On September 10, 2010, AdGrok founder Antonio Garcia-Martinez was hanging out at co-founder Argyris Zymnis’s San Francisco apartment when he received a call from Rodger Cole. Rodger Cole was a litigator at Fenwick & West, and Fenwick & West was one of the big three Silicon Valley law firms. Getting an unexpected call from your law firm is never a good sign — this was no exception.
Cole told them they had just been sued by Adchemy, their former employer. This wasn’t entirely a surprise — when Garcia-Martinez and his co-founders Argyris and Matthew McEachen left Adchemy together to start their new company, Adchemy CEO and their former boss Murthy Nukala made it clear that he was not happy with any of them leaving. Adchemy had sent AdGrok legal warnings a few weeks before filing suit in Santa Clara County Court — these warnings were the “sort of menacing recital of employment-agreement restrictions that serves as the warning shot across the bow in corporate litigation.” The warnings led Garcia-Martinez to secure a preemptive relationship with Fenwick, and explained why it was Cole who received the paperwork.
At the time, AdGrok was tiny — all of three guys and their laptops. The startup had gone through the famous Silicon Valley startup accelerator Y Combinator, and had just presented at ‘Demo Day’ — the end-of-program event that marked graduation. Demo Day was a day-long presentation to invited investors, and it marked the start of external fundraising. To say the lawsuit complicated matters was to put it lightly. Adchemy named each of AdGrok’s co-founders personally in the suit, meaning that if they lost, the founders would be personally liable. The amounts involved in the suit effectively meant that all three co-founders would have been financially ruined.
The following events, relayed in Garcia-Martinez’s 2016 book Chaos Monkeys, is only one side of the story; it is not the definitive account of the events that transpired. But that definitive account might not exist: none of the other actors ever commented extensively about the battle.
That said, the provenance distracts from the purpose of this case. This isn’t really about Garcia-Martinez. Rather, this story is about the actions of Y Combinator, the startup accelerator and investor that Garcia-Martinez allied with, and the moves that its principals executed to protect one of its tiny companies.
It is also a story of power in Silicon Valley.
The Stakes
At the time of the lawsuit, Adchemy had raised nearly $60M dollars, and was much larger than AdGrok’s three person team. AdGrok, on the other hand, was struggling to fundraise, and struggling to get the lawyers from Fenwick to defend them in exchange for equity (this was so that they wouldn’t have to pay the lawyers desperately-needed cash). Through some finagling, Garcia-Martinez got legendary Silicon Valley attorney Ted Wang to agree to a $250,000 loan in payment for their services, to be paid either with cash, or with a combination of equity and equity options. Wang was invested in this for more than just financial reasons; to hear Garcia-Martinez tell it, the attorney was also angry that Adchemy had violated Silicon Valley’s unspoken norms. (For the sake of innovation and the good of the overall ecosystem, it was frowned-upon for large companies to attack fly-sized startups).
Fenwick immediately went to work. Litigator Rodger Cole started “firing sharply worded missives” at Santa Clara County court, rebutting Adchemy’s filed claims, offering to provide externally audited code as proof of innocence, and began the process of hostile depositions (which would suck up time and energy from Adchemy’s executives, including Murthy Nukala himself). But this conventional legal battle was mostly a front: AdGrok could not afford a drawn-out legal entanglement. The key to getting out of the lawsuit was to lean on Adchemy’s weaknesses.
What weaknesses did Adchemy have? Garcia-Martinez writes that it had two:
It had investors, which sat on its board. This mattered, because board members with voting power could elect to kick out the CEO. Adchemy’s venture capital (VC) investors were from famous firms, and not too difficult to find: they were John Johnston from August Capital and Yogen Dalal from the Mayfield Fund.
