Claims of Fraud Go Both Ways in Stanford-StartX Lawsuit

This is not how Arturo Devesa envisioned his fate when he moved to Silicon Valley.

The ambitious entrepreneur founded MedWhat in Florida at the age of 24 to create a healthcare virtual assistant inspired by his mother’s experience fielding patient queries as a nurse—an artificially intelligent chatbot that could answer people’s medical questions.

After winning $30,000 in a business pitch competition at Florida Atlantic University, where he worked as an adjunct professor, he moved to Palo Alto in 2011 with hopes of growing the company. Two years later, the highly competitive Stanford University-backed StartX venture capital fund accepted Devesa and MedWhat into its fold.

Things were looking up.

But Devesa’s dream of making it big in the tech industry soon ebbed into a nightmare of litigation. Claims of fraud, stolen company secrets, a lawsuit and counter lawsuit have embroiled MedWhat and StartX—and several investors along with them. Devesa says the legal ordeal has made him question everything he believed about Stanford’s high-minded pursuit of innovation and Silicon Valley’s promise of meritocracy.

“I was really naive, and now I just see it for what it is,” Devesa says in a recent interview. “It is not this amazing entrepreneur-friendly thing that everybody talks about; it's just business. It's like Wall Street.”

StartX began in 2009 as a small student-led startup accelerator on Stanford University’s Palo Alto campus. Four years later, it joined forces with the elite university as Stanford-StartX, touting the same founder-friendly mission that it expressed at the outset. But as a for-profit entity working under the aegis of a non-profit university, it now had a legal obligation to enforce a clear separation of powers from the academic institution that helped to jump-start it with a $3.6 million grant.

Some 650 companies later, the fund went from raising an average of $1.1 million per company to $9.3 million and built up a thriving revenue model by courting some of the biggest corporate names in the U.S. And now, it’s slated to close.

“We invested in StartX’s program development because we saw the potential for it to provide great value to Stanford entrepreneurs,” Stanford’s Vice President for Business Affairs and Chief Financial Officer Randy Livingston said in a Jan. 17 announcement of the fund’s decision to stop making new investments after June 30. “We are pleased that this vision has been realized, with over 800 Stanford alumni, faculty and students having participated in StartX over the last nine years. It is gratifying that StartX is now in a position to move forward as a financially self-sustaining organization. We look forward to seeing what the community achieves next.”

To Devesa, the timing is more than coincidental. Though the university denies it, the MedWhat founder insists that the dissolution stems from his ongoing litigation, which accuses Stanford of using the fund as a mask by using non-profit employees and resources to run a venture capital enterprise. “My lawsuit shut it down after making public the fraud going on,” he says.

In a December court filing, Devesa claimed that the VC fund’s investments in MedWhat came from Stanford Management Company and “Stanford’s own bank accounts” and were signed by university employees. Since the money was coming from tax-exempt bank accounts under Stanford’s name rather than from the for-profit Stanford-StartX Fund, he says, that amounts to ”violating tax-exemption.”

Devesa’s questions about the structure and management of the Stanford-StartX Fund are just one more part of a fraught, multi-faceted legal case that dates back to April 2018 with a lawsuit first brought against MedWhat by several of its investors, including Stanford-StartX, Caixa Capital, Magic Stone Alternative Investments, Regent Capital Venture Ltd. and Startcaps Ventures.

Allegations in the initial claim last spring include breach of contract, securities fraud, unfair competition and unjust enrichment. Plaintiffs in the original case say Devesa lied about investments he had secured for MedWhat’s Series A funding round to make it look like he met Stanford-StartX’s minimum fundraising threshold.

Devesa purported that Regent Capital committed $3.2 million to MedWhat, according to Stanford-StartX’s complaint, and that an entity called Massive Investment promised another $400,000. Based on an email from Devesa saying, “I confirm that all other investors have already funded,” Stanford-StartX agreed to contribute to the round by buying $400,000 of Series A shares. But Regent Capital ultimately did not invest, and the lawsuit claims there’s no proof Massive Investment did, either.

But Devesa says he wasn’t trying to mislead anyone, and and he fell victim to a broken promise by Regent Capital. He knew their due diligence process could take time, but he says they strung him along by dragged it out for months. Devesa says he was taken aback when Stanford-StartX sided with investors in alleging a variety of missteps by MedWhat.

In researching potential motives, he says he looked up investments by Stanford-StartX in Crunchbase, an online trove of data about companies and funding, and found that both the fund and Magic Stone invested in a direct competitor to MedWhat called Sense.ly. Though MedWhat’s contract with investors required that they disclose any conflicts of interest, Devesa says Stanford-StartX never once alerted him to its dealings with San Francisco-based Sense.ly.

There are differing schools of thought in Silicon Valley about whether to handle competing investments with care or avoid them altogether. It’s not unheard of for accelerator programs or investors to support competing companies. Y Combinator, one of the highest-profile programs for startups that helped launch companies like Reddit, Dropbox and Airbnb, says some overlap is unavoidable.

“Even if you tried not to accept competing companies, you'd still get overlap because startups' ideas morph so much,” the storied accelerator explains in a blog on its website. “The way we deal with it is that when two startups are working on related stuff, we don't talk to one about what the other's doing.”

But it can come at a cost. A Harvard Business School study published in 2015 determined that companies backed by VC firms with concurrent investments in direct competitors “were 30 percent less likely to introduce a new product in any given year.”

To Devesa, news of the fund’s investment in a competitor felt like a devastating betrayal. So he filed a countersuit in the San Francisco Superior Court last June, charging his investors with breaching their contract, defrauding regulators, pilfering trade secrets and defamation, among other claims.

“They are destroying the value of their own investments,” Devesa laments. Not to mention the hopes that lured him to Silicon Valley in the first place.

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