As everyone knows by this morning, Spot Runner–the heavily-funded and once-hyped online-offline advertising agency–is being sued by one of its more prominent investors.

Ad behemoth WPP, which is making a variety of harsh allegations in a lawsuit filed about two weeks ago, is saying it is still not too big to be snookered by the start-up’s top execs and some of its other investors.

WPP (WPPGY), which has been quite active in making digital ad investments over the last several years, is alleging that Spot Runner sold over $54 million in “secondary” shares to line its own pockets without telling WPP much, all while losing money, running out of funding and not building a sustainable business.

The lawsuit essentially paints an ugly picture of Spot Runner as the Bernie Madoff of Web 2.0.

In its strongest phrasing, the lawsuit alleges:

“Rather than working to make Spot Runner a successful and profitable venture, they perpetuated a ‘pump-and dump’ scheme in which they aggressively promoted the Company to new investors (often by promoting that WPP was an investor in and supported of the Company) and then sold new investors large quantities of their own secondary shares at ever-increasing valuations. Such secondary sales were accomplished surreptitiously and without disclosures to Investors required by the controlling Investor agreements or federal and state securities laws.”

Those named in the suit include: Spot Runner CEO and co-founder Nick Grouf, CTO and co-founder David Waxman, venture investors Battery Ventures and Index Ventures, and board members, such as former AOL exec Robert Pittman.

This is obviously a bad turn of events for Spot Runner, which is currently reeling from the advertising downturn too.

Before that, it had gotten over $100 million in funding from a strong slate of investing luminaries.

Investors included international media giants Daily Mail and General Trust and Grupo Televisa, investment company Legg Mason Capital Management (LM) and luxury conglomerate Groupe Arnault/LVMH.

Spot Runner’s previous investors are Allen & Company, Battery Ventures, Comerica Bank (CMA), Lachlan Murdoch, Vivi Nevo, Capital Research and Management, CBS (CBS), Index Ventures, Interpublic Group (IPG), Tudor Investment Corporation and WPP.

All that money had, when times were good, given Spot Runner an eye-popping valuation upward of $500 million.

And that’s the very kind of bubble economics that apparently allowed some at the company to make those lucrative secondary sales the lawsuit alleges, with lots of demand to get in to the latest hot start-up.

To be clear, such sales are not uncommon at tech start-ups in Silicon Valley, often done to allow entrepreneurs to take some money off the table, especially if there is no clear path to liquidation.

But the scope of the sales alleged is quite unusual, with Grouf getting half the proceeds of the transactions, which were made from early 2006 to early 2008.

That said, WPP–which is seeking $11.5 million in damages, as well as legal fees, after investing $10 million–leaves itself open to its own tsk-tsking, since it finally got to participate some in the sales too, dumping $900,000 worth of shares in the last one.

That makes it seem like WPP is just miffed that it did not get enough while the getting was good, which is underscored by the small amount of money being asked for in the lawsuit, in comparison to the large and loud accusations.

Worse still, perhaps, for everyone involved, is the suit’s revelation that Spot Runner was not the revenue geyser it had touted itself as being–which should not come as a huge shock to anyone who has followed any Web 2.0 company in an even cursory way.

Very few, including the star, Facebook, make money, as BoomTown and others have pointed out a lot to little interest.

The lawsuit says the profit-free Spot Runner had $5 million in revenue in 2007 and $9 million in 2008. It alleges too that the company only has $20 million left of its funding and is spending $35 million to $45 million a year.

That’s because Spot Runner was trying to create a new online ad system, which was essentially a do-it-yourself model that tries to iron out inefficiencies in the buying and selling of advertising and bridge the gap between the traditional and online ad markets. It has since changed its strategy and is working on other products, such as a digital-media buying platform called Project Malibu.

Other than Spot Runner’s statement that it would defend itself vigorously, there were mostly no comments all around.

“This situation is unfortunate; we had hoped that we would have had a long relationship with WPP. We believe the claims are without merit and we will vigorously defend against them, including taking all necessary legal action to protect Spot Runner’s reputation,” said a Spot Runner spokeswoman in a statement.