It had potential business partners — which in Adchemy’s case was doubly important, for the company was floundering. Adchemy had — up to this point — only one major customer for its lead-generation product: Accenture. The entire company was running gigantic losses, with no real chance of turning on real product revenue; Murthy needed to pull in a new business partner to look good in time for Adchemy’s next round of fundraising. Through a stroke of luck, Garcia-Martinez discovered that Murthy was working on a major deal with Microsoft.
If AdGrok could attack either or both weaknesses, Adchemy was likely to back off. The only question was how.
The Knife
The first angle of attack was with Adchemy’s investors. Here AdGrok was helped by a change in startup funding dynamics that Garcia-Martinez argues had taken place around the start of the 2010s.
The argument he makes goes something like this: traditionally, the earliest stages of startup fundraising was once done either by using up the entrepreneur’s own savings, or from raised funds from friends or families, or from business ‘angels’ — wealthy individuals who for fun or profit were willing to put their personal money into tiny, nascent companies.
This changed in the early 2010s, in part due to the emergence of the tech bubble of that decade (propped up, no doubt, by low interest rates). But it was also changed by the emergence of a new generation of rich ex-founders and early-employees — the result of the Google IPO, and also a smattering of startup acquisitions over the course of the late 1990s and 2000s. These newly rich individuals became investors, and some of these folks — such as ex-Googler and prominent angel Chris Sacca — raised small funds in the $20 million to $40 million range. This meant that the angels now had enough firepower to invest $200,000 checks instead of $20,000 checks — and early stage startups could go longer without talking to VC firms.
This change in capital environment dovetailed with a change in software development during the time. “The emergence of turnkey, on-demand computation like Amazon Web Services, plus off-the-shelf Web-development frameworks like Ruby on Rails, meant that new ideas were easier than ever to test.” Garcia-Martinez writes, “Many entrepreneurs chose to build shovels rather than dig for gold, creating more complex software building blocks to underpin the innovation, such as back-end services like Parse, accelerating the startup explosion in an almost exponential way.”
All of this meant that by the time AdGrok was formed, it was not shocking for a two-month-old company “with a persuasive CEO” to raise $2 million and have the raise be termed a ‘seed’ round. Nor was it shocking to find these startups hitting its milestones in six months, and raising its next round not too long after the ink had dried on the earlier checks. Garcia-Martinez continues (bold emphasis added):
With so much money, of all sizes and levels, waiting to invest, the best entrepreneurs had the luxury of choosing investors, rather than vice versa, and many investors found themselves anxiously trying to get into rounds. Due to contracts stipulating that investors in one round had the right to invest in the next, as well as personal ties between investors and entrepreneurs, investors getting in on oversubscribed A rounds had to be there in the seed round to earn that place. And that was true going up the various funding levels. That means VCs who would formerly say “Get back to me when you’re raising a series A or B, kid” were basically blocked from popular companies by investors who had nurtured and supported the company since it had been two guys in a trashy office. Heavyweight funds like Mayfield and August knew this, and started doing seed investing, not to own some little piece of a company (they could write small checks all day and still not invest their entire funds) but merely as an option on the real rounds down the road.
This change in dynamic meant that Y Combinator had a unique position in the Silicon Valley ecosystem. Garcia-Martinez continues (again, bold emphasis added):
… in the day-to-day, the lifeblood of a VC wasn’t money, it was deal flow. Getting a first look at a potential Uber or Airbnb is what distinguishes a first-class VC from an also-ran. Given Y Combinator’s immense success in drawing the best entrepreneurs, it had a quasi-stranglehold on the best early-stage deal flow in the Valley. And since early-stage deal flow today translated into later-stage deal flow tomorrow, via the follow-on investing phenomena described, Y Combinator was the gatekeeper to the best present and future deals in the Valley. Like control of the water supply in some arid agricultural region, whoever had the most upstream control of the water sluice controlled everything else—which is what Y Combinator’s Demo Day represented. Thus, powerful and haughty VCs who wanted to attend Y Combinator’s showcase pitch event had to kneel and kowtow to a sandal-wearing bear of a man with a distaste for bullshit and a flair for the written word. That man was Paul Graham, without question the canniest tech investor in human history. And it was to Paul Graham we first turned with our existential problem in those desperate days.
