Why I’m betting Geosign suckered American Capital

The latest theory on the bizarre Geosign/American Capital deal — floated first in the comments of this blog and then in the Financial Post magazine cover story on Geosign (no longer available at the magazine’s site)  — is that American Capital knew exactly what it was doing and took a well calculated risk when it invested its $160 million last year.

The evidence, according to one or more anonymous commenters, is:

A VC with billions in assets doesn’t get suckered by a Guelph tech upstart. Just doesn’t happen — American knew, but maybe they’re not thrilled to disclose that their bet went so wrong.
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Do you really think that anyone invests $160,000,000 into a company that claims to be a multi-million Dollar business without checking every piece of information they can get hold of? I don’t.

Any investor looking into this would certainly ask “now, where does this money come from, exactly?” – VCs tend to grill candidates before money changes hands, even more so when a large-ish amount is involved.

Well, I agree 100% that they should know these things, but I don’t think you can take it as an article of pure faith that they do.

As Randall Howard, a general partner at the Toronto and Waterloo venture capital firm Verdexus, told me last summer: American Capital would have done “a tremendous amount of due diligence. I’d be totally shocked if they didn’t know not only where the revenues came from but where they were going to be coming from.”

Notice that second part of his quote about how they would have known where future revenues were coming from. That’s a long way from “they would have taken a high-risk $160 million bet on a revenue model that was widely known to be shakey and a large thorn in Google’s side in 2006.”

Um, isn’t the the whole point of all that due diligence is to allow the VCs to take a well calculated economic risk and invest in a company with a convincing business model and plan? It’s not supposed to lead to a high-stakes bet on a company that creates nothing of value to anyone and has a business model that Google’s been publicly unhappy with for some time. Why bother with due diligence if you’re just going to bet the farm anyway?

During the course of my research, I talked to people who felt — like the FP magazine writer and the commenters quoted above — that American Capital absolutely had to have known what Geosign was all about, but I also spoke with others who had a different take on the issue. One knowledgeable former employee made the point that there were many investors sniffing around Geosign and that American Capital may have felt pressured into acting fast. He also said there were a lot of red flags about Nye and Geosign that should have worried perceptive potential investors — including the type of people Nye surrounded himself with. And then of course, there are the other points I’ve raised in the past, which no one’s ever really addressed.

Finally, the journalist who wrote the FP Magazine story made a big mistake when he wrote that “American Capital’s latest securities filings peg Moxy Media’s value at US$128 million – which means the sum of Geosign’s former assets are worth less than American Capital’s original minority investment.”

What the 10K actually says is that American Capital invested $128 million, which is a huge difference and has nothing to do with the actual worth of Geosign today. (BTW, if any of you accounting types can explain why the last column in the Geosign lines is empty, I’d be most grateful)

So bottom line: Geosign or Moxy Media, if you will, is worth zero apart from SWI. And, while I could always be shown to be wrong, I’m sticking with my theory that American Capital was suckered. And I’d be willing to bet that over the next year, one or more of the people who made the deal will be gone.

Any takers? The wager’s for a lot less than $160 million.