Karma-Duped: A Cautionary Tale About the Murky World of Venture Lending

I've had a strange and interesting past 18 months. Karmaloop, the company I founded in my parents' basement and ran for 15 years, was pushed into bankruptcy and taken over by a "venture lender" - Comvest Partners II of West Palm Beach. This will be the first of 5 posts about different elements of my experience that I hope will help other entrepreneurs avoid mistakes, and for everyone else, provide a peek into the murky world of venture lending -- a serious piece of our rigged financial system.

I'm a pretty positive guy generally, and I am proud of the brand we built. Karmaloop was more than just a retailer to millions of 18-34 year olds-- it was at the center of a culture that converged around a shared passion for eclecticism in fashion, art, music and progressivism of all stripes (at its peak, Karmaloop had 4 million visitors a month). The brand was a reflection of who our customers were - young people made up of all races from around the globe. And while the website remains, it has been stripped of everything that made it Karmaloop besides the retail.

It's no fun to dwell on the negative. And happily, I have lived my life with relatively little conflict, trying to compromise and find common ground whenever possible. However, I also believe that sometimes it's important to revisit the negative to pull out valuable lessons. If others can avoid my fate, great; if it leads to a closer look at certain unscrupulous financial practices ... all the better.

You may have already read about the Karmaloop bankruptcy. I kept quiet about the true story during the press coverage because I had a $5+ million personal guaranty being held over my head (more on that later) and was repeatedly forewarned by Comvest not to go off script or they would go after me...I stayed on script..when it was over they went after me anyway!

In a nutshell:

Karmaloop, in about its 12th year of business, took a loan from Comvest, a venture lending institution and private equity group.

We borrowed the money from Comvest to expand and launch some new sites, and company finances started to go in the wrong direction, despite the continued success of our core e-retail business. Karmaloop staff undertook a herculean effort to right the ship, and we cut costs and shed sister businesses - it was painful, but we did it. Comvest, about a year into the loan, began to increasingly interfere and exert pressure (keep in mind that even during our financial distress, Karmaloop never missed a monthly payment to Comvest).

I, during this time of increased hostility and interference, negotiated actively with several potential equity investors and/or acquirers for Karmaloop, but Comvest was checking and blocking me every which way ... it seemed as though they didn't want their loan repaid (from the proceeds of those potential deals), but wanted instead to hobble the company enough that we'd have no choice but to file for bankruptcy, upon which they could swoop in and take the entire company. Welcome to the wild world of loan-to-own venture lending. Again so there is no confusion, I need to draw a distinction between venture lending and venture capital - two dramatically different animals (VCs want the business to succeed and sell, not to falter and subsume it like the loan to own strategies of some venture lenders).

With Comvest, it became clear that I had a powerful adversary on the inside, and I frantically tried to stop what was quickly becoming a runaway train. In an effort to prevent the looming takeover of my company, not only did I put every penny I had back into my company, but I also leveraged myself to the hilt to borrow money to put into it (btw, this was not very wise). As my money went in, Comvest blocked other capital sources, jacked up fees, interfered wherever possible (among other things, they inserted an incredibly destructive and incompetent full-time advisor, and they simply delayed and dragged when time was of the essence).

In the end, my capital-raising efforts proved futile. Comvest will say that I showed Karmaloop to 160 people and there was no interest, but, in fact, many parties were interested. Comvest got ownership of Karmaloop in the bankruptcy; they scared away other interested parties by setting a very high bid ceiling and, even before the process, by speaking with (i.e. discouraging) any potential investors or lenders I brought to the table. After they got Karmaloop, they pumped in some capital, ran it for a year and flipped it to another company.

The end? Nope ... Comvest came after me personally for $5+ million. Comvest knew I didn't have any money - I had literally liquidated everything (down to my wife's engagement ring and all my savings, 401k, etc.) and (foolishly) put every penny I could find back into Karmaloop to try to save it - yet they came after me anyway. Why? To try to push me into personal bankruptcy and tie me up. Why again? Because I believe and have been told they want the entrepreneur/owner cowed. Banks like Comvest subscribe to the philosophy of always attack; never defend. A strong offense is a strong defense. And even if they can get one penny, they wouldn't think twice about ruining someone's life.