(...) It was all the more impressive because I had miscast PG as a sort of avuncular, academic presence who dabbled in dense essays about startups, hosted founder dinners, and wrote a few checks. Nothing could be further from the truth. Y Combinator was the sort of unforgiving power player that remembered the names of investors who had crossed portfolio companies in the past, or who had disseminated unflattering portraits of YC, and blacklisted them from any YC dealings, or from the minds of YC founders. This was done with little thought of the size of their funds or their influence in the Valley, leaving more than one self-important VC sputtering at a dressing-down, or left out of a round because the company’s founders had gotten a warning from PG.
The harsh reality is this: to have influence in the world, you need to be willing and able to reward your friends and punish your enemies.
When Graham first learnt of the lawsuit, he emailed Murthy to discuss the matter. Murthy was polite and deferential, but did not budge on his position. The lawsuit was still on.
Undeterred, Graham emailed Garcia-Martinez: “Come meet me at home to discuss this on Saturday. Come alone, don’t bring the others, and try to keep them out of it.” (Graham’s goal: to spare AdGrok’s other co-founders from the drama, so that they could continue building whilst the lawsuit resolved itself).
And so Garcia-Martinez arrived at PG’s house in Old Palo Alto.
PG shared his anti-Adchemy game plan. In a nutshell: YC would anathematize Adchemy’s VCs, and declare that they’d never do business with YC again unless they straightened this out. Knowing PG, not only would they be disinvited from Demo Day, but PG would probably also steer companies to take money from other funds instead. Given that many if not most YC funding rounds were oversubscribed with investors, an excommunicated investor could be excluded without damaging the fund-raising company at all. At the end of the day, who really gave a shit if the check came from August versus Sequoia? That money was just as green either way. That meant that those funds would start losing YC deals wholesale to their competitors, and, as we reviewed earlier, getting locked out in the early rounds likely meant the same in the even juicier later ones. PG was about to flush a whole chunk of their deal flow down the toilet, just like that.
I smiled, imagining the sputtering fits pitched by the partners over at Mayfield and August when PG read them the riot act. YC was actually willing to sever ties with some of the most illustrious names in Valley investing over the piss squirt that was AdGrok. It may seem like nothing to you, reader, who maybe inhabits a normal realm of twenty-first-century economic life where things like tit-for-tat reciprocity enforce social codes. But in the passive-aggressive popularity contest that is Silicon Valley, someone actually going to bat for you—really going to bat, like telling important people to go fuck themselves—that’s rarer and more short-lived than a snowflake in a bonfire.
I thanked PG profusely, and then he padded back into the kitchen for his lunch.
The next weakness was Adchemy’s big deal with Microsoft. Here Garcia-Martinez turned to (then) fellow YC founder and mentor, Sam Altman.
[In 2016, when the book was published] Sam Altman is the current head of Y Combinator, and the person whom Paul Graham has entrusted with transforming his brainchild into a long-lived and scalable institution. In 2010, he was CEO and founder of Loopt, a company that had pioneered the location-check-in product that Foursquare would later eclipse (only to itself stumble), and which Facebook eventually worked into its product.
At the time, though, Loopt was still a location player, and Sam would take an hour out of his busy week, usually late afternoon on a Friday, to field whatever questions I had, no agenda required. The boys came along for the first session, and never again. I think they were scared of him, and with good reason. In one of PG’s essays on desirable founder qualities, he had this to say about Sam: “You could parachute him into an island full of cannibals and come back in five years and he’d be the king.”
I believed it, as did the boys. His official AdGrok nickname was “Manson Lamps,” after Tony Soprano’s psychotic rival, who possessed an intense and unsettling stare. This was a flip and admittedly unfair comparison; Sam never proved himself anything other than a capable operator and loyal friend to YC companies.
