Lawyers and Clients
oil on canvas, circa 1970
Lawyers and Clients
oil on canvas, circa 1970
How is this for an understatement?
Subscribers aren't keen on reading through the fine print at the bottom, and they'll feel betrayed if they click through to your site only to learn that the special offer isn't valid on what they want to buy. (from Exceptions* Apply: Keeping Your Legal Text Quick and Cool, an article in Email Insider).
Actually it is a pretty good article which makes a number of common sense points about legal disclaimers in various special offers.
But the point that it really makes, although the article does not say it, is that you need quantity of disclosure (that is all the right disclosures) and quality of disclosure (that is the disclosure has to be user friendly). Quality of disclosure is really important because it generates confidence in, and comfort with, the site.
I have written about this sort of thing before. In my post, More on Privacy and Flash Cookies, I noted that one of the claims in the law suit against Specific Media was that their disclosures are opaque. Here is what the article I was discussing actually says, “The company's "privacy documents require college-level reading skills for comprehension and include substantial legalese, ambiguous and obfuscated language designed to confuse, disenfranchise, and mislead the users," the lawsuit asserts. “
This sort of obfuscation goes a long way to creating that creepy feeling of being used and undermining confidence in the system.
As many people have pointed out, if you want a “free” internet, providers of content have to be able to make money somehow, and (as in broadcast TV) advertising is the easy answer. The more people participate in the system and the better information advertisers have about the participants, the more value there is in the system and the more robust a set of “free” offerings the system will support.
That does not mean turning big brother loose and creeping everybody out. To the contrary, it argues for a clear set of well articulated and well understood standards that give users confidence in the sites they visit.
One of the big positives about working at a large firm is access to legal experts in disciplines that interrelate with key issues that our start-up clients face. I was rehashing some conversations I recently had with founders and start-ups on employment issues and wanted to highlight some issues of which start-ups should be aware. In my research, I unearthed this gem of an ebook that succinctly lays out the “Five Common Employment Law Hazards for Start-ups” by one of our resident employment law experts – Mike Rosen. Download the ebook ( 5 Employment Law Hazards for Start-ups__eBook_info.pdf)
Mike is right when he says that faced with “limited personnel and monetary resources… many emerging companies employ a band-aid approach to HR-related issues”. With that in mind, he sets out the areas where employment related disputes for venture-backed start-ups most consistently arise. Keep reading for a synopsis of the 5 major areas where venture-backed start-ups stumble and expose themselves to disputes as they relate to employment law...
I finally saw Social Network. Don't know why I avoided it for so long, but I did. Holding aside the bashing of Mark Zuckerberg (and the tech community in general - including its attitude towards women), which I don't want to comment on (I am sure others have done a better job than I could), it seems to me that the plot was really driven by poor or, more exactly, nonexistent legal work. It turns out that this movie is a great case study of some of the things we are always counseling entrepreneurs on. I want to be clear that I don't have a view as to how realistic (or unrealistic) the movie was. First, agreements among founders. The notion that the agreement between Mark and Eduardo amounted to a conversation to the effect that I get 60% and you get 30% is flabbergasting. I have written too much about founders and vesting to repeat it all here. But, I routinely counsel founders to have some agreement in writing around who owns what and what happens when the founders come to a parting of the ways. In this context, I discuss vesting and its importance. For example, I often say something like, "What happens when one of you is not pulling his weight? Or takes a job with some big company? Will he or she still own the same amount as you are now contemplating." Not everyone ends up deciding to use vesting among founders, but my clients have at least considered it. If even modest legal work had been done at the front end, the whole law suit with Eduardo would have been avoided. Note that Eduardo ended up with about 5% of the company. I don't know whether anyone thinks that was fair or not, but if there had been some sort of arrangement around vesting the deal would have been negotiated and agreed to. There might not have been a need for the sleazy dilution move. Well, with respect to the sleazy dilution move, the notion that a reputable attorney would put a bunch of documents in front of someone who is not his client (and to all appearances is unrepresented and unsophisticated) and does not give a stern warning that this person needs to seek his own counsel, seems over the top to me. On the one hand, there is no doubt but that it moves the plot along nicely. On the other hand, if the warning had been given and the advice taken, who knows where the story would have gone. It probably would have avoided the suit and ended in a fair place Ð or at least a place agreed upon by the parties not decided by a battle. Speaking of not seeking legal help, the beefcake twins top the charts. If they had intellectual property, they did nothing to protect it. When you hire someone to write code for you, you want to own the code -- thus an agreement that expressly makes the intellectual property a "work for hire." BTW, Mark could have entered into an agreement to write the code and still use it for his own purposes. While it seems clear that the twins has some idea that was like Facebook, it is not at all clear that their idea was not a very limited directory for Harvard College students. Anyway, all these problems worked out in the end because the massive juggernaut of Facebook overwhelmed them. As the lawyer said in the end, this is a traffic ticket. Having said that, not a lot of ventures have so much to divvy up that they can survive this sort of thing. A lesser business would have been sunk for want of competent legal work.