But one source close to the Spot Runner side, while not addressing the specific allegations, noted in an interview with me that what looks bad now did not then:

“These are different times and things look differently.”

You can say that again. And again after that.

As point of that fact, check out a video I did, below, with Grouf last July at Spot Runner offices in Los Angeles, right after it had gotten one of its giant piles of money. (Grouf is pictured here.)

This video took place right after a lot of the transactions that the lawsuit alleges, which makes sense since Spot Runner was the hot start-up at that moment and many would have been trying to get into the action.

I met Grouf many years ago when he–along with Waxman–founded PeoplePC and Firefly Networks.

Grouf sold the struggling PeoplePC–which hawked computers bundled with an online service–to Earthlink (ELNK) in 2002 for $10 million and assumption of $35 million in liabilities, in a Web 1.0 meltdown deal that followed a disastrous IPO.

But with a hot new start-up, everything looked pretty again, perhaps too pretty, for Grouf.

As I wrote at the time about the hype, which including rumors of Spot Runner being sold for big bucks to Google (GOOG) or Microsoft (MSFT):

“This is its biggest burden, I think, setting expectations very high for what is still a little start-up…Who knows whether the company will be able to overcome its hype, but time (and money) will tell.”

Obviously, we can tell a lot more now.

Here’s the Grouf video (the full lawsuit text and a memo Spot Runner sent to employees about it are also below):

Here is the full lawsuit (click on + button to zoom in):

And, finally, here is the letter Spot Runner sent to employees, who have suffered from layoffs, about the lawsuit:

Team,

As you may have heard, WPP, a minority shareholder (less than 3%) in Spot Runner since 2006, filed a lawsuit against the company and its board members primarily related to the sale of Spot Runner stock and Spot Runner’s communications with WPP. This situation is unfortunate, as we appreciate and value the relationships we have with all of our investors and we had hoped for a long and supportive relationship with WPP. We believe these claims are without merit and we will vigorously defend against them, including taking all necessary legal action to protect Spot Runner’s reputation.

We feel strongly that WPP’s complaint contains many baseless accusations and we want to give you a broader perspective on the matter. This lawsuit is unrelated to our products and services–it is centered on legal agreements entered into with WPP, a sophisticated investor, regarding the way that shareholder stock sales were handled. WPP alleges that Spot Runner’s board members failed to disclose to WPP the stock sales by shareholders, allegedly in violation of the board’s obligations to stockholders, among other things.

We are confident that Spot Runner complied with all of its obligations under the various shareholder agreements. When these sales occurred, there was overwhelming demand for Spot Runner stock and the company did not want to dilute existing shareholders by issuing new shares. Therefore, the founders (in 2006) and the board members and other preferred shareholders (in 2007 and early 2008) agreed to make room for important, new investors and respond to their desire to invest in Spot Runner by selling their own shares. In 2007 and 2008, WPP and other preferred shareholders were given notice that the sales were occurring and they had the opportunity to participate in the sales. In fact, WPP signed various documents acknowledging this opportunity.

Spot Runner and all of its employees conduct business with the utmost integrity. Our team, technologies, and products and services are core assets of which we can all be proud. It is because of your hard work that we have come this far. To that end, we continue to drive hard toward successfully launching Project Malibu and realizing its full potential. You also should know that our board members remain majority shareholders in Spot Runner–a concrete sign of their commitment to and confidence in the business.

Our outside counsel will work with the board and management team to develop a formal reply, which ultimately will be filed with the court. These legal proceedings should not affect our day-to-day operations.

We are grateful that we can count on you to remain focused on serving our clients and partners to the best of your abilities.

Thank you again for all that you do for Spot Runner.

On one of my many trips to Los Angeles (what can I say? I like to hang where LoRo* hangs), I dropped in to see Nick Grouf of Spot Runner.

As many might know, Spot Runner is an online-offline ad agency play that has gotten big funding and even bigger hype of late.

We’ll see how that goes. But Spot Runner actually seems to be tackling an underserved (and unexciting) market of local and national clients in need of cheap online ad solutions married to more traditional marketing venues to boost revenue.

