gross's Idealab! in Pasadena, Calif., provided office space, startup capital, and managerial advice to dozens of fledgling Web companies such as eToys, CarsDirect, and Citysearch. He was one of the Internet's hottest stars, and others raced to copy his model. The buzz allowed Gross, in March, 2000, to sell $1 billion in Idealab preferred stock to a number of wealthy individuals and businesses, such as Dell Computer and the T. Rowe Price Science & Technology fund.

Now, many of those investors are hopping mad. They say Gross squandered $800 million of their money buying controlling stakes in such duds as cosmetics e-tailer Eve.com and wireless-data provider Scout Electromedia. The investors claim that Gross has ignored their pleas to liquidate Idealab and is instead offering to buy them out at a fraction of what their shares are worth. They have even dragged former General Electric (GE ) Chairman Jack Welch into the fray, accusing the former Idealab board member of bailing out when they need him most. "I don't know what I'm going to do," says Guy Oseary, an Idealab investor and co-owner of pop singer Madonna's Maverick Records label. "If he would just liquidate, he would make a lot of people happier."

TOUGH TALKS.

  Gross declined to be interviewed for this story. Instead, Idealab President Marcia Goodstein responded by e-mail to a list of questions. Goodstein said the company is only trying to balance the interests of investors who want out against those who want to stick with it. "The market took a terrible turn, and they are angry," Goodstein wrote. "We share their frustration and are now working hard to secure a return for all our shareholders."

That effort involves a mid-December offer from Idealab to buy back its preferred stock for 10 cents on the dollar. The offer is the result of months of often-contentious negotiations between the company and some of its largest investors, including Dell, T. Rowe Price, and Moore Capital Management, a New York City investment group. The offer expires on Jan. 18.

The investors have some leverage. Under terms of the preferred stock, Gross agreed to give investors an increasing stake in Idealab if the company's value slipped below the price set when the investment was finalized a year and a half ago. Since Idealab is privately held, its worth is hard to determine, but it's certainly far less than the nearly $8 billion at which it was valued by investors in March, 2000.

The company could be worth less than $1 billion, in which case holders of the preferred stock would be entitled to the entire company. This provision has prevented Gross from raising new capital, which has locked him and his investors into a bit of a stalemate. Says Michael E. Moran, general counsel of former investor 24/7 Real Media Inc.: "We had a gun to each other's heads."

Moran's company accepted 10 cents on the dollar for its $25 million investment in a separate deal negotiated with Idealab in October. "We sold because we wanted liquidity," says Moran, "and felt the price offered was the highest we were likely to be offered at this time."

HOUSE THAT JACK LEFT.

  But several other investors say privately that they're less inclined to accept the offer because they believe Gross is lowballing them. In recent months, Idealab has sold nearly $200 million worth of shares in its one clear winner, Overture Services -- formerly known as Goto.com -- a search engine that charges companies for placement.

Goodstein confirmed that Idealab has $200 million in cash on its books and $150 million worth of stock in a handful of publicly traded companies. In addition, Idealab has investments in more than 20 privately held businesses. If just the cash and securities were distributed to preferred shareholders, that would come out to $350 million, or 35¢ on the dollar -- considerably more than Idealab is now offering.

And what about Welch, who joined Idealab's board in March, 2000, when the preferred stock was being sold, and left this past September? "I never made a nickel on Idealab," Welch says. "I wanted to learn about the Internet, and they seemed like bright guys. I resigned because I've resigned from all of my boards but one, Fiat." His advice for Idealab's unhappy investors: "Tell them to get good advisers."

By Christopher Palmeri in Los Angeles and Linda Himelstein in San Mateo, Calif.

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