I finally saw Social Network. Don't know why I avoided it for so long, but I did. Holding aside the bashing of Mark Zuckerberg (and the tech community in general - including its attitude towards women), which I don't want to comment on (I am sure others have done a better job than I could), it seems to me that the plot was really driven by poor or, more exactly, nonexistent legal work. It turns out that this movie is a great case study of some of the things we are always counseling entrepreneurs on. I want to be clear that I don't have a view as to how realistic (or unrealistic) the movie was.
First, agreements among founders. The notion that the agreement between Mark and Eduardo amounted to a conversation to the effect that I get 60% and you get 30% is flabbergasting. I have written too much about founders and vesting to repeat it all here. But, I routinely counsel founders to have some agreement in writing around who owns what and what happens when the founders come to a parting of the ways. In this context, I discuss vesting and its importance. For example, I often say something like, "What happens when one of you is not pulling his weight? Or takes a job with some big company? Will he or she still own the same amount as you are now contemplating."
Not everyone ends up deciding to use vesting among founders, but my clients have at least considered it. If even modest legal work had been done at the front end, the whole law suit with Eduardo would have been avoided. Note that Eduardo ended up with about 5% of the company. I don't know whether anyone thinks that was fair or not, but if there had been some sort of arrangement around vesting the deal would have been negotiated and agreed to. There might not have been a need for the sleazy dilution move.
Well, with respect to the sleazy dilution move, the notion that a reputable attorney would put a bunch of documents in front of someone who is not his client (and to all appearances is unrepresented and unsophisticated) and does not give a stern warning that this person needs to seek his own counsel, seems over the top to me. On the one hand, there is no doubt but that it moves the plot along nicely. On the other hand, if the warning had been given and the advice taken, who knows where the story would have gone. It probably would have avoided the suit and ended in a fair place Ð or at least a place agreed upon by the parties not decided by a battle.
Speaking of not seeking legal help, the beefcake twins top the charts. If they had intellectual property, they did nothing to protect it. When you hire someone to write code for you, you want to own the code -- thus an agreement that expressly makes the intellectual property a "work for hire." BTW, Mark could have entered into an agreement to write the code and still use it for his own purposes. While it seems clear that the twins has some idea that was like Facebook, it is not at all clear that their idea was not a very limited directory for Harvard College students.
Anyway, all these problems worked out in the end because the massive juggernaut of Facebook overwhelmed them. As the lawyer said in the end, this is a traffic ticket. Having said that, not a lot of ventures have so much to divvy up that they can survive this sort of thing. A lesser business would have been sunk for want of competent legal work.
Graham Brooks of .406 Ventures might have been quoting someone last night at North Eastern's EntreTech forum event hosted at the EEC when he said “Being an entrepreneur is like jumping off a cliff without anything, but hoping that you can pull together a parachute before you hit the ground”. He’s not so far off, but it really struck home as a wonderful way to start this blog about knowing when to leap. I don’t have the answers, heaven knows I was not ready when I jumped into my start-up late in my undergraduate days, but in my current role as lawyer and advisor to start-ups it’s important that I can at least help my clients know that they have the tools and the fabric to put a parachute together before they jump. If they build a para-glider, a parachute or end up with a lump of plummeting fabric is any ones guess. So what am I blabbing about? An issue that many entrepreneurs have to deal with – When do I leave my steady job to devote full time to my start-up.
