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The Latest Craze In Silicon Valley: Bankruptcy

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When Avaya Corp. filed for Chapter 11 bankruptcy reorganization on Jan. 19 it represented a sad end to the $8.2 billion buyout of the Santa Clara, Calif. technology company by Silver Lake and TPG almost a decade before. But it was hardly unique in Silicon Valley.

Venture capitalists who once considered an unthinkable breach of decorum to put a company in bankruptcy now see it as a way to salvage what they can from their would-be unicorns. While most tech startups consist of little more than leased office space, some yoga balls and a bunch of promising ideas, their intellectual property can generate hard cash in an auction. As old-line photography company Kodak demonstrated in 2012 when it sold a portfolio of patents to groups led by Intellectual Ventures for $525 million, even a dead company might have valuable assets hiding in its files.

“It really exploded after the Kodak bankruptcy,” said Jeffrey Cohen, a partner with Lowenstein Sandler who as a Cooley LLC partner handled the two-year-long bankruptcy of Quirky, a crowdsourcing site for inventors that consumed $175 million in VC money before it failed. “In the tech space now there are some emerging companies that have emerged enough before they fail to have assets to play with.”

Gawker was wiped out by the $140 million libel verdict it lost to former pro wrestler Hulk Hogan, though the online media company managed to sell some of its other properties to Univision for $135 million after it went into bankruptcy. Karhoo, an on-demand ride service, went bankrupt after blowing through $52 million and was refinanced by auto giant Renault. Online fashion retailer Nasty Gal filed for bankruptcy last year, wiping out the fortune of its youthful founder Sophia Amoruso, and its remains were quickly bought by Boohoo.com for a reported $20 million.

Last month Lily Robotics joined the crowd, filing for bankruptcy after its follow-me autonomous drone failed to take off. Lily drew a huge amount of attention -- and more than $15 million in funding from the Winklevoss twins, Spark Capital and others – after posting a video on YouTube purportedly showing the drone in action following skiers. It couldn’t produce a working product on time and has vowed to repay $34 million in customer orders dating back to 2015.

Even Avaya tried to cash in on the bankruptcy of onetime tech giant Nortel, paying nearly a billion dollars for Nortel’s enterprise solutions business in 2009. Avaya, which is still operating, filed Chapter 11 to restructure its own $6.3 billion debt load.

Such sales have helped reduce the stigma of bankruptcy for startups that flop, said Cohen. Before, he said, venture capitalists “viewed bankruptcy as a stain on their investment acumen.”

“They would say `I’m not covering payroll next week,’ and the founders would say `That’s it, shut the lights off Monday’ and walk away,” Cohen said.

Then came the high-profile sales of patent portfolios by Nortel, Kodak and others and VCs started picking through the wreckage more carefully. The Quirky bankruptcy was typical of the new approach. When it was clear the company would either need to raise more capital or shut down, the VCs and their lawyers started working on strategies to salvage what they could.

Among Quirky’s businesses was Wink, which developed a smart home hub capable of linking thermostats, lighting, security systems and other devices when Silicon Valley capitalists were betting that one company would come up with the communications standard that would dominate the industry. While Wink didn’t win that race, it had a reasonably successful product and a primary vendor, Flextronics International, with a strong incentive to keep it in business.

“Flex had a lot of inventory built up with their IP embedded in it,” said Cohen. “They had a lot to lose.”

Flex paid $15 million for Wink as a standalone company in separate bankruptcy proceedings and Quirky sold its patent portfolio for another $5 million. Qurky’s creditors included Comerica, which lent $30 million and stood first in line for any proceeds. “Our motivation was to get Comerica out,” Cohen said. “We got them $20 million instead of turning the lights off and walking away.”

Some of the dot-bomb bankruptcies bear comical, even prophetic names. Cohen represented creditors of Beyond Oblivion, a music service that tried to compete straight up against iTunes with the catchy moniker BOINC, as in “Time to get BOINCED.” The founders invested more than $40 million building infrastructure but “when they hit a certain tolerance level no one was willing to fund it anymore,” Cohen said. It was sold for $3 million to the founders plus Huntsman Gay Capital, who successfully relaunched it in Venezuela.

Some Silicon Valley VCs are choosing a quieter state-law procedure known as an assignment for benefit of creditors, or ABC, where a trustee sends checks to creditors and liquidates the business.

“It’s exploded in the last few years but you haven’t heard about it because it allows them to fly under the radar,” Cohen said.

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