What happens when venture capitalists decide your business is better than theirs

A hedge fund run by two former Goldman Sachs Group Inc. managers called to express interest in investing in Mr. Park’s on-line video store, Kozmo.com Inc. Mr. Park and his partner, Yong Kang, quickly set up a dinner with the principals of the hedge fund, Integrity Capital Management, and gave them a tour of Kozmo’s New York City headquarters. A deal seemed to be at hand.

“Yong and I really enjoyed hanging out with you guys yesterday night,” Mr. Park wrote in an e-mail to Ross Stevens, chief executive of the now-defunct Integrity. Included with the e-mail was a copy of Kozmo’s business plan.

It’s an e-mail Mr. Park now wishes he had not sent. Integrity did not invest in Kozmo. Instead, Mr. Stevens and partner Frederick Tausch closed the fund in April and set up their own Internet company, Urbanfetch.com Inc. Both companies offer one-hour delivery of videos, snacks and books ordered from websites.

The business is so similar to the one Kozmo launched in 1998 that it is taking its new rival to court.

In a lawsuit filed in New York State Supreme Court, Kozmo accuses Urbanfetch’s principals of violating a confidentiality agreement and misappropriating Kozmo’s business plan. Kozmo is seeking unspecified damages as well as an injunction to put Urbanfetch out of business.

Urbanfetch has filed a countersuit, seeking $50 million in compensatory damages and $10 million in punitive damages. Urbanfetch maintains that Kozmo’s suit has no merit and was “deliberately orchestrated to wreak havoc” with Urbanfetch’s efforts to raise money.

The dispute is believed to be the first major suit involving two Silicon Alley companies, and it threatens to undermine the informal way Internet entrepreneurs and venture capitalists have done business. Kozmo would not be in its current predicament had it demanded that Integrity sign a formal non-disclosure agreement, but, then again, very few venture capital firms are willing to do so.

Such agreements would be prohibitively expensive, says Karen Kerr, managing director of high-tech investor ARCH Venture Partners. Still, she says, there is an implicit understanding that venture capitalists will not disclose confidential information to a company’s competitors.

“This is a major ethical lapse, and these Integrity guys deserve to be nailed to the wall,” says Steve Brotman, general partner of Silicon Alley Venture Partners.

Many fear that the suit will create a climate of mistrust. Entrepreneurs are paranoid by nature, and what happened to Kozmo will only make them more so.

“This is a handshake business, and that’s what’s allowed it to grow so fast,” says Robert LoCascio, chief executive of New York Internet company LivePerson.com. “Once you get lawyers involved, you can be working on documents for a month before you ever close a deal.”

Kozmo declined to discuss the lawsuit. Urbanfetch’s Mr. Stevens could not be reached.

Though Integrity did not sign a non-disclosure agreement, Kozmo contends that it promised to keep discussions confidential. Integrity’s principals deny this.

What is not in dispute is that Integrity never invested in Kozmo, and that a month later Mr. Stevens and Mr. Tausch shuttered their fund in order to launch Urbanfetch.

“This has to be the slimiest thing I’ve ever heard of,” says Ms. Kerr.

The legal issues are murky.

Mr. Park and Mr. Kang say that they disclosed their “proprietary methods, procedures and systems for a one-hour (delivery) shopping and rental business.” They also say that Integrity received a copy of their business plan that was clearly labeled “strictly confidential.”

“Stevens and Tausch explicitly agreed with me that all information disclosed (to them) would be kept confidential and that neither they nor any of the defendants would use the confidential information disclosed to them by Kozmo to compete against Kozmo,” Mr. Kang says in his affidavit.

Mr. Stevens counters that the document they received made no mention of confidentiality, and that neither Mr. Kang nor Mr. Park ever discussed keeping their talks private. The only process Mr. Stevens says he observed while visiting Kozmo’s headquarters involved clerks taking orders over the computer, walking to the shelves to retrieve the videos requested and handing those videos over to bicycle messengers.

“To my knowledge, when Park writes in his affidavit about Kozmo’s so-called ‘order-fulfillment system,’ he is referring to nothing more than this ‘process,’ ” Mr. Stevens says in his affidavit.

Experts in intellectual property say that without a written confidentiality agreement, Kozmo will have a hard time proving its case.

“It just highlights the fact that you should have a written nondisclosure agreement anytime you disclose something confidential,” says a New York lawyer, Parker Bagley, a partner with Milbank Tweed Hadley & McCloy. “The fact is that courts are reluctant to impose an implied contract when there is nothing in writing.”

In its countersuit, Urbanfetch argues Kozmo does not need to prove its case for the suit to be effective. “Park and his lawyers know fully well that even the whisper of legal claims can become a death knell in the venture-capital setting,” Mr. Stevens says in an affidavit.

He asserts that California venture fund VantagePoint Venture Partners was set to invest $10 million in Urbanfetch, but the financing was canceled after Kozmo filed suit.

Kozmo’s backers do not seem put off by a costly lawsuit. It just received a $28 million investment from a group led by Silicon Alley’s premier venture capital firm, Flatiron Partners, and this funding has allowed it to hire Shearman & Sterling, one of New York City’s top law firms.

Related Topics: Venture Capital