Here’s my video interview with Grouf at Spot Runner’s offices on Wilshire Boulevard:

I met Grouf many years ago when he–along with Spot Runner partner David Waxman–founded PeoplePC and Firefly Networks.

Grouf sold the struggling PeoplePC–which hawked computers bundled with an online service–to Earthlink (ELNK) in 2002 for $10 million and assumption of $35 million in liabilities, in a Web 1.0 meltdown deal that followed a disastrous IPO.

He then started working for the Presidential campaign of Sen. John Kerry, helping figure out how to best and most cheaply place critical television ads–crunching all sorts of data about lots and lots of neighborhoods and towns and cities nationwide to figure it out.

What Grouf figured out, though, was that a system for doing so was nonexistent.

That experience turned into Spot Runner, which is essentially a do-it-yourself model that tries to iron out inefficiencies in the buying and selling of advertising and bridge the gap between the traditional and online ad markets.

Offering cheap ad templates, clients can make and place low-cost television and radio ads for small and national businesses, as well as political campaigns, and get analytics about the impact of the ads. Some ads cost as low as $500.

Spot Runner got a pile of cash to try to do that better, recently nabbing $51 million in funding to add to the $60 million already raised.

Investors include international media giants Daily Mail and General Trust (DMGT.L) and Grupo Televisa (TV), investment company Legg Mason Capital Management (LM) and luxury conglomerate Groupe Arnault/LVMH (MC.PA).

Spot Runner’s previous investors are Allen & Company, Battery Ventures, Comerica Bank (CMA), Lachlan Murdoch, Vivi Nevo, Capital Research and Management, CBS (CBS), Index Ventures, Interpublic Group (IPG), Tudor Investment Corporation and WPP.

Its board includes Index’s Danny Rimer and former AOL exec Bob Pittman.

All that money has given Spot Runner an eye-popping valuation upwards of $500 million.

This is its biggest burden, I think, setting expectations very high for what is still a little start-up.

And while there are rumors of both Microsoft and Google, as well as Comcast, being interested in acquiring the company, Grouf dismisses the speculation.

He says Spot Runner is more intent on using the money raised to buy companies and improve its offerings.

For example, it recently bought Weblistic, a local search listings creator, and hired former Microsoft exec Joanne Bradford.

Bradford, who was a VP and chief media officer of MSN Media Network, is executive vice president of National Marketing Services at Spot Runner, focusing on getting national advertisers to also think small and targeted.

Who knows whether the company will be able to overcome its hype, but time (and money) will tell.

(*And a free D6 bag for anyone who correctly identifies who I am referring to here, either by sending in a comment or an email to me at kara@allthingsd.com.)

A source close to Yahoo’s thinking emailed and declared that BoomTown was misinformed and ignorant of the insider mechanics of the high-level corporate wrangling when I suggested in a post earlier today that the settlement between Yahoo and Carl Icahn was perhaps not the time to break out the bubbly.

You know, because Yahoo’s (YHOO) stock is still moribund, morale is still low, Microsoft (MSFT) is still looming and the economy is still tanking.

Other than that, Yahoo sources wanted to let me know the Icahn truce was a win.

And that is absolutely true, technically speaking.

One source told me, for example, that Icahn was going to go to a short slate (four of nine), and once he went to a short slate, it was highly possible that shareholders would have put on a few members of his choice anyway.

In other words, if I can manage the onerous math involved: Three or four of nine board seats Icahn might have gotten if the proxy fight went forward would have been a lot worse than three of 11 seats that the activist investor actually got in the deal.

Plus, added another source, Yahoo has consent over two of Icahn’s board choices, one of which will likely be former AOL (TWX) head Jon Miller, an experienced Web exec who is favorably looked upon by Yahoo CEO Jerry Yang.

Yahoo certainly had the wind at its back after Legg Mason Capital Management’s (LM) Blll Miller said he was backing current management last week, so Icahn probably blinked and took a bird in the hand now.

