The Stanford University-backed fund will halt new investments from July, seemingly as the accelerator reaches financial stability but in the midst of a legal battle.
It appears that 2019 is going to be a much more tumultuous ride than last year – after all, it is not every day that the university venturing ecosystem loses one of its most influential investors.
Stanford-StartX Fund, the investment vehicle operated by Stanford University’s affiliate accelerator and backed by the institution, announced on Friday that it would stop making new investments come June 30 after six years of supporting startups.
Officially, the fund is being wound down because the accelerator has reached financial stability and will shift to a different funding model. The program has increasingly engaged with Fortune 500 companies to support their innovation efforts, though StartX did not reveal how exactly its new model will work.
There is a less palatable explanation for the sudden shutdown however. Stanford-StartX Fund has been embroiled in a legal battle with one of its portfolio companies, US-based virtual medical assistant developer MedWhat, which participated in the accelerator in 2013 and obtained $560,000 in a 2014 seed round backed by the fund, which returned in 2015 and 2017 to inject additional undisclosed amounts of capital.
Problems emerged when the fund filed a lawsuit against the startup last April asking for repayment of its investments, plus interest, that it had made in the form of convertible debt. StartX was joined by fellow plaintiffs Caixa Capital, the corporate venturing arm of financial services firm La Caixa, Regent Capital Ventures and Startcaps Ventures, though details of the allegations remained under wraps.
The court sent the case to a mediation panel in May but talks to find an amicable solution fell apart quickly, and in June MedWhat followed by filing a countersuit on eight counts – breach of contract, breach of fiduciary duty, securities fraud, wire fraud, unfair business practice, injurious falsehood, intellectual property (IP) infringement and blackmail.
MedWhat’s allegations are serious – among other things, the company said Stanford University and fellow complainant Magic Stone Alternative Investments had backed rival medical assistant developer Sensely without disclosing the move during due diligence. Investors then allegedly exploited MedWhat’s proprietary information to support the Sensely investments.
Venture capital firm IncWell, meanwhile, has been accused not only of enticing some MedWhat engineers to leave for a competitor without MedWhat’s knowledge, but in a much more serious allegation has supposedly also committed wire fraud by impersonating MedWhat chief executive Arturo Devesa in an effort to gain illegal access to financial information from MedWhat’s account with First Republic Bank.
MedWhat has also claimed that all plaintiffs breached their convertible note contracts and committed securities fraud by obstructing the notes’ conversion in a qualifying financing round. Stanford and IncWell allegedly both convinced other MedWhat shareholders to side against Devesa and refrain from exercising their conversion rights.
Regent Capital has been accused of misleading MedWhat over interest in a series A commitment only to gain access to the company’s IP for a competing investment in China, while Caixa Capital allegedly used its investments in MedWhat to collect venture capital funds from the Spanish government. Caixa Capital purportedly deleted documents on MedWhat after the partner leading the investments left in 2016.
Astonishingly, matters became significantly worse for Stanford-StartX Fund and Stanford University itself earlier this month. During discovery – the pre-trial procedure in which each party can obtain evidence from the other through a series of actions such as requesting documents – MedWhat said it uncovered tax fraud committed by Stanford University and the person who was, allegedly, actually in charge of running the fund.
At this point, it is worth understanding some of the accelerator and fund’s history. StartX was launched in 2009 to support early to late-stage companies, followed by the fund’s creation in 2013 to support portfolio businesses. The fund size, notably, was always uncapped and had invested $31.4m in 82 companies within a year and a half of launching. At that point, expectations were that the fund may invest as much as $200m – a formidable figure.
The accelerator was set up by chief executive Cameron Teitelman, who formed two startups while studying at Stanford and saw the need for better support, together with Stanford University and its health system Stanford Hospital & Clinics.
Teitelman secured annual grant funding from backers including Stanford University to operate the program and led it to great successes – the accelerator has supported some 650 companies to date and helped increase average funding for startups from $1.1m in 2013 to $9.3m today.
In 2016, Stanford University committed to continue supplying annual grant funds. Teitelman stepped aside in 2017 to become chairman of the board and was replaced by Joseph Huang.
Importantly, StartX was established as a non-profit organisation and the fund as a for-profit vehicle that was to be independently operated. Stanford University itself is also a non-profit.
Here, things get dicey. Documents uncovered by MedWhat allegedly show that Stanford University and its endowment Stanford Management Company have been the actual decision-makers for fund investments, rather than Suzanne Fletcher, who is officially the fund manager.
If this is true, it would mean that Stanford University controlled for-profit investments – essentially channelling its own money through a non-profit vehicle – and that Fletcher lied to potential investees when they were told she was running an independent fund. It would also mean that Alto Litigation, Stanford’s law firm, inadvertently revealed information that not only proved MedWhat’s case but could cause serious problems for its client down the line.
MedWhat also provided documents showing that investments and wire transfers supposedly made by Stanford-StartX Fund actually came from official Stanford University bank accounts that are tax-exempt. Email correspondence between MedWhat and the fund submitted to the court, meanwhile, appear to show that Stanford University employees were involved, breaching official university guidelines that it cannot be actively involved in commercial enterprises.
There are apparently no indications in the court documents that Stanford-StartX Fund owns offices, has dedicated email addresses or has recruited directors or employees, instead citing only university offices, employees and emails. This would make the fund a shell company.
Sharing offices would not be illegal, so long as the fund was paying at least market-rate for the space and there was a written agreement in place, but the university would be in danger of losing its tax-exempt status if MedWhat’s allegations turned out to be true.
The lawsuit saga continues at the time of writing. It is, of course, impossible for Global University Venturing to say that the lawsuit – and particularly recent developments around alleged tax fraud – are the real reasons the fund is being shut down, but the announcement’s timing is noteworthy and it will be interesting to see whether more information emerges.
With Stanford-StartX Fund one of the most prolific investors in the ecosystem, its loss will certainly be felt. Let us hope others will not see its closure as a reason to dial back on their own commitments to university venturing.