Has the deal of the year become a nightmare?

My only excuse for being slow on this is that we’ve been busy, but the rumours are still swirling that there is more going wrong at Geosign Technologies Inc. than anyone imagined.

The background is this.

Part one: Geosign closed a $160 million venture capital round in March. That’ll undoubtedly be the biggest VC deal in Canada in 2007. American Capital Strategies Ltd. (ACAS:NASDAQ) did the entire deal solo. Word was that $50 million of the financing was a secondary sale by the founder (ie., that’s alot of “fur coat” money). Some Canadian VCs had tried to do a deal with the company, but none got very far.

American Capital bills itself as “the second largest U.S. publicly traded alternative asset manager with approximately $11 billion in assets under management (second to Fortress (NYSE: FIG)). American Capital, both directly and through its global asset management business, is an investor in management and employee buyouts, private equity buyouts, and early stage and mature private and public companies. American Capital provides senior debt, mezzanine debt and equity to fund growth, acquisitions, recapitalizations and securitizations. American Capital and its affiliates invest from $5 million to $750 million per company in North America and €5 million to €400 million per company in Europe.”

This was American Capital’s second deal in Canada, according to public and industry sources. The first was a $24 million deal with Midland’s Weber Manufacturing in 2004. If I’m not mistaken, that’s been a bit of a disaster, and the investment was a wipeout in just over two years. Even their senior lender took a haircut on it. (Back in 2004, American Capital had just $4 billion under management, so things have grown more than just a snick over the past three years.)

Part two:

A few days after the $160 million financing closed (could it be the publicity of the $160 million financing made its way to Mountain View, Calif.?), Google clamps down on the arbitrage that firms such as Geosign were undertaking; (Google arbitrage is referred to a scheme where “a person tries to exploit the difference between the costs of placing Google Adwords and the income that is derived from displaying Google Adsense ads on niche sites”).

Blogger JenSense gives some background on that bomb.

American Capital’s lawyers pour over the reps, but can find no way out and no misrepresentations by Geosign’s owners. Just a case of bad timing. Or good, depending on which chair you occupy.

Part three:

The layoffs start, which is where the blogs swing into action in late May. Seven Mile and Profectio lead the charge, and plenty of anonymous comments fill in the information gaps as they try to manage the bad PR that comes from a large layoff in a town like Guelph, Ontario.

Part four:

VCs and lenders have been more comfortable in financing money-out deals of late. And even more ready to finance partner buyouts. The Geosign experience may get us all second-guessing the wisdom of financing large secondaries.

For American Capital, what was certainly deal of the year material for the Canadian market has just turned into their second piece of bad luck in as many deals. While it is natural to sympathize with their horrible experience, I think the VC world needs to vow to learn from it, as well.

Had most of that $50 million secondary stayed in the company (How many homes can one own? How many business schools can one name? You don’t need a $50MM secondary.), it’d be much better financed to weather the storm they are currently sailing through as Geosign adjusts its business model.

MRM