As to Yahoo, cashing in now rather than gambling makes sense. I see exactly why the company made this move–it ensured a certain outcome, as annoying as it doubtlessly is to have to seat Icahn at Yahoo’s board table.

(Also, who gets to sit next to him? I vote for the always jovial Eric Hippeau!)

So, cashing in now and avoiding a fight makes sense for both sides, I hereby admit.

Except, well, that the man that Yahoo quite correctly was characterizing as a technology nincompoop just days ago will be sitting on its board.

Icahn is still not qualified to be on the board and will also probably be an unhelpful, disruptive influence.

In addition, while three out of 11 is better than three or four out of nine, Yahoo might have done better in the proxy fight.

More importantly, in fighting, Yahoo leadership would have shown it was resisting the snake oil solutions that Icahn has been peddling, which essentially boils down to selling all or part of Yahoo off to Microsoft so that Icahn can get back his underwater investment.

Doing a deal with Microsoft might be a good idea, actually, but Yahoo has not been able to make a truly rational decision about what its focus should be, due to all the noise and pressure and, yes, the press scrutiny, of every one of its moves.

Now with Icahn, who can be very persuasive, incessantly poking away from within, I think he will probably not let up and definitely not be the kind of influence Yahoo needs.

Given my math-impaired mind, I could be wrong, of course.

With fewer seats going to its nemesis, Yahoo is right when it says that Icahn, who was inevitable, will not be as much of a drag as he could have been. Unfortunately, he will still be a drag, however.

Could the new and improved Yahoo CEO Jerry Yang actually manage to beat back the proxy fight being waged against him by activist investor Carl Icahn?

It increasingly looks that way, with only 12 days to go until Yahoo’s annual meeting on Aug. 1.

But exactly which Yang will be running Yahoo (YHOO), if he does win, is probably the most important question shareholders need to ask.

Will it be the seemingly energetic Yang of the past two weeks, invigorated by the battle with Icahn and his new best friend and Yahoo foe, Microsoft (MSFT)?

Or will it be the other Yang?

Because for months and months now, since Microsoft waged its takeover bid on the Internet company he founded, the woe-is-me vibe emanating from Yang has been working the last nerve of anyone paying attention to the proceedings.

Given that this vibe was combined with a kind of cave dweller PR strategy of not speaking publicly–other than releasing an indignant, noncapitalized letter every now and then about the situation–some questioned Yang’s ability to gin up the kind of passion needed to bring Yahoo back from its current straits.

Even before the Microsoft parry in February, the ho-hum mood had trickled down to the troops, causing lower morale, too many departures and a general feeling–deserved or not–that Yahoo has been circling the drain for much too long under its current lackluster leadership.

And, let us not forget the drippy stock performance either.

And while BoomTown, especially, has to give both Yang and also Yahoo President Sue Decker much credit for appearing onstage at our sixth D: All Things Digital conference in May, most who saw the appearance (we posted the whole thing last week, starting here) were not blown away by the performance, considering it too enervated.

What then, do we make of the current round of pugnacious, dare-we-say, passionate, and, as it seems, pretty effective moves Yang has made this week to ward off the attacks of Icahn and Microsoft?

I should have gotten clued-in to the shift when Yang actually made contact with me on July 9, after being out-of-touch for many, many moons, presumably due to pique over my 100-day Sacred Cow Countdown (he started it!).

As it happened, I was in Seattle visiting a lot of Pacific Northwest companies, including Microsoft, when he called.

After our discussion, I published these choice quotes from Yang in a post on July 10, titled “Jerry Yang’s Pledge: Not on My Watch”:

“I think handing over the company to Carl Icahn for the express purpose of hoping he can negotiate a complex deal with Microsoft is a big mistake for shareholders. This is particularly true since Icahn has no plan B and therefore will have no leverage and will be dealing with Microsoft from a position of weakness.

“Furthermore, Microsoft’s interest in Yahoo has been inconsistent at best and they refuse to even put a firm proposal on the table. Their motivations are suspect and there is simply no good reason to think they will actually show up at the end of the day. And then what will shareholders be left with? A weakened, Icahn-controlled Yahoo.”

