Delaware decision shows how private equity preys on vulnerable CEOs

Rick Stollmeyer built a software company from his California garage and realised a dream when he took it public in 2015 at a valuation approaching $1bn. Much of what came next seems to have been a nightmare for the former US Navy submarine officer. As a guest on an entrepreneurship podcast, he lamented the shareholders of his company who would not countenance him selling down his stock, describing his periodic divestitures as the equivalent of “sucking through a very small straw”.

Mindbody, Stollmeyer’s software business that powered the systems of gyms and fitness studios, announced just before Christmas 2018 that it had a deal to sell itself to Vista Equity Partners. The deal allowed Stollmeyer to both cash out as well as keep his job and get a stake in the privatised company. But last month, a Delaware judge ruled that he breached his fiduciary duties to the other Mindbody shareholders by putting his liquidity needs first and selling at too low a price in a leveraged buyout.

“Stollmeyer tilted the sale process by strategically driving down Mindbody’s stock price and providing Vista with informational and timing advantages during the due-diligence and go-shop periods,” according to a decision from Kathaleen McCormick, the chief judge of the Delaware Court of Chancery.

McCormick awarded base damages to Mindbody shareholders of $1 per share on the $36.50 per share deal, or roughly $40mn to be paid by Stollmeyer and Vista, the latter who was found liable for separate misconduct.

McCormick’s ruling is a detailed window into how private equity firms can prey on the neuroses of chief executives for their own gain.

A Mindbody shareholder, the hedge fund Luxor Capital, had sued after the Vista deal was announced arguing that Mindbody’s board, including Stollmeyer, had breached their so-called Revlon duty, which required that once they sought to sell the company that they seek the best possible price for all shareholders.

Luxor had come to believe that the company could have maximised value if it had stayed public. McCormick was convinced by the evidence presented that Stollmeyer was desperate for liquidity. Beyond the podcast taping where he complained about being constrained from selling stock, Stollmeyer had family demands for money, had made a multimillion-dollar pledge to a college and was tapping cash from a bank credit line.

His banker at the boutique, Qatalyst Partners, in the summer of 2018 had introduced him to Vista, the software specialist, whom Stollmeyer would quickly covet as a buyer. Vista had invited him to its annual portfolio company convention, CXO, later that year. There he met a series of Vista executives including Robert Smith, the billionaire founder and another heavy hitter, Brian Sheth.

At CXO, he learned that Vista had bought another company Marketo, for $2bn and flipped it for $5bn, an example of how Stollmeyer could profit further down the road.

Even as Qatalyst tried to rein in its client at times, the bank’s behaviour also drew the rebuke of the Delaware court. Just as Stollmeyer was pledging his allegiance to Vista, Mindbody’s banker was greasing the wheels for Vista’s victory in the auction. Evidence showed that the adviser had tipped off Vista about Stollmeyer’s price expectations and provided it with subtle deal process advantages.

Vista’s mandate is to buy companies at prices that allow their investors to make good returns. Cultivating CEOs of potential targets is their job in the hypercompetitive world of leveraged buyouts.

But it now faces liability alongside Stollmeyer as the court found that the firm had failed to ensure that securities filings accurately described interactions with Stollmeyer that had commenced prior to the official sales process.

A Silicon Valley financier, who had got to know Stollmeyer, ultimately felt sympathy for him. The entrepreneur, this person said, was not excessively greedy. Rather, Stollmeyer was tired after 20 years at the helm, susceptible to Vista’s siren song and naive about the dark arts of cut-throat M&A.

Better oversight from his fellow Mindbody directors and advice on the norms he needed to observe during the auction would have proved useful too. Securities filings at the time showed that Stollmeyer owned $60mn in company stock based on the deal price, funds that may soon be shipped back to those Mindbody public shareholders he once found so exasperating.

sujeet.indap@ft.com