The rise and fall of GenapSys

Hesaam Esfandyarpour dreamed of researchers, doctors and patients unlocking the genetic codes behind deadly or debilitating diseases thanks to a small, low-cost machine.

Venture capital and private equity firms, trusts and foundations pumped at least $230 million into his company, Redwood City-based GenapSys Inc., over nearly a dozen years.

What investors got in return was a limited launch of the company's gene sequencer, a scuttled blank-check merger and more than two years of litigation -- four cases over three courts in two states -- that some company officials said straitjacketed GenapSys as it attempted to raise more cash.

In the end, GenapSys was sold in September in U.S. Bankruptcy Court in Delaware for about $42 million to a group of late-stage investors led by San Francisco-based Farallon Capital Management LLC.

Central to it all is Esfandyarpour, who agreed in November 2020 to step down as CEO but remained on GenapSys' board. He continued to own at least 31% of the company's stock as it entered bankruptcy proceedings this summer.

Esfandyarpour, who did not respond to multiple attempts to contact him by telephone and LinkedIn, continues to fight GenapSys investor and prominent Bay Area biotech venture capital firm Foresite Capital, which charged in a 2020 civil suit against Esfandyarpour and GenapSys that Foresite was fraudulently induced to pony up $50 million the year before.

Foresite founder and CEO Jim Tananbaum declined to comment on GenapSys.

As GenapSys' board tried to raise critical cash earlier this year, Esfandyarpour filed a lawsuit in Delaware's Court of Chancery that questioned the validity of a deal that removed him from the CEO role.

What's more, Esfandyarpour and his wife, who was a GenapSys employee, challenged the company's Chapter 11 bankruptcy filing in July. But the court in September awarded GenapSys' assets to the group led by Farallon.

Farallon's plans for the new company, called Sequencing Health Inc., are unclear.

'New opportunity for discovery'

GenapSys' story starts in 2005, as Esfandyarpour pursued an electrical engineering Ph.D. and finished his post-doctoral work at Stanford University and landed at the Stanford Genome Technology Center.

With the memory of a family member being misdiagnosed at an early age, Esfandyarpour and his team worked on developing a new method for sequencing DNA -- reading the components of the self-replicating carrier of genetic information -- by using electronic signals. That compares to optical-based technologies traditionally used to identify genetic markers.

By 2010, Esfandyarpour was ready to start a company, GenapSys, that not only tapped his electronic data sequencing software to find mutations but would put that power into a box the width of an iPad. The project required expertise in DNA sequencing, genomics, semiconductor technology and machine learning.

The resulting device, Esfandyarpour said during the J.P. Morgan Healthcare Conference in January 2019, was akin to a mainframe-to-mobile pivot for genomics: 'We're just at a starting point,' he said.

Gene sequencing today is largely done by bulky, 500-pound next-generation sequencing, or NGS, systems that cost hundreds of thousands of dollars. But GenapSys said its bench-top box, weighing less than 10 pounds, could deliver DNA sequencing that was just as accurate for less than $10,000 per unit.

NGS is a process that in some cases can take a couple of days. Esfandyarpour said GenapSys' Genius device would give researchers the ability to accurately sequence an entire human genome within hours. It included two electronic microfluidic chips -- with 1 million and 16 million sensors -- and ultimately a second-generation chip of 144 million sensors that Esfandyarpour said would give scientists and doctors unprecedented power to diagnose diseases.

The applications of a portable, affordable and accurate gene sequencer would go beyond cancer diagnostics, research and drug development, GenapSys said, into infectious diseases, personalized medicine, forensics, food science and more.

'There are 400,000 research labs and only 5,000 own a sequencer today, but every one of them see the genome as valuable,' Esfandyarpour told the Business Times in 2019 about the ability of Genius users to peer into the genome, the full collection of genetic material in our bodies.

'If you reduce the cost to less than $10,000, it can be bought with a credit card -- every lab can afford it,' he said. 'It opens up a completely new opportunity for discovery.'

With GenapSys foreshadowing genetic sequencing that would be quicker and cheaper, investors took notice. The company raised $230.3 million in secured debt and preferred equity, according to a bankruptcy court filing, though Esfandyarpour's LinkedIn profile says the company raised more than $270 million and funding tracker Crunchbase puts GenapSys' haul at $319 million.

In addition to Foresite, A-list investors included Farallon, Decheng Capital, Casdin Capital and Stanford Management Co., the university's endowment-investing arm. Other investors included a San Francisco trust associated with Prologis Inc. Chairman and CEO Hamid Moghadam.