Then Yang went into overdrive over that next weekend as Yahoo managed to make a new Microsoft search proposal–which was really very, very generous–look radioactive by loudly declaring that Icahn’s taking over of Yahoo was crazy-glued to the plan.

It was not, but no amount of Microsoft spinning could undo the damage of what looked like a goofy power play by Icahn and Microsoft.

That was followed at the end of last week by the news that Yahoo had convinced one big investor, Bill Miller of Legg Mason Capital Management (who has always been a supporter of Yang and especially, Decker), to back the current board.

Legg Mason owns about 4.4 percent of Yahoo.

While not saying it was final, Miller noted that it was his intention to stick with Yahoo’s leadership, adding that he also wanted Yahoo and Icahn to settle their differences before the annual meeting.

Of course, Miller still tried to get Microsoft back to the table, noting, “If Microsoft wants to acquire Yahoo, it can make the terms and conditions of its offer public.”

One can hope, Bill! (Actually, as I have written many times, Microsoft should make that move if it really intends to compete against Google.)

But, best of all, was Yahoo sticking a big fat banner on its much-trafficked home page Friday, alerting its users–most of whom were really just minding their own business and trying to get their daily horoscopes.

Nonetheless, in a box that flashed various outrages about the proxy fight, Yahoo linked to a presentation that pretty much called Icahn a Luddite. It included a quote attributed to him from The Wall Street Journal: “It’s hard to understand these technology companies.”

You can say that again, Carl!

And Yang did say it again in video message to Yahoo employees, noting, “We’re taking full advantage of the power of our network to remind our stockholders why voting for Carl Icahn’s board of directors is a bad choice.”

Ah, there is nothing like a technically clueless billionaire as an enemy to get Yang’s blood boiling!

Apparently, that has helped employee morale too. This weekend, I have heard from several execs contemplating leaving, tired of waiting for the 12th shoe to drop, who noted that more passion from Yang was helping.

“People feel like he is showing some strength, which you never see,” said one. “It sounds corny, but we want someone we believe in.”

Well, we’ll see if institutional investors believe, after they get a recommendation midweek from the large proxy-advisory service ISS Governance Services, which Yang and other Yahoo execs and board members visited last week to make their case.

That will come one day after Yahoo releases its second-quarter earnings on Tuesday, which I am sure will be decent, as they just have to be, considering the hubbub around Yahoo.

(And you can be sure Yahoo CFO Blake Jorgensen is working overtime this weekend, adding in all he can to make the picture as pretty as possible.)

It’ll be a big week for Yahoo, as usual, made bigger if Icahn does not mount an effective offense, such as releasing a cogent plan of his own and showing he has some managers in the wings who can run Yahoo if he were to get the reins.

Which Yang is not showing any signs of giving up anytime soon.

I fully expect Yang to get even more hopped up this week with more speeches to employees, more visits to shareholders and perhaps even more calls to the press. (BoomTown is waiting by the phone!)

Of course, this is all just show. And while it’s a good one, as I said, the most important thing everyone has to keep in mind is what this all means after Aug. 1.

So I have some questions for Yang:

Does he have the energy and vision and, most important, management chops, to really move the needle at Yahoo and make the kinds of changes it needs?

And what are those changes? More of the same direction (more social, more open) or perhaps a much more radical focus on core businesses like content and communications?

And what about search, a losing game as Yahoo inevitably will be crushed between Google (GOOG) and Microsoft? And what about fending off that pair’s new focus on display advertising, where Yahoo does excel?

Will Yang, if he does not think he has what it takes, be willing to step aside? And does that mean Decker will become CEO, or will he bring in new outside execs who have not been part of the problems of the past?

I could go on and on, of course, but it pretty much boils down to one key question:

Is the Yang who acts like he can win really here to stay?

Apparently, Legg Mason (LM) also finds the latest Microsoft-Icahn agenda profoundly unappealing. Still, the investment firm said it remains willing to consider a sale to Microsoft (MSFT), given the right conditions. “If Microsoft wants to acquire Yahoo, it can make the terms and conditions of its offer public,” Miller added. “If Yahoo shareholders support it, I am confident the board of Yahoo will accept it.”