The biggest common denominator in dealing with successful start-ups is still luck. Luck as I define it is being in the right place at the right time (so be prepared to be in a lot of wrong places, before the right time comes along). You want to at least stack the odds in your favor. Technology start-up entrepreneurs are usually smart, and have technical skills to boot which makes them very employable. So it doesn’t come as a surprise that many start-up entrepreneurs have regular jobs working days, before coming home to work several additional hours on their concept or idea while still dealing with all the other aspects of life like family and friends, chores and errands. They usually have some kind of team in place and some of them have gone far enough to create a corporate entity and have taken care of the usual start-up documents and legal strategy that I recommend. However, the question still looms – When can I give my two-week’s notice? When can I spend days and weeks working on this idea, rather than cobbling together a few hours after work and spending weekends making incremental steps?
I have not written about options in a while, but a post by Fred Wilson has led me to want to make a couple of points. Before I start in on the points I want to make, in fairness to Fred Wilson, as he himself points out, he has barely dipped his toes into this topic and he plans many more posts.
With respect to vesting, Fred has the following to say, “Vesting usually happens over a four year term, but some companies do use three year vesting.” It is true that in the case of venture funded companies the “norm” is four year vesting with a one year cliff, but I rarely see three year vesting. (Right now, I don’t recall ever seeing it in the context of a “normal” option grant for a venture financed company.) I don’t mean to quibble, by I have noticed a trend to the other end. There are at least a couple of VCs (one in Boston and one in Silicon Valley) that I know use five year vesting with a one year cliff. Anecdotal information suggests that this practice is gaining ground.
The reason for this trend, if it is a trend, is that VCs want to more precisely align the payoff to the option holder with the liquidity event (exit) for the VC. As it turns out, many very high quality venture funds have average holding periods for investments of north of 8 years. That is to say that, on average, it can be 8 years (or more) from the closing of the first investment to the exit. During that period, many employees can vest large piles of options, and (at least in theory, and to be fair, often in practice) leave the company, exercise their options and take their talents elsewhere. Top re-incentivize these employees, it may become necessary to “reload” option packages from time to time. This practice, of course, can be expensive. And, if the employee leaves and has to be replaced, the replacement will need an option package.
I understand this thinking, but I am not a big fan of five year vesting. Although, I don’t think there is a principled reason to pick 3, 4 or 5 (or any other time frame for that matter), here are is a reason why I don’t like it. First, in the tech world five years is an eternity – hell four years is an eternity. It makes the brass ring harder to see and less tangible. In effect it diminishes the incentive value.
Many employees are great for different stages of a company’s development. So, the guy who did product development at the start and was great with a team of two engineers can’t run a team of twenty. He added great value for a period in the company’s development and then had to be replaced. Only a few employees will really make every transition (admittedly some will).
The compensation, including the incentive compensation, needs to dovetail with the expected performance not with the VC investment horizon. (Just to make an exaggerated point, if vesting were to be keyed to the investment horizon, then the early employees might be looking at 8 year vesting and the later ones 2 year vesting.) I can hear VCs saying we expect everyone to grow with the company etc. anyway how do we know we only want Harry for four years when we hire him but we want Sally for five? What signal would varying vesting schedules send? And so on. We need a one size fits all solution…
So why 4 years? Well, this amount of time seems to represent a compromise of sorts between wanting the liquidity to be consistent with liquidity and wanting it to be consistent with the relevant term of the services provided. It seems to work in most cases. So, before you buck the trend, you should have a good reason because if you go for a longer period you will undermine the value of your options to your employees and will make it harder to hire and keep them. If you go for too short a period, you run the risk of undermining the incentive to stay.