Foresite in June 2019 invested $50 million, according to a bankruptcy court filing, as part of an overall $90 million Series C raise by GenapSys. Farallon led the Series D round in February 2021 that included money from private equity firm Soleus Capital Management LP and a unit of pharmaceutical and life sciences investor PBM Capital.

By December 2021, GenapSys and Colorado state officials were touting the company's plans to tap an eight-year tax credit to open a 40,000-square-foot office and lab site in a Denver suburb that would create 241 jobs.

By then, however, issues had arisen with GenapSys' product, and friction had emerged between Esfandyarpour and his company's investors.

Claims and counterclaims

The first point of contention came in early February 2020, when GenapSys disclosed $75 million in debt funding from Oxford Finance LLC, deals with more than 25 distributors worldwide and plans to release its sequencing system in the Asia-Pacific region to detect the then-newly discovered virus that causes Covid-19.

In a lawsuit filed in Santa Clara County Superior Court four months later against GenapSys and Esfandyarpour, Foresite said it learned about the news 'with the rest of the market' in a GenapSys press release. The public version of the complaint is heavily redacted, but it is clear Foresite felt GenapSys and its founder, chairman and CEO, Esfandyarpour, were not telling a complete story.

The allegations by Foresite -- whose investments at the intersection of tech and biotech include early-cancer detection test pioneer Grail Inc. and single-cell analytics tools company 10x Genomics Inc. -- include fraudulent inducement, negligent representation, breach of contract, breach of implied covenant and breach of fiduciary duty. The firm is seeking damages, the rescinding of its stock purchase agreement and an award for exemplary and punitive damages.

GenapSys and Esfandyarpour in that same month, June 2020, filed a cross-complaint -- also heavily redacted -- that alleged Foresite and Tananbaum were 'determined to steal GenapSys.' Foresite officials, who initially met with GenapSys leaders in 2017 but did not invest at that time, 'stole' intellectual property from GenapSys to start two competing companies, GenapSys and its CEO said in the cross-complaint.

'The story Foresite tells in its lawsuit cannot be true, indeed it is not remotely plausible,' GenapSys and Esfandyarpour said in the cross-complaint.

The cross-complaint alleges Foresite and Tananbaum, among other things, breached their contract with GenapSys in regard to a nondisclosure agreement and the Series C funding round, misappropriated trade secrets and interfered with prospective GenapSys investors.

The cross-complaint seeks damages and to prevent Foresite and Tananbaum from using GenapSys trade secrets.

The case is scheduled to go to trial in August 2023.

'Doomed to fail'

Esfandyarpour had overseen a 'limited launch' of GenapSys' first-generation DNA bench-top sequencer in late 2019 that ultimately led to the sale of 'a few dozen' instruments and customer billings of less than $1 million, according to a bankruptcy court declaration by now-former GenapSys CFO Britton Russell.

It was a pivotal time for GenapSys.

Three directors, including Moghadam, resigned by the summer of 2020. Moghadam, who had joined the board after investing in GenapSys in 2017, said he would return if the company's governance was reformed, independent directors were appointed and board committees were established, according to a July pre-trial brief filed by the company and some of its directors in response to a Delaware Court of Chancery lawsuit brought by Esfandyarpour in April of this year.

'Under the present governance structure and with your limited experience as a CEO, the company is doomed to fail,' Moghadam told Esfandyarpour in summer 2020, according to the company's and directors' response to the April suit.

Moghadam would convince Esfandyarpour to re-appoint him to the board in September 2020 along with Bob Zollars, a senior advisor at Frazier Healthcare Partners, to help the company move forward, particularly with attempts to raise additional money, according to a July pre-trial brief filed by Esfandyarpour in support of his April suit.

Esfandyarpour, who claimed in his brief that he was subject of 'character assassination,' said he had been willing as early as spring 2020 to step down as CEO in favor of a commercially focused CEO. Disputes with Foresite, however, complicated management of the company, he said.

Meanwhile in 2020, Oxford Finance, which in December 2019 had extended a $30 million term loan, said GenapSys was in default.

GenapSys wasn't faring much better with potential investors, including well-regarded investment management company Kohlberg Kravis Roberts & Co. (KKR). Governance reforms were critical to any new investment, according to the July filing by the company and the director defendants -- KKR, for example, 'became especially distrustful' of Esfandyarpour.