Legg Mason’s vote is an important endorsement for the increasingly desperate Yahoo (YHOO), which today added a massive anti-Icahn button to its homepage in an effort to court shareholder sympathy. Click on it and you’re taken to a vicious critique of Icahn and his intentions for Yahoo that ironically begins with the investor’s own words: “It’s hard to understand these technology companies.” Yahoo then offers proof of that apparent lack of understanding with a helpful chart. Pulled from the company’s 34-page SEC filing today, it shows share prices of 12 of the 15 public companies in which Icahn has involved himself lately in apparent decline.

Apparently, Legg Mason (LM) also finds the latest Microsoft-Icahn agenda profoundly unappealing. Still, the investment firm said it remains willing to consider a sale to Microsoft (MSFT), given the right conditions. “If Microsoft wants to acquire Yahoo, it can make the terms and conditions of its offer public,” Miller added. “If Yahoo shareholders support it, I am confident the board of Yahoo will accept it.”

Legg Mason’s vote is an important endorsement for the increasingly desperate Yahoo (YHOO), which today added a massive anti-Icahn button to its homepage in an effort to court shareholder sympathy. Click on it and you’re taken to a vicious critique of Icahn and his intentions for Yahoo that ironically begins with the investor’s own words: “It’s hard to understand these technology companies.” Yahoo then offers proof of that apparent lack of understanding with a helpful chart. Pulled from the company’s 34-page SEC filing today, it shows share prices of 12 of the 15 public companies in which Icahn has involved himself lately in apparent decline.

Spot Runner, the online ad agency, delivered yet another Web 2.0 miracle today, raising another $51 million in funding from a diverse group of investors.

Among other services, Spot Runner makes and places low-cost television and radio ads for small businesses and is trying to bridge the gap between the traditional and online ad market.

In this round, those stepping up to invest in the Los Angeles-based start-up include international media giants Daily Mail and General Trust (DMGT.L) and Grupo Televisa (TV), investment company Legg Mason Capital Management (LM) and, curiously, luxury conglomerate Groupe Arnault/LVMH (MC.PA).

This group, along with existing investors, forked over the $51 million to add to the $60 million already raised. This appears to give it a massive valuation of upward of $500 million.

Well, at least in the land of Web 2.0 it does. In the real world, it still remains to be seen. But that has not stopped the nonstop investment party of late for Web 2.0 start-ups.

Web-based instant messaging company Meebo recently raised another $25 million at a reported $250 million valuation, while widgeteer Slide got $50 million for a $550 million valuation.

Of course, the champ of them all has been the social-networking site Facebook, which now has a $15 billion valuation.

Wheeeeeeeeeeeeeee! Or maybe not so much, but obviously no one in Silicon Valley is listening to BoomTown at this Kool-Aid carnival.

Spot Runner’s previous investors are: Allen & Company, Battery Ventures, Comerica Bank (CMA), Lachlan Murdoch, Vivi Nevo, Capital Research and Management, CBS (CBS), Index Ventures, Interpublic Group, Tudor Investment Corporation and WPP.

So far, this group has invested $60 million in Spot Runner. Its board includes Index’s Danny Rimer and former AOL exec Bob Pittman.

“We want to use the investment to make a real penetration in the market,” said Nick Grouf, chairman and CEO of Spot Runner. “We want to expand both organically and through acquisitions, as well as expand our staff, and these strategic investors will help us do that.”

Spot Runner has already been doing that. For example, it recently bought Weblistic, a local search listings creator, and hired former Microsoft exec Joanne Bradford.

The Daily Mail is a large media company based in the United Kingdom, with newspapers, online and radio assets, while Grupo Televisa is one of the largest media conglomerates in the Spanish-speaking world.

Groupe Arnault/LVMH owns some of the world’s toniest brands, including Moët & Chandon, Hennessy, Louis Vuitton and Givenchy.

Grouf, again along with partner David Waxman, also previously founded PeoplePC and Firefly Networks.

In the spirit of the funding, here’s one of my favorite Kool-Aid commercials: