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Kalashian V. Advent (or the Alantec) Case
The following narrative is based on Padilla (2001): The Alantec Inc. dispute (Kalashian
v. Advent VI L.P., CV739278 [Santa Clara Sup Ct. filed March 23,1994]) provides a
good example of equity tunneling by VCs using down-round financing. Alantec was
founded in 1987 by Michael Kalshian and Jagdish Vij. In 1988, the founders received a
first round of venture capital money of $1.5 million. By the fall of 1990, venture
capitalists had invested $16.5 million and acquired a 90 percent ownership and voting
interest, as well as a majority of the directors on the board. The venture capital investors
were dissatisfied with Alantec’s management and Vij and Kalashian were ousted from
the company by the end of 1990. The venture capitalists brought in John Wakerly to
develop a new product and invested another $500,000 to support the development of
the product.
At the time, Kalshian and Vij still owned all of the common stock, representing a
combined 8 percent ownership interest in Alantec. The board decided to approve two
new rounds of financing at highly dilutive terms to the two original founders. They did
not inform the founders of the new rounds. To get around the majority vote of common
stock needed to approve the financing, the board issued new common stock at $.005
per share to the CEO and two other employees loyal to the investors, who then
approved the new issues. By the end of the two rounds, the founder’s ownership of the
company went from 8 percent to .007 percent.
The new product proved a success and allowed Alantec to go public in 1994. In
1996, the company was purchased by ForeSystems for $770 million. The founders’ final
share was valued at about $600,000, while their predilution 8 percent interest would
have been worth over $40 million.
The case settled out of court with a large settlement payout to the founders.
The Alantec Case
In the California Superior Court case of Kalashian v. Advent VI Limited Partnership (the
“Alantec case”), several leading venture capital funds were sued by the founders of
Alantec Corporation for fraud and breach of fiduciary duty after approving a down round.
The founder shareholding was reduced from an initial 8% to less than 1%.
The company later went public and was sold for $770 million. The founders claimed
they had lost $40 million as the investors had fraudulently manipulated the stock by
issuing new shares at a discount to the market price, triggering anti-dilution protections,
issuing shares to the company’s new management to obtain shareholder approval and
refusing to let the founders participate in funding rounds.
The defendant venture capitalists defense was that the company was facing bankruptcy
and that no other financing was available. The case was ultimately settled for a reported
$15 million. The Alantec case is illustrative of a situation where interested director
venture capitalists faced legal action in a down round financing.
Methods of limiting the conflict and legal risk could be to utilise a committee of
disinterested directors to approve the transaction, obtaining approval of all fully informed
shareholders and/or obtaining an independent valuation to set a fair price for the
financing. In any case, it is important to consider and evaluate the legal risks and issues
that occur in a down round financing.
Kalashian Case
These issues were on public display in the seminal case of Michael Kalashian et al. v.
Advent VI Limited Partnership et al (“Alantec”), involving Alantec Corp. a Silicon Valleybased manufacturer of computer networking equipment. In a nutshell, the founders of
Alantec saw their ownership stake in the company drop from 8% to less than 0.007% as
a result of a series of financings in 1990-1991 after the founders had left the company.
In early 1996, Alantec was acquired by Fore Systems Inc. for approximately $820
million. The founders sued the company, its board, and several venture capital fund
investors in the company for fraud, breach of fiduciary duty, and vicarious liability based
on conspiracy. They claimed, among other things, that venture capitalists sitting on the
board of Alantec, believing that the founders had too much stock in the company in view
of their diminished roles in the company, conspired to deliberately dilute the founders by
issuing themselves additional stock below the true fair market value of the company,
while giving away common stock to the new management of the company simply to
permit them to vote those shares in favor of the new financings. Among other things, the
defendants countered that, at the time of the financings, Alantec was on the verge of
bankruptcy, was unable to line up any other financing sources, and hat to issue the
stock to new management in order to retain and motivate them to run the company.
While the case settled out of court, the plaintiffs successfully withstood motions for
summary judgment.