A second person claiming to be a cofounder of the generative AI startup Stability AI has taken the company and its CEO Emad Mostaque to court in a lawsuit that contains allegations of fraud and embezzlement.
Cyrus Hodes, an artificial intelligence entrepreneur, filed the lawsuit on Thursday to the U.S. District Court for the Northern District of California. It alleges that he was misled by Mostaque into believing his 15% stake in the business was “worthless” just months before Stability AI’s August 2022 fundraise of more than $100 million at a $1 billion valuation from venture capital firms Coatue and Lightspeed. The company, which is best known for its association with the viral text-to-image generation system Stable Diffusion, has since emerged as one of the leading public faces of the generative AI boom.
In the suit, Hodes says he sold his stake to Mostaque for $100 across two transactions in October 2021 and May 2022. In doing so, he alleges he was “fraudulently cheated” out of equity that within months would have been worth $150 million on an undiluted basis because Mostaque withheld information about active fundraising attempts and a planned business pivot into AI text-to-image generation.
The suit further accuses Mostaque of destroying evidence after being notified by Hodes’ counsel of potential legal action in December 2022. Mostaque wrote in a March 2023 Twitter post that his “WhatsApp got deleted,” which the complaint alleges to have been intentional.
Avi Weitzman, a partner at law firm Paul Hastings who is representing Hodes, described the maneuver as a “shocking swindling” in a statement shared with Forbes. “This was corporate greed at its worst. We look forward to a full airing of Defendants’ wrongdoing in Court,” he wrote.
“The suit is without merit and we will aggressively defend our position,” Sophie Mills, a spokesperson representing Stability AI, shared in a statement.
The lawsuit also claims that Mostaque “embezzled funds” from external investors to pay the rent for his family’s London apartment and his children’s schooling. It cites an unnamed “former investor in one of Mostaque’s businesses” who disclosed to Weitzman that Mostaque “has a pattern of bamboozling investors and misappropriating investor and company assets for personal use.” The suit further alleges that Mostaque himself acknowledged to Hodes in 2021 “that he had improperly used company funds” — obtained from the Trinity Challenge, an organization which provides grants to health-related projects — for personal use.
Forbes previously reported that several Stability AI employees had voiced concerns about tens of thousands of dollars being transferred from Stability AI’s corporate accounts to the personal bank account of Mostaque’s wife Zehra Qureshi, the company’s former head of PR. Motez Bishara, a spokesperson for the company, said at the time the couple had made loans to the business and sums owed to, or by, the couple were settled by the end of 2022.
Hodes was an early collaborator with Mostaque on a business idea of using artificial intelligence to help governmental agencies address the Covid-19 pandemic. He appears alongside Mostaque in a virtual event for the project’s launch on YouTube. But the business failed to take off and was scrapped the following year. “Lots of people promised a lot and they didn’t come through,” Mostaque previously told Forbes. Hodes’ lawsuit alleges that a key reason for the project’s failure was that Mostaque was “secretly diverting” his attention and company resources to Stability’s AI image generation efforts.
The case has similarities to another lawsuit leveled against the startup best known for its association with the viral text-to-image generation system Stable Diffusion. In May, Tayab Waseem claimed that Mostaque reneged on an agreement to grant him a 10% cofounder stake in the company. That suit, which was first reported by Vice, was voluntarily dismissed by Waseem on the same day. (Stability AI previously did not comment on Waseem’s suit.)
Waseem’s complaint also portrays Hodes as a cofounder of Stability. It includes a slide from a company investment pitch deck which states that “Emad [Mostaque] founded stability.ai with Cyrus [Hodes] on the premise that the principles he used as a former hedge fund CIO in emerging markets and technology could be used to solve large problems and create huge value.”
This story has been updated to include a statement from Stability AI.
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