Cyrus Hodes, one of the cofounders of AI scaleup Stability AI, has filed a lawsuit against the company and Emad Mostaque, its CEO — and his fellow cofounder — claiming that his stake in the company was “fraudulently purchased” for well below market value.
The lawsuit has been filed in the northern district of California.
Hodes, who stopped working at Stability in late 2021, claims that between 2021 and 2022 Mostaque purchased his entire 15% stake in the company for $100, “having led Hodes to believe that the company he had helped build was essentially worthless”, according to the lawsuit.
Five months after the sale of Hodes’s stake, Stability AI raised $101m at a post-money valuation of $1bn. In March this year, Bloomberg reported that Mostaque was looking to raise another round at a valuation of $4bn.
The lawsuit alleges that, based on current valuations, the value of the shares sold by Hodes “would have a market value of over half a billion dollars (on an undiluted basis)”.
It claims that the purchase of Hodes’s shares for $100 “epitomises corporate greed at its worst and simply shocks the conscience”. Hodes is asking for the sale of his shares to be rescinded and his ownership of Stability AI to be restored.
'Fraud and misrepresentation'
The lawsuit alleges that Hodes was “led to believe that the company had no real value” owing to the company's failed attempt to build an AI model to help inform a public health response to COVID-19.
It claims that Mostaque was “secretly diverting [his own] attention and, on information and belief, company resources, to a different project that he failed to disclose to Hodes” — a text-to-image generation model.
The lawsuit says that in August 2022, three months after purchasing Hodes’s 15% stake, Mostaque and Stability AI released the open-source model Stable Diffusion. Hodes stopped working at the company in autumn 2021.
It alleges that Mostaque “brazenly deceived Hodes about the core business of Stability AI that Mostaque was developing, its likely valuation, and its fundraising”. The lawsuit claims that, in May 2022, at the “precise time that Mostaque purchased the final block of Hodes’s shares”, Stability and its CEO were “secretly negotiating with venture capital firms looking to invest in Stability AI at a $1bn post-money valuation”.
Getting personal
The lawsuit makes a number of claims against the CEO himself.
It alleges that “Mostaque had embezzled funds from Stability AI to pay the rent for his family’s lavish London apartment” and that Hodes learned that he “had a long history of cheating investors in prior ventures in which he was involved”.
Sifted reached out to Stability AI and Mostaque for comment. A company spokesperson said: “The suit is without merit and we will aggressively defend our position.”
Hodes’s legal action represents the second lawsuit against Stability and Mostaque. On May 23, 2023, Tayab Waseem, who claims to have served as the company’s chief scientific officer from July 2020 to July 2021, filed a lawsuit claiming that the company had promised him shares, then cut him out by saying he had worked as an “unpaid intern”.
Waseem withdrew the suit later the same day; at the time, Stability did not respond to the publication Motherboard’s request for comment.
Embattled Stability
The new lawsuit represents the latest in a string of controversies surrounding Stability AI, tarnishing the reputation of a company once viewed as one of Europe's most promising generative AI startups.
Leaked company messages and pitch decks seen by Sifted in April suggest that the company may have also overstated its capabilities while raising tens of millions of dollars of external capital. A recent report from Forbes alleged that Stability failed to pay staff and taxes on time.
Bloomberg recently reported that Stability raised a convertible note after struggling to raise fresh capital at a $4bn valuation.
The company denied both reports.