To what degree is a venture capital firm culpable for the sins of its portfolio companies? That's what US investors are waiting to find out, following July's ruling by a federal judge denying motions to dismiss copyright infringement claims against online music swapping outfit Napster.
The VC in question is San Francisco-based software investor Hummer Winblad Venture Partners, which invested $15 million in the Mountain View, California file-sharing company back in May 2000. A few months later, a federal court issued a preliminary injunction against Napster, holding it accountable for losses incurred by the music industry, including music publishers, songwriters and record labels, who claimed a combined loss in sales of $17 billion thanks to web-savvy music fans swapping songs for free.
Adding to the chorus of accusers, in April 2003 Vivendi's Universal Music Group and EMI Group filed a suit against Hummer Winblad itself, claiming that by investing in Napster, the venture capitalist had in fact promoted piracy.
Central to Vivendi's accusation is that after investing in Napster in 2000, Hummer Winblad installed co-founder John Hummer as a board member and made partner Hank Barry the company's interim CEO. This, the prosecution argues, gave the firm greater control over Napster than venture capitalists typically have over the companies in which they hold minority interests. This degree of control, the case argues, makes Hummer Winblad complicit in the copyright infringements.
The Napster case has left the America's venture industry in a tizzy. The National Venture Capital Association (NVCA), for example, issued a letter to the US Senate Banking and Small Business Committee, claiming the lawsuit and any similar subsequent cases might scare VCs away from participating in risky technology investments altogether.
However, some industry observers argue that the case should give cause to much teeth-chattering among venture capitalists because it focuses on whether or not Hummer had management control. The venture capital investment strategy is more typified by minority stakes.
Which is precisely why buyout funds should tune in to the Napster case. Management control is arguably what buyout investing is all about. If the judge rules that copyright infringement charges can extend to investors who have such control, some buyout firms in particular may find themselves open to a whole range of lawsuits sparked by the alleged misdeeds of portfolio companies.