SCO Says VC Wants Out

The SCO Group's war chest may have just gotten a lot lighter. The company, which is suing IBM and several Linux user companies, has filed an 8-K report with the Securities and Exchange Commission stating that BayStar Capital wants SCO to redeem all of the venture-capital firm's 20,000 shares of SCO's Series A-1 Convertible Preferred Stock.

In October, BayStar agreed to invest $20 million in 20,000 additional SCO shares, increasing its total ownership of SCO to about 3 million shares, or 17.5% of the company. BayStar's investment was part of a $50 million investment, with The Royal Bank of Canada investing $30 million in 30,000 shares of SCO Series A-1 Convertible Preferred Stock. At the time, this pushed SCO Group's cash position to $61 million, which president and CEO Darl McBride said would go toward the enhancement of its Unix operating system and software, the development of Web services, and fighting its ongoing legal battles against companies it believes have infringed upon SCO's intellectual property.

BayStar's investment in SCO was structured as a private placement of nonvoting Series A Convertible Preferred Shares, convertible into common equity at a fixed price of $16.93 per share--the average closing bid price for the company's common stock for the five trading days prior to and including the date of closing. SCO's stock closed on Friday at $8.37 per share.

An SCO spokesman said Friday that the company is seeking further clarification from BayStar, which cited four items from its agreement with SCO that it said had been breached.

One area of representations and warranties that BayStar accuses SCO of breaching came with the release of a Feb. 6 news release announcing the exchange of the preferred stock issued in connection with BayStar's $50 million in private financing. SCO was obligated to let BayStar review the release prior to its distribution, and also was obligated to file a Current Report on Form 8-K within two days of the date of the Exchange Agreement. The SCO spokesman says his company agreed to write a release at the time of the exchange and send it to BayStar for review before issuing it, and that SCO followed those procedures.

SCO would also have breached a second provision if there was "a material adverse change or development in its business that had not been disclosed" in its annual report on Form 10-K for the fiscal year ended Oct. 31, 2003. But according to SCO, BayStar hasn't provided specific information about any "material adverse change or development" that might have occurred between Oct. 31, 2003, and the close of their deal on Feb. 5, 2004.

SCO also states that as of Feb. 5, there was no information about SCO that had not been publicly disclosed but would be required to be disclosed in its annual report. SCO would have breached this representation if it had provided BayStar false information or if it had not disclosed information that would be required to be disclosed in its annual report. Again, BayStar has not provided SCO with details as to how it has allegedly breached this representation.

SCO would have breached one section of its agreement with BayStar if any representations and warranties it previously made on Oct. 16, 2003 as part of the original Series A stock financing transaction were not true on Feb. 5, 2004. SCO claims its does not yet know which of such representations and warranties BayStar claims SCO allegedly has breached.

Although it's uncertain at this time where all of this is leading, Dion Cornett, managing director at Decatur Jones Equity Partners, says this is a tough way for BayStar to get its money back. If BayStar's claims against SCO are true, SCO may have to give back the investment amount, plus an 8% dividend. However, a legal battle over the investment is hardly what BayStar wants, particularly because SCO would be fighting the suit with BayStar's money.

Cornett speculates that IBM's plans to have SCO's case dismissed could have shaken BayStar's confidence. "Common sense tells you something spooked [BayStar]," Cornett says. "Something tells them this isn't the home-run investment that they though it would be, and you don't make an investment you don't think is a home run."

A Royal Bank of Canada spokesman on Monday wouldn't comment specifically on the future of his company's investment in SCO. "We're aware of what BayStar is doing and are reviewing all of our options," he said.