The Facebook/Ceglia Case: Good Lessons For Entrepreneurs
by Robert C. White Jr. on August 06, 2010
Facebook was recently sued by New York businessman Paul Ceglia. Ceglia alleged that he is entitled to ownership of 84% of Facebook due to a prior written agreement that he had entered into with Facebook’s founder, Mark Zuckerberg. Many components of this matter are unclear, and it may be a while before it is finally resolved. It’s hard to predict the result, but in any case this is a very difficult situation for Facebook. Unless they are able to get the case dismissed on technical grounds (due to Ceglia’s long delay in bringing this action), they face either getting into litigation with uncertain results (which could conceivably make Ceglia a significant shareholder of Facebook) or settling with Ceglia by basically paying him to go away. This could be a significant sum. This is especially unfortunate for Facebook because the company and the media are focused on this matter instead of celebrating Facebook’s recent significant milestone of reaching 500 million users.
Regardless of the final resolution of the Ceglia matter, entrepreneurs should learn several extremely valuable lessons here:
1. Always document equity ownership very carefully. Don’t ever be casual or informal about this critical item.
2. Don’t ever rely on relationships, friendships or people “doing the right thing”. These things are great, but they won’t help you if a controversy arises. Remember also that people and situations change over time.
3. Don’t ever put off or give low priority to documenting ownership and the terms and conditions of any relationship or situation because you’re in a hurry to get other things done. This is a very common mistake. Take the time to do these things right up front. If you don’t have the time, take it from some other task.
4. The best time to document these items is early in the company’s life cycle.
5. Carefully document relationships with any individuals or companies that provide any services of any kind in connection with intellectual property. Ensure that proper written agreements are prepared and signed before any intellectual property work is performed to ensure that all rights to the intellectual property remain with the proper owner (normally the entrepreneur or the company).
6. Carefully document all employment and consulting agreements to ensure that all aspects of such relationships are clearly laid out. Do this before any work starts. Clearly document any rights that these parties have to acquire or receive equity, such as options, warrants or restricted stock.
7. If you have multiple projects and matters (as was the case in the Facebook situation), be sure that the status of each relationship or arrangement is clearly defined and documented and that the ownership of any assets (including intellectual property) is clearly documented. Many entrepreneurs work on several projects at one time, and it may not be totally clear where the actual work or assets reside. If things like this are unclear, this might give another party the right to claim ownership or other rights in companies or projects other than the one on which they worked or to expand the scope of their claim. Carefully define the scope of any work that is done, and have proper acknowledgement in the applicable written agreement.
8. Remember that equity can be the most expensive currency you can use in the long run. Entrepreneurs often have to give up equity to conserve cash up front, but the costs of this are huge when the equity value grows in the future. Get good financial advice here.
9. Take the time (and get the right advice and help) to ensure that any documentation that you use is clear and correct. It appears that this might be a problem in the Facebook matter. Ambiguous or incomplete documents often lead to other serious problems.
10. Keep a detailed spreadsheet of the equity ownership of your company and update it regularly. Include all rights that other parties have to acquire equity, such as options, warrants, convertible debt and anti-dilution rights from financing transactions. You can also use this spreadsheet to run scenarios on possible future financing transactions at various valuations. This “fully diluted” equity ownership spreadsheet will be invaluable to you.
It will be very interesting to see how the Facebook/Ceglia matter turns out. My gut feeling is that it may cost Facebook some cash. Regardless of that, learn from the lessons that this matter offers and ensure that your company doesn’t face a similar bad situation in the future.
For more information about the author, Robert C. White, Jr., click here.