‘Sama’, as Altman was widely known, was a well-connected node in Silicon Valley: “you know him, and you’re not more than two hops from anybody that matters.” Garcia-Martinez emailed Sama to ask if he knew anyone on the Microsoft deal team with Adchemy, explaining, solicitously, what Murthy was attempting to do to AdGrok. Sama called to clarify. Garcia-Martinez describes what happened next:
Sam Altman assured me he’d try to do the best he could, and promptly cut off the call.
A week went by. Driving on the 280, I saw his number flash on my phone and pulled over; Sam Altman cannot be dealt with at eighty miles per hour.
“So I talked to [name redacted], who is Adchemy’s business-development contact at Microsoft. He assures me he brought up the AdGrok issue in one of their meetings with Adchemy. He stated it was going to be problematic if Adchemy was embroiled in litigation while discussing the Microsoft deal.”
I almost dropped my phone. This was precisely the decapitated horse’s head in Murthy’s bed that we needed. Murthy, with his back against the wall, running short of cash and with no salable product even remotely on the horizon, needed both the accounting and the marketing win of a big infusion of Microsoft money. Weasel that he was, Murthy had an overriding sense of self-preservation, and was still rational enough to realize that destroying AdGrok was not worth destroying Adchemy in the process. If indeed Microsoft BD had raised a flag about AdGrok, there’s no way Adchemy could continue the suit. It would be suicidal.
“Sam, I don’t know how to thank you for this.”
“No problem.”
Click.
The Resolution
Garcia-Martinez did not have eyes everywhere, of course. Much later, he learnt that PG’s pressure on Adchemy’s investors was working:
One of our investor friends had visited Mayfield Capital on unrelated business. Given the open nature of most VC offices, with all conference rooms and partner spaces facing some airy, sunny central area, he could see that Yogen Dalal, the managing partner for the Adchemy investment and Silicon Valley notable, was in a conference room having what appeared to be a strained conversation with Murthy. Board meetings or advisory sessions (not that Murthy took advice from anyone) should have taken place at Adchemy, not Mayfield, at that stage. That, plus the timing, signaled that this conversation was likely about AdGrok. It seemed that PG had delivered, and Adchemy’s investors had started putting the squeeze on Murthy, using their moral (not to mention financial) suasion to get Adchemy to retire the suit.
In late October Adchemy’s tone changed abruptly: where before they were menacing, now they were conciliatory. AdGrok received an offer to dismiss the suit. By February the whole ordeal was over, but for the lawyer’s fees. The three co-founders signed some token agreements, and sent Fenwick a copy of their code for safekeeping (they encrypted the zip archive; so confident were they that nobody would even bother to check).
AdGrok had won.
But the episode was not without cost. A few years later, on the event of Adchemy’s death in 2014, Garcia-Martinez would post on Facebook:
Through the most dogged persistence, we managed to raise a seed round in the teeth of a bitter lawsuit, and continued to fund operations. But the damage had been done. My co-founders and I were tired of the fight, and the startup adventure for us had been a yearlong, unremitting existential battle that had subsumed whatever product vision we had. The company sold to Twitter in May 2011 and the product disappeared. In a way, Murthy won in the end.
After raising around $120 million in funding, Adchemy was bought by Walmart Labs for an alleged $30-$40 million — a “fire-sale ‘acquisition’”. Many employees who purchased stock in the company lost their savings, and the investors lost most if not all of their capital. Murthy Nukala, on the other hand, managed to negotiate a $2.4 million golden parachute deal for himself, and various other amounts for a small group of Adchemy executives. All of those deals were multiples of their salaries.
If the Business Insider article reporting this arrangement is to be believed, Murthy walked away rich, while stiffing his employees and investors in the back.
To our knowledge, Garcia-Martinez never crossed paths with Nukala again.