Just ran across an article by Harold Feld related to “Paid Prioritization,” which is a part of the net neutrality argument. In large part this article is about the potential consequences of regulating internet service und Title II of the Communications Act of 1934, as amended. If the FCC does that, it would give the FCC very broad regulatory powers. Anyway, here is Mr. Feld’s very nice description of paid prioritization:
“Lets apply this to existing services clearly covered by Title II. Verizon offers me a choice of two Title II voice services on my landline, analog voice and digital voice. Digital voice is a higher level of service and costs more, in that (Verizon tells me) the sound quality is better and it comes with many more exciting features. That’s clearly a “higher level of service” in the same way that buying a 5 mbps down pipe is a “higher level of service” than buying a 1 mbps down pipe, and Verizon may properly charge me more for it. That hardly counts as precedent for Verizon to start selling me Domino’s Pizza “priority service” so that my calls to them go through 100% of the time crystal clear, while my calls to Joe’s Local Pizzeria drop on occasion and when they go through, the line has all kinds of annoying static. Similarly, it doesn’t count as precedent for AT&T selling me super swift access to Hulu while (comparatively) degrading my access to Youtube -- whether they are charging me, charging Hulu, or charging both of us the "QoS fee."”
The whole argument around paid prioritization revolves around whether the carriers can maximize individual profits at the expense of the network as a whole and the consequential effects on innovation and growth.
As many people have noted, the internet, social media, mobile web etc. are all near their infancy. Nobody knows what forms they will take in the future. Would you have predicted Twitter just a few years ago? But, there is no arguing that Twitter has created a lot of new real estate and added a lot of value to the web. If paid prioritization would have created an impediment to the creation of Twitter, Foursquare, or many others, we would all be the poorer for it.
The paid prioritization debate needs to revolve around Metcalf’s law: the power of networks expands [exponentially] with the number users [sort of]. The FCC (and Congress) needs to look at paid prioritization through this lens. Only then can they decide if paid prioritization (or some version of it) is good, bad or indifferent.
I figure if you're a founder or start-up on the hunt for an angel money, you'd want to at the very least want to know how things look from a potential investor's perspective and the rules that they are going to use to gauge potential invetments. Enter Luke Johnson from across the pond. Luke writes a column on entrepreneurship in the Financial Times and has worn both the successful entrepreneur and angel investor hats. His latest piece: "My rules for being an angel investor" offer a glimpse into at least one angel's criteria for making investments.
My takeaways from his article-
Here is a link to an article by Wendy Davis on the ongoing issues around the use of Flash cookies. This article is sort of about a law suit against Specific Media for “allegedly violating Web users' privacy by using Flash cookies for tracking purposes.”
According to Wendy Davis, the point about Flash cookies is this, “Flash cookies can be used to reconstruct HTTP cookies, even when consumers have deliberately deleted their HTTP cookies to avoid tracking. Because Flash cookies are stored in a different place from HTTP cookies, users who delete the latter don't also shed the former. People can trash Flash cookies via Adobe's online controls, but many users don't appear to be aware of the cookies.”
Any setting of standards in this area (privacy) to be fair has to take into account actual behaviors. Writing a bunch of policy disclosures that are not easily understood and are not read (at least in part because everyone has figured out that they will take for ever to read and even longer to understand), does not cut it.
Another article, also by Wendy Davis, quotes Joe Barton (R-Texas) as follows, “There is now a small army of companies collecting, analyzing, trading, and using information about consumers' habits, purchases, and private data, while some of these practices may be entirely legitimate -- some, in fact, ultimately beneficial to the consumer -- I do worry that not only are many Americans unaware of these practices, but those who seek out information in privacy policies often come up against complicated legalese."
Just in case anyone is wondering what might be ultimately beneficial to the consumer, again from the second Wendy Davis article, here is how John Morse, President of Merriam Webster put it, “We know that the twenty million people who use our site want it to remain free, and we work hard to balance the needs of advertisers, which is what allows the site to remain free, with the privacy needs of our users,"
As I have written before, this is an area that just cries out for some principled basis on which to set expectations about what information can be gathered and how it can be gathered. Abuses in this area will ultimately undermine usage and adoption thereby undermining the value of the network. Fair and respectful gathering and use of data will increase usage and adoption and therefore the value of the network. My proposal is that the regulatory argument should be about where that line is – that is what maximizes the value of the network. I think this law suit and others like it makes it pretty clear that there are limits beyond which confidence will be eroded and real costs will be incurred. The costs are hard to measure because they are costs that all of us pay in the form of diminished value in the network.
