Daily Voice bankruptcy is a setback for ‘hyperlocal’ news

FORTUNE — Good news! The Daily Voice, a company that produces “hyperlocal” news sites in Connecticut and suburban New York, has filed for Chapter 11 bankruptcy.

OK, that’s not good news at all, but neither are layoffs. And when the company was preparing to announce mass layoffs to its staff last March, Chairman Carll Tucker sent out a memo on a Friday saying: “Monday morning we will share with you the news about where we’re going and how we’re going to get there. The news is good — but you’ll need to sit tight while we finalize our plans.” His sign-off: “I am pumped about the prospect of working with you to build a great company.”

On the following Monday, the staff learned that the company was shutting down its 11 Massachusetts sites and laying off 45 employees without severance. The company now employs just 44 people to run its 41 remaining sites, and that includes salespeople and administrative staff as well as journalists.

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Tucker blames the bankruptcy filing on a lawsuit filed last year by some former reporters who claim they were incorrectly classified as “exempt” from being paid overtime. The company, formerly known as Main Street Connect LLC, “does not have the financial wherewithal” to continue fighting the lawsuit,” and that it is scaring off potential investors, Tucker said in court papers. The company says its legal costs are already at $500,000, and that it is relying on debt to finance operations. Tucker says he has lent the company $250,000 of its $550,000 of secured debt. Its total debt is $867,000, and its assets are worth less than $400,000. Its remaining local sites drew about 437,000 unique visitors in March, for an average of less than 11,000 each.

And yet Newsday reports that Tucker believes the company to be “healthy,” in the paper’s words.

Hyperlocal news just doesn’t make much economic sense. With online ad rates in general small and shrinking, trying to derive revenue from tiny markets might be the worst possible strategy for a Web publisher. As sites like the Huffington Post have shown, ad-supported online news (aside from niche publishing) works only at high volumes. One of the ideas behind hyperlocal was that tiny neighborhoods are sort of a niche, but the ad markets in which they operate aren’t very different than they are for any other general news operation.

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The Columbia Journalism Review‘s Kira Goldenberg, writing about a panel discussion of hyperlocal publishers in January called “Hyperlocal Publishing Models that Work,” defined sites that “work” as being those that “have yet to fail.” None of the publishers on the panel, which included Daily Voice, were earning profits. “In the absence of financial metrics,” she wrote, “‘successful’ in the world of hyperlocal news startups … means growing — both audience and ad base, a continuing challenge for companies that, by design, cover finite domains.”

And yet, The Daily Voice had managed to attract investors like George Soros, Wesley McCain, Saks CEO Steve Sadove, former Bill Blass CEO Haresh Tharani, and columnist (and Tucker’s wife) Jane Bryant Quinn. The company launched in 2010 and has raised $18 million from various investors.

The company plans to continue operations and hopes to exit bankruptcy within 60 days. In the meantime, the litigation will be put on hold, and the company will seek to either sell itself off or undergo a restructuring.

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