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Investor immorality: The strange case of Blue Noodle

August 17, 2011: 10:38 AM ET

Start-ups fail all the time. But there is a right way and a wrong way to do it. This is an example of the wrong way.

On Monday, most employees of social media startup Blue Noodle didn't get paid. They called their lead venture capital firm, which wouldn't discuss the situation with them. They called their former CEO, who refused to pick up the phone. They called their lender, who said to call the venture capital firm. And thus the circle began anew.

"In my more than 20 years of working in Silicon Valley, I've been involved on more failed companies than I'd like to admit, but there is always an orderly wind-down process," says John Montgomery, chairman of law firm Montgomery & Hansen. "It sounds like the VCs in this case are treating the company like a car they abandon in a parking lot with the keys in the ignition."

"I've never heard of this happening before," adds Marty Pichinson, co-managing member of shut-down specialist Sherwood Partners.

Blue Noodle is a Toronto-based company, with offices in San Francisco and New York. It also has been known as NeoEdge Networks and GWN.

The basic business plan was to help casual social game publishers monetize in-game advertising, and in 2009 decided to focus on games operating on the Facebook platform. The move was supported by a $4 million VC investment led by VanEdge Capital, a $100 million Canadian venture fund whose principals included veterans of Electronic Arts, DreamWorks Interactive and Taleo. The company then raised an undisclosed amount of venture debt late last year from MMV Financial.

All seemed okay until January, when Facebook announced that game publishers would be required to use Facebook Credits as their exclusive currency. "We had put most of our eggs into the Facebook basket, and that was like a shot through the heart," says a former Blue Noodle employee who requested anonymity. "There wasn't really a Plan B."

At around the same time, lender MMV Financial began to seriously flounder. As we reported last month, the firm ultimately would decide to close its U.S. offices and stop all new underwriting. The result was twofold: (1) MMV needed money to repay its own investors, and (2) MMV no longer felt compelled to maintain good relations with its VC firm partners.

By last month, Blue Noodle had defaulted on its debt. MMV took immediate controls of the assets, including the company's bank accounts, for the purpose of a sale.

Left with no operational control, the Blue Noodle board – including its CEO Lesley Mansford and its rep from venture firm VanEdge – resigned. Senior VP of operations Todd Heringer quickly took the reins, but then soon resigned himself. Employees kept being paid – presumably by MMV or out of existing company cash – but some began seeking other employment. There also was talk that Blue Noodle would be acquired by RockYou, although RockYou declined to confirm or deny its interest when asked by Fortune.

Around one dozen employees continued to work and got paid during the final July period, but still had lots of questions. Some wanted to know if they should keep coming into the office. Others simply wanted employment records, so they could go elsewhere. These questions intensified on Monday, when Blue Noodle didn't deposit paychecks in employee accounts.

One employee, QA team leader Mark Thurgood, tells me that he kept getting the runaround: "VanEdge either wouldn't return our calls, or would tell us to talk to MMV," he says. "MMV would tell us that they only were responsible for the assets, and that liabilities like employees were still VanEdge's responsibility. Everyone is basically washing their hands of us."

I spoke to MMV co-founder Ron Patterson, who basically repeated the assets vs. liabilities argument. He also said something odd near the end of our conversation: "I'm trusting that you're a reporter, like you say you are." Who else would I have been and, more importantly, who did he not want to be discussing Blue Noodle with? Its employees? Lawyers for its employees?

VanEdge, on the other hand, would not even provide a "no comment." I've made several calls to the firm, including lead Blue Noodle partner Glenn Entis, over the past two days, and have received no response.

My understanding is that MMV has reached a deal in principle to sell the Blue Noodle assets to a company called DoubleFusion, but it's unclear if remaining Blue Noodle employees would be subsequently retained.

All of this is a disgrace. VanEdge doesn't have a responsibility to return my calls, but it does have a responsibility to the employees of its portfolio company. Even if a lender has taken control of assets, that doesn't mean you simply dissolve the board and walk away. And the lender should not take control and then pass the entire responsibility buck to equity holders.

Again, some employees simply want records of their employment at Blue Noodle, so they can get other jobs. But neither VanEdge nor MMV will provide them, let alone paychecks or pink slips.

"I'm acting like I've been laid off, but I haven't actually been told I'm laid-off," Thurgood says.

It's likely that both VanEdge and MMC are following their lawyers' advice, which is designed to make sure neither get stuck with a final bill. But sometimes you need to look your lawyer in the eye and say: "You're right on the law, but wrong on the moral responsibility. These people don't deserve to be left hanging in the wind."

Too bad neither VanEdge nor MMV had the common decency to do so.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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