The other point in the Wendy Davis article on the Specific Media law suit that caught my eye was right at the end she mentions the attorneys bringing the suits and says this, “All of the Flash-cookie suits were filed by lawyers David Parisi and Joseph Malley [who I could not find easily on the web], both of whom are among the attorneys suing defunct behavioral targeting company NebuAd for allegedly violating users' privacy.” The fact that these cases have not attracted more lawyers and more action may indicate that the bar doesn’t think there is much there or it may indicate that it is early on in a game where the potential damages are poorly understood.
comScore has recently(?) created a new site, comScore Data Mine, that posts “little gems” of data from their vast data base. I had some fun exploring the various data points they posted. Definitely worth a visit.
The buzz around double dip recession seems to have declined a bit in the last several weeks. But it still does not feel like a robust economy. To the extent that retail is a key indicator of where we are (or really where we were), here is what comScore Data Mine has on retail e-commerce in the U.S.:
According to comScore Data Mine, U.S. retail e-commerce actually declined in 2009 compared to 2008. They are predicting a “a return to solidly positive growth rates” in 2010. I don’t know what they think “solidly positive” is, but the increase from 2007 to 2008 was approximately 20%. If that is “solidly positive” the sector should be on fire.
Travel is another indicator of the health of the economy. Here is some good news from the Data Mine:
Here is another little gem from comScore’ data mine, “Online travel spending grew 9% in July, representing the seventh consecutive month of gains. This is quite an achievement, considering this streak comes on the heels of eleven consecutive months of negative growth rates in 2009. At its nadir, which came in September 2009, growth rates had fallen to -11%.”
Where is the wealth in the U.S – by age group, I mean? Probably in the 50+ group. After all they have been working for a while. They have the savings (such as savings are in the U.S.). As has been the case for so long in the U.S., it is all about the boomers. But where is smart phone usage? According the data mine, “Smartphone penetration is highest among persons age 25-34 with 36.2% of mobile owners in this segment using a smartphone device.” Once you get to the age group over 45, smart phone usage declines pretty rapidly.
If you combine this fact, with the prior two, it is easy to confirm (what I think everyone imagines) that retail e-commerce will continue to grow smartly for the next couple of decades. It also tells you how deep the recession was – that in the face of these compelling demographics, this sector flattened.
Troll the web on this subject and you’ll find a trove of information on the subject of adding a cap feature to an angel’s convertible note. (In fact, Dave's blog from a couple of days ago touches on this very subject! - Not planned I promise) I recently had the opportunity to analyze this in the context of a deal and here’s my 2 cents of insight to add to the mix.
What cap am I talking about?: Most angel and seed investments in a start-up are structured as convertible notes that accrue a nominal (sometimes more) interest over a set amount of time. These usually convert into the equities sold during a following venture round at a set discount to the price that the venture investor pays for their shares. See my earlier post on friends and family financing where I extol the virtues of the discount rate as a just reward to the people who invested in your company when it was far too risky for any venture financing. However, although the discount rate does reward your seed and angel financers, it only does so to a certain point, and does not, by itself, fairly share the riches in a rags to riches phenomena. This can give rise to a quirky disincentive for early stage investors not wanting the biggest pre-money valuations for the companies that they invested in.
Mark Suster has struck again with yet another contribution to the seemingly endless debate about convertible notes versus priced seed rounds. His conclusions will, of course, shock and amaze: Price the “effing” round. All the investors agree. (I probably overstated that.)
I don’t want to rehash the now tedious discussion, but the following thought has occurred to me more than once: Investors who hold notes that are convertible at a discount are indifferent to the next round valuation (sort of – (a) a low valuation theoretically helps the return on the seed investment and (b) everyone likes to invest in a company that made it big). These investors have a built in return that they will book at the next round no matter what the pricing of that round is.
At the risk of being boring, a note that converts at a 20% discount to the next round provides a 25% return upon conversion whether the round is priced at $10 million or $500 million.
