The dark side of an economic crisis among technology companies
Explaining what economic "damage" is to a private startup company investor is arguably the most difficult challenge in an economic court, writes Dr. Tiran Rothman.
Several articles have been written in the last decade focusing on the flourishment of Israeli startups and on the entrepreneurs who have succeeded in bringing their company to the status of Unicorn. On the contrary, during times of recession and in economic courts, the dark side of startups is rarely disclosed and is distant from reaching newspaper articles. During economic downturns like the one we are currently experiencing, a struggle for scarcity of resources such as capital leads to a rise in the number of lawsuits filed in court. Instead of solely focusing on raising money, it is essential that entrepreneurs and investors alike must prepare for periods of economic crisis. Both the legal and financial sides will frequently determine the success of a company, and in the beginning stages of development, a solid agreement will prevent a wealth of difficulties if and when they arise.
The company's value is a significant and fundamental problem in technology companies, especially with early-stage firms that get into lawsuits.
Explaining what economic "damage" is to a private startup company investor is arguably the most difficult challenge in an economic court. Other challenges include determining the value of an emerging company that has initially started with zero revenue. In terms of public companies, other challenge exist, such as deciding whether a company’s technological or clinical development has contributed negatively to the share price or is something externally unrelated to its activities. I.e. should the decision reached be taken otherwise, and if so, what will the economic damage result from this? Unlike "classic" firms, technology companies have different problems, mainly due to the uncertainty element inherent within startups, in addition to their unique mechanisms such as SAFE recruitment or technological complexity that affects the development of a company.
As a general rule, conflicts with public, private, small, and large technology companies can be classified into three groups:
- Claim for damage caused to shareholders
- Legal disputes in which one of the parties wants to "cash out," whether one of the founders or investors.
- Claims regarding the firm's operations such as recruitment or unsuccessful business development activity.
One example of this is the Teva case. The company has been sued several times for its involvement in the opiate affair in the United States. Moreover, a class-action lawsuit is currently being conducted in Tel Aviv. To elaborate on this, Teva is being sued for hiding information from the public known to the company's management but did not report to the market in real-time. The lawsuit has a focus on the economic harm shareholders face as well as the decline in stock prices created as a result of the company hiding information from its investors.
On the financial side, it is required to assess the damage caused by creating an event analysis in relation to the stock price change relative to what was happening in the market. Teva case is not a unique one, and in fact, there has been many companies that have been sued for their business, technological, or clinical activities even in the event of management viewing it as the correct decision at the time.
Another example is Purple biotechnology; a dual company also traded on Nasdaq. Its investors sued Teva for raising capital on Nasdaq a few months prior to the publication of the results of a significant experiment. The lawsuit places emphasis on why the company did not wait for the trial result to be published and only then raised capital. In this case, if the results were good (as it was at the end), the recruitment price could potentially be higher, and if the trial did not show good results, why recruit at all? It is not necessary to go into detail here, but it is important to understand the consensus and a few claims in the capital market of technology companies regarding the companies' business, technological, and clinical activities.
Even among non-technology companies, there are financial claims whose primary purpose is to estimate the damage to its shareholders due to the alleged concealment of information from its shareholders. For example, a few months ago, TASE traded firm 'Ofer Lewinsky' reported an optimistic report of winning a real estate project. The stock rose following the published information, and the company managed to raise bonds successfully. However, after a few months, the company clarified that the information was too optimistic. The stock reacted accordingly with a decline. In this case, the damage was caused to both the bondholders and the shareholders who may have purchased it at the time of the positive reporting.
We learn from this that the periods of economic crisis increase the number of lawsuits, especially among technology companies in which the element of uncertainty is more significant. It is therefore crucial that investors and entrepreneurs should always prepare for even more complex days and understand the risk along with the potential in technology companies' investments.
Dr. Tiran Rothman, Vice President at Frost & Sullivan, also serves as an expert witness in the economic court.