These venture lending/private equity hybrid institutions can destabilize, take, own and operate or sell your company, make a profit and still come after you, the entrepreneur or owner, for additional money because of guaranty language in a bank note.

The U.S. has a very long list of people who have been screwed by a bank, and many folks have suffered tremendously (completely losing their livelihoods, losing their homes) and are still trying to get their bearings (in the grand scheme of things, I've been fortunate). Given the endless stories of Wall Street bankers looting, flipping, foreclosing, taking, slashing, etc., a great many people in the country are angry at what they see as financial institutions running amok. But it's more than just the "too big to fail" banks. As Paul Krugman wrote recently, "Predatory lending was largely carried out by smaller, non-Wall Street institutions; ....the crisis itself was centered not on big banks but on "shadow banks" ....that weren't necessarily that big."

http://www.nytimes.com/2016/04/08/opinion/sanders-over-the-edge.html?_r=1

At roughly $2.5 billion in assets, Comvest is considered a "smaller" bank.

"Vulture" capitalism isn't entrepreneurship or enterprise. These financial raiders don't create, they don't build; all they need is a spreadsheet and incredibly one-sided laws. Unfortunately, their gain comes too frequently at the expense of people's jobs and with tremendous collateral damage.

When they use bankruptcy to get complete ownership, the predatory banks control the story, set up fall guys and silence criticism during the takedown through exhaustion and threats to the entrepreneurs/owners. Intimidation worked on me for a time, but now I plan to write and speak about my experience to other entrepreneurs. I will relate it to the larger issues about venture banking going on in the country, but also discuss specifics - tricks and "technical defaults" used to turn the screws, block alternative deals and take over companies - and about what entrepreneurs should look out for.

Additionally, I have some interesting anecdotes about interactions with Comvest - from execs who commute to work by private plane to Palm Beach from their home in the beautiful Bahamas (side note, also a tax haven); the origins of Comvest starting with Value Jet; what I believe was their racist outlook toward my minority-majority management; and importantly, the string of broken promises they made to Karmaloop's customers, its vendors, and me.

Comvest is a $2.5 billion institution, yet once they got control of Karmaloop, they refused (despite many promises to me, including in writing) to pay back refunds due to tens of thousands of Karmaloop's 18-34 year old customers or due to the many small clothing brands our business had previously helped nurture.

Of course, there are many good banks, and we obviously need banks and lenders, but the inherent conflicts of loaning and also owning, as well as the lopsided laws protecting such institutions, need to be changed. Not to mention the consumer side of banking - and those banks' treatment and exploitation of the vulnerable in our society. I am more fortunate than many, and I know that, and I wake up everyday trying to do new and positive things and I have an amazing family - I never take this for granted.

You may read this and ask: why don't I just sue? That's a lot of people's first reaction ..., "this is America ... sue everybody!". Right? Wrong. I will also talk about why I have no legal recourse to sue. A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan. Crazy?

Did I make a lot of mistakes? Yes. Was I incredibly naive or even stupid? Yes. Were there many other solutions to our problems other than the bank taking over ownership of the company? Yes! Is the venture lending system a reflection of the business practices and enterprise we really want in our society? I say, No!

Here's a teaser from my next post, a quote from Rick Icaza, president of UFCW Local 770 in Los Angeles regarding Comvest and Haggen Grocery Stores:

"This is not just a case of an inexperienced, unprepared retailer floundering in a competitive market. This is a case of a profit-hungry Wall Street investor, Comvest Partners, of West Palm Beach, Florida lying to employees and the communities they serve in order to make a quick buck. Now they leave behind a mass of broken lives and stores -- all because they couldn't see beyond the end of their own quarterly report looking out only for itself, without any consideration of where these families will get their next meal."

http://supermarketnews.com/latest-news/ufcw-locals-slam-haggen#ixzz400rnHnSL

Stay tuned.