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Reducing Start-up Business Litigation Risks

Wednesday, 29 October 2014

Start-up businesses are finding themselves embroiled in litigation for basic legal failures at the outset of their endeavour. Many of these costly errors could be avoided with simple legal advice.

The messaging service Snapchat, which markets an application allowing users to send temporary photos and videos, has recently settled a dispute over its creation and ownership.

Frank Reginald Brown challenged Snapchat’s chief executive, Evan Spiegel, that he had originally provided the idea of images which would “disappear” when the two attended Stanford University together. Snapchat, judging by recent investment, is valued at approximately £6.2bn.

Start-up businesses, in particular tech companies, can face a variety of legal issues surrounding ownership and rights. The imprecise nature by which a start-up comes about, with undefined share holdings or property rights, often results in the prospect of litigation when the business’s value increases later down the line.

Facebook Litigation Highlighted the Creation Problem

Facebook has been the subject of much litigation, following the contested circumstances of the website’s inception and creation as popularised by The Social Network.

Among others, Facebook has settled lawsuits with the Winklevoss twins (for stock worth $150m), over allegations that Mark Zuckerberg had stolen the idea for the social networking site from them.

Facebook was also famously sued by Eduardo Saverin for breach of fiduciary duty, where Saverin received 5% of the company for having his shareholding diluted.

Patent Litigation is Also a Problem

Evidence has emerged that start-up companies are frequently the targets of patent litigation lawsuits. In the US, it is now the case that the majority of suits filed by non-practicing entities (a legal person who holds a patent without developing or using it for business) were against companies earning less than $10m in revenue.

Recently, Square, the credit card processing company which allows for consumers to pay for products and services via a small device plugged into the audio port of a smartphone or tablet, has been subject to complaints of patent infringement and breach of fiduciary duty.

The lawsuit, filed in January, alleges that Professor Morley – the plaintiff – had originally contributed his technical expertise into development of the device before being effectively removed from the company, which was only beginning to take shape.

How Can Start-ups Avoiding Litigation and Other Legal Issues?

For virtually all businesses that are just setting out, the simplest way to avoid legal problem is to seek legal advice. There will certainly be a short term cost for access to legal advice and to have documents professionally drafted but this usually pays dividends in the long run.

In the absence of professional assistance, businesses are advised to clearly document all decisions and agreements surrounding shareholdings, intellectual property rights and participation in the internal operations of the company. These should include details of the specific operational roles to which people involved in the start-up’s creation are assigned.

Clear documentation can provide a reference point in any future conflict or disagreement between stakeholders and can hopefully be used to settle most disputes before litigation arises.

For specialist legal advice for start-ups contact Peter Gourri today by email or telephone 0207 611 4848.

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