Both KKR and Farallon would not commit capital to GenapSys if Esfandyarpour were still CEO, according to the company and director defendants' July filing.

'The moat to climb here seems to be Hesaam's credibility, which in part the CEO search should help,' Zollars told the board, according to the July pre-trial brief by company and the director defendants.

The board formed a CEO search committee, and Esfandyarpour appeared supportive of the process, the company and director defendants said in their pre-trial filing. As part of a 'side letter' agreement setting terms for his resignation as CEO, Esfandyarpour said he would not vote any shares to remove or appoint directors, according to the filing.

The contract, the independent directors thought, according to the July pre-trial filing, would 'disarm' Esfandyarpour and allow a public company-ready board to be assembled.

Yet Esfandyarpour 'delayed and sabotaged transition plans,' the company and directors claimed in the pre-trial filing, with the CEO telling search firm Russell Reynolds that he should remain an employee and actively manage the company after the hiring of a new CEO. He demanded that he retain the voting rights of his GenapSys shares, according to the July filing by the company and defendant directors, and asked for additional compensation and other benefits.

Esfandyarpour, in his pre-trial briefing in July in the Chancery Court case, said he had 'super-majority' voting rights.

In November 2020, the independent directors gave Esfandyarpour an ultimatum: He could step down as CEO or they would resign. Moghadam said that while resignation would translate into him losing $15 million -- his entire investment in GenapSys, according to the company and director defendants' July filing -- doing so to cut his connections with Esfandyarpour was 'worth it.'

'Remember, you have two choices,' Moghadam would tell Esfandyarpour, according to the company and director defendants' filing this past July. 'If you want to continue to do this game your way, you have that option. The three of us (independent directors) will not be along, but that's OK.'

The three independent directors -- including Zollars and Fred Nazem, CEO of venture firm Nazem & Co. -- resigned. It's not clear from the court record if they were the only independent directors at that time.

Esfandyarpour's wife, Kosar Parizi -- who was GenapSys' vice president of advanced technology -- appealed to Moghadam via WhatsApp.

'Hesaam is a brilliant technologist and a very hard working entrepreneur,' Moghadam wrote back, according to the July filing by the company and director defendants. 'However, he is a terrible CEO.'

Moghadam did not respond to phone calls or an email seeking comment for this story.

'Dire situation'

By the end of November 2020, an ill Esfandyarpour, according to his pre-trial brief this past July, agreed as part of the 'side letter' deal to resign as CEO, receive $414,000 a year and keep his board seat. Moghadam, Zollars and Nazem returned to the board, according to the company and director defendants' pre-trial brief.

KKR ultimately did not invest in GenapSys, but Farallon did with the February 2021 Series D round. The Farallon investment, Esfandyarpour noted in his pre-trial brief in July, was negotiated by him.

GenapSys, also in February 2021, hired Jason Myers, a veteran of NGS pioneer Ion Torrent and other companies, as its new CEO. By the middle of last year, GenapSys stopped selling its instrument and offered refunds to existing customers, according to former CFO Russell's declaration.

The underlying semiconductor technology performed well, Russell said in his bankruptcy court filing, but there were 'numerous performance issues' with the bench-top sequencer due to 'inherent design flaws,' which he did not specify.

GenapSys needed to redesign its sequencing product to better meet customer requirements, Russell said in his declaration, and the company engaged investment bankers to help look for more money. By late 2021, the company signed a letter of intent with a special purpose acquisition company -- a SPAC or 'blank check' that merges with private companies as a backdoor to going public -- but the deal fell apart, Russell said in the filing.

By early 2022, GenapSys was having trouble raising money due to the overhang of the Foresite litigation. Yet Farallon in March delivered an equity term sheet that included loaning and/or investing money as part of a Chapter 11 filing plus additional cash by other investors, according to Russell's declaration.

Foresite, meanwhile, proposed a settlement of its suit, according to Russell's declaration.

In Esfandyarpour's April suit in the Delaware Court of Chancery, he claimed the 'side letter' deal was revoked and that some members of GenapSys' board were not validly appointed. He assembled a coalition of shareholders in April who removed some directors and appointed new ones, according to his July pre-trial brief.

The company would argue that those consents from other shareholders were invalid because the attempts to remove and appoint directors breached the side letter agreement, but Esfandyarpour won a status quo order pending an early July trial.

The legal holding pattern limited GenapSys management from taking any actions outside the ordinary course of business, Russell wrote in his declaration. GenapSys had no access to restricted cash and couldn'