VSP Capital Saga Continues

VSP Capital continues to ignite controversy, after a year that already has seen multiple partner resignations and the disbandment of its third fund. The newest drama involves allegations by multiple sources that firm founder Joanna Rees-Gallanter crafted a plan to acquire certain VSP portfolio company interests at a below-market rate.

VSP Capital closed its third fund with $185 million in early 2005, with a strong roster of limited partners that included Adams Street Partners, Duke University Management Co., Horsley-Bridge Partners, Parish Capital Advisors, TD Capital and the University of California Regents. The firm had lost general partner Tony Conrad shortly after it began fund-raising, so the final fund document listed GPs Rees-Gallanter, John Hamm and Matt Crisp as so-called “key men.” Were any of the three to leave, LPs would have the option of voting to disband the fund.

Soon after, a serious fissure began to form between Crisp and the tandem of Rees-Gallanter and Hamm. In order to avoid the possibility of Crisp leaving and triggering the key-man provision, VSP sent investors an amended partnership document that would have added venture partner Vince Vannelli to the key-man club, while retaining language requiring just three such people. It also was in this correspondence that VSP formally changed its name from Venture Strategy Partners.

Before LPs could vote on the amendment, however, Crisp left VSP in a split that sources said was acrimonious. With the key-man provision triggered, VSP’s limited partner advisory board unanimously approved a resolution calling for all LPs to vote in favor of disbanding the fund. Just days later, VSP acknowledged the defeat by asking investors to refrain from future financial backing.

The firm’s third fund was extremely young, but did have three startup portfolio companies:

• Evil Twin Studios, a San Francisco-based character animation company;
• Truveo Inc., a Burlingame, Calif.-based provider of targeted data mining solutions; and
• Umbria Communications, a Boulder, Colo.-based provider of market research that collects and analyzes blog postings and comments.

Rees-Gallanter and Hamm originally suggested rolling the trio into Fund II, but the LP advisory board instead insisted that they be auctioned off as a package. After failing to receive any secondary market bids, however, VSP altered the auction so that the companies could be offered individually.

Vannelli decided that he wanted to bid for both Evil Twin and Truveo, since he had led the original deals and wanted to remain involved. His original offer was at cost for the two companies – a combined $1.95 million – but later conveyed to Rees-Gallanter that he would raise his offer to $2.05 million since he had heard that John Hamm also had interest.

In an emailed response, Rees-Gallanter suggested to Vannelli that he allow her and Hamm to buy both companies at cost, and then subsequently purchase one-third of each company for one-third cost. Vannelli appeared interested in the proposal, and engaged in a brief email string. In reality, however, Vannelli also seemed to believe that such collusion would be a violation of VSP’s fiduciary duty to its investors, as they would receive $1.95 million instead of $2.05 million. He forwarded the email string to his attorney, and also to a handful of select individuals with interest in VSP III, according to someone who had seen the correspondence.

Rather than bailing on the process, Vannelli remained involved, even holding several unsuccessful discussions with John Hamm about a joint bid (Hamm resigned from the general partnership of Fund III in order to move the process along faster). Both men then began making separate bids for each company, but in extraordinarily small increments. Hamm describes it as “dollar-by-dollar in a multi-million dollar auction.”

In order to break the logjam, Rees-Gallanter recommended a sealed bidding process whereby Vannelli and Hamm would each submit final offers via simultaneous emails to VSP’s attorney at Cooley Godward LLP, using the previous high bid as a minimum. All parties agreed, and Vannelli ultimately wound up with Evil Twin and Hamm won Truveo. Both companies sold at a premium. The third portfolio play – Umbria – is in the midst of being auctioned off, sources said.

Hamm says that the final process was fair to limited partners, who now have had all of their investment returned from Fund II. He also rejects any suggestion that Rees-Gallanter’s email proposal to Vannelli could be interpreted as self-dealing or anything else improper. “What is important is that we had a blind bidding process that resulted in Vince owning one company and me owning the other. Joanna oversaw it and limited partners are satisfied… The rest of it is just garbage.”

Rees-Gallanter, in an email to PE Week, said that “the investors in VSP III will be getting substantially above cost for the assets as an outcome of the process I proposed and ran. Often these type [sic] of assets are sold in the secondary market at a discount. This was absolutely not the case in VSP III. The process was fair and the least disruptive to the portfolio companies who are focused on building their business, not raising capital.”

Vince Vannelli did not respond to requests for comment.

Constance Loizos contributed to the reporting of this story.