So, consider this: A VC investor who puts $500K into a priced seed round with the expectation of investing $5mm in the A round will want a low valuation on the A round. It is in the VC’s economic best interest to get a “good deal” on his $5mm investment, to the detriment of the return on his seed investment because the seed investment is nominal by comparison to the A rond investment. On top of this motive, the VC is probably on your board and probably has blocking rights, rights of first refusal etc. As a practical matter, bringing in a true competitive bid will be difficult on a good day. In fact, if there are blocking rights it may be impossible.
Also, consider this: An angel who puts $500K into a priced seed round without the expectation of participating in the A round (or perhaps hoping to have a minimal participation) will want a really high valuation to avoid dilution. Note this investor will also be worrying about later rounds. Again, because of contractual rights (such as the right to block the issuance of senior preferred) this investor may be in a position to affect your ability to raise the next round. Now, you can usually get around this issue because it always comes down to "raise the new money or die", and the investor will go with the obviously correct choice. But, make no mistake about it, these investors can and do create major problems from time to time.
Now consider this: A VC with a $500K principle amount convertible note (at a 20% discount and no cap) will get a 25% return on the $500K at the closing of the A round without regard to valuation. He will be planning to make his return on his A round investment and will negotiate like a VC to get a “good deal.” But, these notes are typically done without all the ancillary documentation that accompanies priced seed rounds. As a result, the holders do not have blocking rights. Because of signaling and other issues (the investor is already involved with the company, he may have rights of first refusal etc.) the VC investor will be tough to deal with, but, from the entrepreneur’s point of view, it probably beats having to deal with all the contractual rights inherent in a priced seed round.
Finally, consider the angel investor holding the proverbial convertible note: Economic indifference to the pricing (sort of – see my parenthetical in the second paragraph), fewer contractual rights, and no substantial new investment in the next round – how much better does it get?
As Suster points out, it is hard to argue that investors should like convertible notes (without caps), but it is also hard to argue that entrepreneurs should not like them. In the end, it seems to me that this is all about supply, demand, familiarly with investments, savvy and negotiation. Familiarity and savvy are usually on the side of the VC. Because of the dynamics of the seed market, as it exists today (see Andy Payne’s recent blog regarding the glut of angel money), supply and demand may be on the side of the entrepreneur (for once). Don’t feel bad about getting a “good deal”; investors sure won’t.
Marc Theerman has an informative post on the Ringleader Mediastamp Law Suit. You should read the post, but the gist of it is that Ringleader, a mobile advertising company, has been sued because it is using a mobile "cookie" technology called Mediastamp. Apparently, this technology does not permit the person on whose system the Mediastamp technology is placed to opt out. As if that were not enough, unlike traditional cookie technology, the Mediastamp coding, apparently, cannot be erased (or at least not permanently erased).
The fact that someone has brought a class action case around this technology suggests that someone thinks there are some damages. In any event the mere fact of a class action claim is a hassle. If it goes anywhere, and maybe even if it does not, it is may well have repercussions for what other advertising companies do and don't do.
The presence of a claim, without regards to the merits, also suggests that there is some lack of clarity around what advertising companies can and cannot do. Any time there is a lack of clarity around an issue like this one, where there could be real money at stake, there will be this kind of friction and waste in the system.
This brings me to my next point:
Why would someone deploy such a technology? What if you made it erasable, like traditional cookies? What if you let people opt out or opt in? The implication seems to me to be that the user (Ringleader, in this case) does not think that people would opt in, or the user thinks all would opt out or erase the program. So, they make it hard for you. Once you have it you are stuck with it.
A company that does this sort of thing (depositing a tracker on your computer/cell phone/iPAD that you canÕt delete or opt of), is admitting that people would never voluntarily let them do that. Otherwise, just ask and let people erase.
The biggest single problem with this sort of behavior is that users of computers, smart phones and other devices, kind of know that there are companies out there that will be doing things the users don't like or want. It breeds distrust and lack of confidence in the web. This kind of distrust slows adoption and becomes a drag on use. This is why we need clear standards that consumers and advertisers understand and that enhance confidence and quality of experience.