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3/4/2003
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Napster Suit Unnerves Venture Capitalists

Efforts by Universal Music and EMI to sue the VCs that backed Napster could disrupt the venture capital industry

SAN FRANCISCO (AP) -- Venture capitalists didn't need another reason to avoid high-tech investments, but two major record labels have given them one anyway.

Still seeking retribution for Napster's online file-swapping system, industry giants Universal Music and EMI are trying to break new legal ground by suing the venture capital firm that helped finance the revolutionary Internet service.

Napster failed last year, but the discord about the service and the free music that it distributed is far from over.

The music industry's latest legal assault would push the boundaries of blame by holding investors liable for the actions of a company and its management.

It's a showdown venture capitalists have long dreaded.

If the music labels prevail, "it could destroy the whole venture capital industry," said J. William Gurley, a general partner at Benchmark Capital in Menlo Park, Calif.

The music labels say they are just looking for justice.

"Businesses, as well as those individuals or entities who control them, premised on massive copyright infringement ... should face the legal consequences," the record companies said in a statement.

The record labels' suit, filed in Los Angeles last week, alleges Hummer Winblad Venture Partners' $13 million investment in Napster enabled tens of millions of Napster users to infringe on music copyrights. San Francisco-based Hummer Winblad made the investment in April 2000--long before federal courts declared Napster illegal.

If venture capitalists can be held responsible for the actions of the companies in their investment portfolios, Gurley wonders if the same principle could be applied to individual investors who own stock in companies with legal headaches.

"Should someone be able to come after you because you invested in Philip Morris when you should have known that cigarettes are bad for people?" asked Gurley, a former Hummer Winblad partner who left the firm before its Napster investment.

The National Venture Capital Association has even broader concerns.

Mark Heeson, the trade group's president, was so concerned about the entertainment industry's aggressive litigation that he sent a letter to Sen. John Kerry, D-Mass., last year.

"The ability of entrenched industries to deter investment in next-generation technologies has profoundly anticompetitive and anti-innovative implications throughout American industry," Heeson wrote.

In an interview, Heeson said that's just what the Hummer Winblad lawsuit could do.

Other venture capitalists say they aren't worried, arguing that the lawsuit against Hummer Winblad is as much of an oddity as Napster itself.

"It's not changing the way I approach investments, nor is it changing things for any of the people I know," said Wes Raffel, a general partner for Advanced Technology Ventures in Palo Alto, Calif.

A surprise decision that went against the record labels and movie studios last week may even embolden some venture capitalists.

U.S. District Court Judge Stephen Wilson squelched a copyright infringement suit against two other popular Internet file-swapping services, Grokster and StreamCast Networks Inc., after concluding they couldn't be held liable for pirating by their users.

Still, there's little doubt that the latest Napster suit is designed to scare venture capitalists, according to several attorneys who specialize in investment law.

"It's pure thuggery," said Philadelphia lawyer Howard Scher.

The suit against Hummer Winblad and two of its partners, Hank Barry and John Hummer, seeks $150,000 per copyright violation, plus punitive damages. It's the kind of money that the labels couldn't get out of Napster after the company went bankrupt last summer.

"This suit is all about finding a deep pocket," said Houston securities lawyer Joe Cohen.

Neither Barry, who once served as Napster's chief executive, nor Hummer, who sat on Napster's board of directors, returned calls seeking comment.

Venture capitalists have always realized that they could lose money if a startup in their investment portfolio ran into serious legal problems. As a rule, they traditionally cash in on just a handful of successful startups, offsetting losses and paltry returns from most of the companies they finance.

Until now, though, venture capitalists had presumed their losses would be limited to the amount of money that they invested in a company.

The Hummer Winblad suit raises the possibility that they could lose more than 100 percent of their investments.

"That makes everyone nervous because it injects even more risk into the system," said Palo Alto attorney Barry Kramer, who works with venture capitalists. "There is already enough risk in venture capital. We don't need any more."

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