A group of limited partners of 6-year-old venture capital firm East River Ventures is seeking to replace the current general partners after finding what they claim are violations of their partnership agreement and a breach of fiduciary duty.
The six-member special committee of limited partners sent a letter in late September to all of the firm’s LPs detailing what it believes are the breaches by the general partners. Among other allegations, it accuses the general partners of the New York-based firm of breaching fiduciary duty by borrowing more than $1 million from the East River Ventures II (ERV II) fund; borrowing from ERV II to pay themselves management fees for East River Ventures I fund; and co-investing without LP consent in ERV II portfolio companies.
The letter asks the LPs to vote on three issues: whether to retain or remove the general partners, whether to approve the appointment of Menlo Park, Calif.-based Sierra Ventures as the new general partner, and whether to approve or disapprove the liquidation of the partnership. The ballot obtained by Private Equity Week instructs limited partners to return the surveys to Robert Dewey and Stanley Rawn, two of the limited partners who make up the special committee.
Rawn declined to comment through an attorney and Dewey did not return phone calls.
The two current general partners of East River Ventures, which previously had a larger staff that included more GPs, responded to the ballot with a letter of their own a few days later.
“We believe the committee’s letter is, at best, misleading,” the letter reads. East River urges LPs not to take any further action until hearing directly from the GPs, who said they would contact each LP separately.
The two East River GPs, Walter Carozza and Alex Paluch, do not address the accusations in the letter, but do say: “We believe that we have acted consistently in the best interests of the funds we manage and our limited partners.”
Their letter also details recent changes that the firm has made, including reducing management fees to 1.5% by the end of the year, cutting their own salaries by 60% and moving to less expensive offices.
“The letter to the limited partners is not accurate and there is absolutely no legal reason to remove the general partners,” said Carozza in a phone interview, adding that there are political reasons behind the effort to remove the GPs.
“We’re working to work this out with the committee,” he said. “I expect there will be [a resolution].”
In response to Carozza’s comments, the committee’s attorney said, “The committee stands by its original letter.”
Jeffrey Drazen, general partner with Sierra Ventures, is as an individual investor with “several million dollars” invested in ERV, according to the special committee’s letter. Drazen says that his firm would not act as a general partner. But he says Sierra would make a different arrangement with the other LPs over management of the East River funds.
Drazen says that he was approached by the special committee to have Sierra manage fund assets if the GPs were removed, which is not guaranteed to happen. Drazen did not voice a preference in favor of replacing the general partners although his firm stands to gain $750,000 in management fees if approved.
“It’s my hope that the independent committee and the existing general partners will reach an agreement,” he says, declining to speculate on what kind of agreement might take shape.
Despite industry-wide dissatisfaction with general partners on the part of LPs, most voice their dissatisfaction by not investing in a firm’s future funds. Removing the general partners from a fund is not a common occurrence.
“It’s very, very rare,” says Michael Littenberg, an attorney with Schulte Rogh & Zabel who often helps draft partnership agreements. “You don’t typically see LPs remove GPs.”
Littenberg adds that most adverse legal actions between the two groups come in the form of lawsuits over performance issues or un-invested capital. Typically, LPs view a removal of a GP as a last-case remedy, he says.
A recent example of such an ousting, Littenberg adds, is the case of MVC Capital, formerly known as meVC Draper Fisher Jurvetson. MVC is a publicly traded investment company that saw its managers ousted by investors in a proxy vote earlier this year. They changed their investment strategy last month (see story on page 12).
“It’s not a good solution from most standpoints,” Littenberg says. “In any private investment vehicle, the general partner has a wealth of knowledge about the investments and the fund where it’s hard for someone to step inside their shoes. It’s never going to be an ideal solution from the standpoint of the LPs and there’s usually some sort of settlement.”