Reference no: EM131064420

Read the case "Giving Away Facebook".

Answer the following questions and/or statements in detail:

1. Can you know if you have a potentially hugely successful company on your hands when you first launch it?

2. Should all companies take the precautions Facebook failed to take? Or can some companies be more relaxed about such legal issues as partnerships and ownership? Why or why not? Use credible sources and research to support and explain.

3. What types of agreements and contracts do you think Mark Zuckerberg, his partners, and Facebook's early investors should have drawn up? Use credible sources and research to support and explain.

4. What contracts do you think the Winklevoss twins and Divya Narendra should have drawn up when they hired Zuckerberg to work for their company? Use credible sources and research to support and explain.

Giving Away Facebook

For a bunch of seemingly smart kids, the guys involved in Facebook's founding did some pretty stupid things-at least from a legal point of view. This resulted in years of lawsuits and billions of dollars in settlements.

Most new start-ups are in the position of having to give up some degree of ownership in return for early-stage financing. After all, investors want to get something for their money, and that is typically a percent of the equity-or ownership-of the company. And they deserve a big payout for taking a chance on an entrepreneur, for risking their money before anyone else. Nevertheless, those decisions shouldn't be made lightly or without considering the legal consequences, even when a "business" is still in the idea stage. Or when it's just being discussed in your college dorm.

The exact facts revolving around the founding of Facebook remain in dispute. But some things are agreed upon. A site called "TheFacebook. com" was launched in 2004, by Mark Zuckerberg, Dustin Moskovitz, Chris Hughes, and Eduardo Saverin while they were students at Harvard University. Saverin, a wealthy student, provided Zuckerberg with $15,000 to purchase the servers for TheFacebook. In return, Zuckerberg allotted Saverin 30 percent of the company.1 That was generous-extremely so. And it was a decision that would come back to haunt Zuckerberg.

In the meantime, while getting ready to launch TheFacebook, Zuckerberg was also working for twins Cameron and Tyler Winklevoss and for Divya Narendra, who had hired him to work on their own social networking site. Their site had essentially the same concept that would become Facebook. The decision not to tell his employers that he was working on a competing site was another problem that would come back to haunt Zuckerberg and Facebook.

Those are the facts that are agreed upon. Other issues remain in dispute and have eventually ended up in court.

Like many teams in a start-up venture, some founders-notably Zuckerberg and Moskovitz-stayed more closely involved with growing the venture, while others, particularly Saverin, had other demands on their time. When founders don't clearly delineate their responsibilities and what consequences will happen for failing to live up to their responsibilities (if any), this inevitably creates tensions and disagreements, which is exactly what happened in the case of Facebook.

Zuckerberg moved the new company to Palo Alto, California (from Cambridge, Massachusetts). To help finance Facebook's growth, Zuckerberg brought in other investors, notably Peter Thiel, cofounder of PayPal. As a result of this investment, Saverin's 30 percent ownership was diluted substantially. Saverin alleged this was done unfairly, and later sued the company. Although the exact terms of the suit were not revealed, Saverin eventually received 5 percent of the ownership of Facebook. His $15,000 investment ended up being worth many billions.

Another complication came about because Zuckerberg failed to disclose that he had a conflict of interest while working on the Winklevosses' project. He launched Facebook a few days before their intended launch, and they immediately alleged that he had stolen their idea and intentionally delayed the launch of their project so he could launch his. The Winklevosses later sued, winning a lawsuit against Facebook for more than a million shares of Facebook stock and $20 million in cash.

Zuckerberg's legal complications continued. Another person, Paul Ceglia, alleged that he hired Zuckerberg to work on his company, StreetFax.com, at the same time that he was working on what would become Facebook. In 2010, Ceglia sued, producing a document showing that Zuckerberg gave him 50 percent of the company in return for a $1,000 investment. Facebook's lawyers assert the document is a fake.

Of course, it's true that every extremely successful company is likely to encounter legal challenges. After all, once millions or even billions of dollars are involved, many people will want a piece of ownership. But many of the problems and huge settlements encountered by Facebook were avoidable.

Zuckerberg was accepting money to work on the Winklevosses' social networking program while simultaneously developing his own competing program. This was a clear scenario for conflict. It was inevitable that his motives would come into question-especially when he launched a competing site a mere few days before his employers planned to. It may have seemed to Zuckerberg like a mere gig for him to pick up a few extra dollars, but whenever you're working on another company's projects, you are responsible for maintaining its trade secrets. Moreover, it's likely that Zuckerberg was laboring on a "work-for-hire" basis, meaning that anything he produced while working for them-such as computer code-in fact belonged to them. That could have been another area of conflict.

But perhaps the biggest problem was that in his eagerness to raise the money he needed to launch, Zuckerberg gave away a huge percentage of the company. He failed to get any kind of legal advice that might have helped him structure an agreement that would have delayed putting a percentage value on Saverin's investment (such as until the first round of financing) or that would have made clear how Saverin's percentage would be diluted.

As the Facebook example proves, simple college-dorm agreements can later become the basis for extremely serious stock ownership battles.

Even though most of those involved with Facebook's founding eventually got fabulously rich, the complications arising from their lack of legal foresight created tremendous problems, strained friendships, and led to legal battles and settlements worth millions-even billions.