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Why Lawsuits Are On the Rise at Startups and What To Do About It

13.05.2015

Lawsuits. I’m so tired of the nature of the legal system in the United States where bullying, intimidation and mobster-like shake-downs are becoming prevalent. As I write these words I already imagine my next deposition in which I’m asked to read this out loud.

Lawsuits are becoming so prevalent these days. Even when I’m not the one being sued I find myself being dragged into deposition after deposition and my blog (along with all my emails) are being served as evidence. So I look forward to reading this to opposing counsel at the next deposition where I can tell them that I’m not afraid of appearing in court and I’m not intimidated into frivolous claims in search of shake-down money.

Watch the Video

I often speak about co-founder fighting and how this ends in lawsuits but this has become much more prevalent. I’d encourage you to watch this quick 3-minute video with some views on what I call “The Co-Founder Mythology” that is perpetuated in Silicon Valley. The simple point is that if you control 51% of your company and/or the voting rights you can avoid a lot of headache and you can still be very generous with early people who join your mission.

Lawsuits are on the rise. Much money is at stake and founders have been conditioned that suing is ok.

I angel funded a company 5 years ago. They won two big national contracts. The vendor who previously serviced those accounts sued them. For what? It is still not clear to me but the company had only raised < $2 million and after more than a year fighting against a larger company and after many hundreds of thousands of dollars they finally settled out of court. Why? Because no VCs would fund them with a pending lawsuit of this nature.

I funded a company where the CEO stepped down. He signed a release and remained on the board. He regretted the decision and sued the company and the board – it’s still not totally clear to me what he was suing about. But he signed a release when he left the company in exchange for compensation. He sued anyways. After > 18 months and > $2 million a judge summarily dismissed his claims.

I funded a US company that bought a URL and a brand name and filed for a trademark. They were then sued for trademark infringement by a foreign company who had no product, no customers and no employees in the US. They tried to claim that the company was infringing. It was a pure shake down. After hundreds of thousands in legal fees and after hours of depositions the founder settled to put it behind him.

I am in the process of another frivolous lawsuit now. I’m not being sued but the company is. A former founder of the company was terminated for lack of performance. He had a stock option vesting program and had vested a significant amount of his stock but not all. He’s suing the company to get all of his stock options even though he signed a vesting agreement. There is no basis for this claim but hundreds of thousands and countless hours later we’re still stuck in the legal system.

What do each of these cases have in common? There is not a single case I’ve been involved with in any of the startups I’ve backed that has even a small bit of merit. I’ve seen situations with gray areas and when that exists I always encourage founders not to be bitter but to rationally consider whether a small, early settlement makes sense.

So why exactly have lawsuits (anecdotally) picked up so much in the past 5 years? This is only an educated hypothesis but I’ll bet it’s pretty close to grounded in reality: Everybody saw “The Social Network” and everybody has a belief that suing will net them millions whether they’re in the right or the wrong. We’re back in a frothy market where in stead of being considered that they might be spending tons of money winning shares a company that one day could be worthless (like the stock of many startup companies) – they always believe they’re fighting for millions.

Lawsuits are particularly common amongst co-founders. Why? Because even in 2015 I still see people riffing on ideas and working on business plans, product flows or coding on projects without first forming a company, signing contracts that assign intellectual property to that company and trusting that “friends” would never sue you. When it involves real or perceived large sums of money, friends sue. This also happens out of “startup weekends” where it’s unclear who contributed to the IP and where many people don’t continue with the idea beyond the first 30 days.

When it involves large sums of money friends conflate “I gave you key ideas” into “I helped make you successful” when in reality success is almost always the result of years and years of hard work, tough decisions, execution, hiring, marketing, fund raising and the countless other actions that lead to business success. Most ideas are fungible. If you think Facebook, WhatsApp, Google Search, AirBNB, etc are totally “novel” ideas you’re kidding yourself. They were just done 10x better than similar ideas that existed and the hard work is what should be rewarded.

I started writing about problems when founding a startup years ago but the problem has gotten worse. I’ve been warning about co-founder problems and what I call “The co-founder mythology” for years but the fights are getting more venomous.

I would like to just offer some very simple advice:

1. If you want to start a company create a legal entity – it’s dirt cheap
2. Make it clear in writing that anybody you speak to about the idea does not constitute their contributing to your IP and if they do any work for you please make sure you sign a legal agreement assigning the IP to you
3. Be formal with every employee contract – even with friends.
4. Make sure you have standard vesting – even before your raise capital. At least one year cliff and 4-year vesting. No acceleration. Everybody signs – even you. No “special deals.”
5. Where possible avoid 50-50 ownership. It leads to more problems than I care to say. Nobody talks about this publicly because the fights are too personal so people don’t blog about them. It is insanely common.
6. Be very careful with everything you write in an email or send in a text message. These will be read out loud in a court of law and will be used out of context if needed. Humor is tone deaf in court. I was forced to explain why I say “I switched to the Dark Side” (referring to VC) on my blog. I was continually asked whether I was evil in a serious tone. It’s not crazy to use services like Confide or Cyberdust that delete your messages after you send them.
7. Follow HR protocols. This is something many young founders err on because often they have never worked in a “real” company. If you think you may have to terminate employees always have legal advice. Where possible sign releases in exchange for your providing more benefits or compensation than the law stipulates. Never be mean or bitter for outgoing employees – it never pays.
8. It *should* go without saying but I’m going to say it anyways. Be aware of gender bias or discrimination and don’t do it. If people bring this up take it seriously. Same goes for issues involving race, sexual orientation, disabilities or age. Know the law and practice it. Do not tolerate employees who do not.
9. Where possible avoid lawsuits. Again, I know that sounds obvious. But most lawsuits end up settling and often after an insane amount of money spent on lawyers and time wasted and unfocused. People settle out of attrition when they realize how long and painful our legal system is and how much money it costs.

The post Why Lawsuits Are On the Rise at Startups and What To Do About Itappeared first on Bothsides of the Table.

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