The Lean Start-Up

April 25, 2010

Interesting article in The New York Times today on the so-called “lean start-up”.  It provides a mini-profile of the efforts of entrepreneurs Eric Ries and Steven Blank, who are proponents of this approach, which is an extension of the idea of boot strapping as much as possible prior to taking on outside investment.  Among the key elements of the lean start-up methodology are: (i) because most are Internet-based businesses, they are able to take advantage of open source software development, (ii) they employ agile development methods, (iii) they focus on making some  minimum viable product to get something in the market place to test customer interest, and (iv) on funding, they take as little outside money as possible.  In many respects, this idea boils down to doing whatever it takes to get revenue in the door as soon as possible with whatever product is already available. 

Link to article:

Vernon v. Cuomo: Lessons for When Things Start to Come Apart in a Startup

April 25, 2010

When things start to go awry in a startup company, they can go very wrong indeed.  The situation that gave rise to the North Carolina decision in Vernon v. Cuomo, Case No. 06CVS8416 (2009 N.C. B. C. 6 Mar. 17, 2009) and (2010 N.C. B. C. 5 Mar. 15, 2010), provides a case in point.  In March 2009, the North Carolina Business Court found that a group of majority shareholders who were also Board members of a corporation breached their fiduciary duties to such an extent that the court ruled that the corporation should be dissolved for abusive management — a rare circumstance – but gave the majority  shareholders the option of avoiding dissolution by buying out the shareholdings of the plaintiff minority shareholders at a judicially determined fair valuation.  Because the majority shareholders opted for buying out the minority shareholders, the court’s proceedings entered a valuation phase and that valuation decision was issued last month.  (A link to both the March 2009 decision on liability and the March 2010 decision on valuation is provided below.)

Liability Phase

Reading the facts as summarized by the court in the 2009 decision makes for interesting reading about the various “dysfunctions” that sometimes arise in any closely held company where stress is high amd resources are scarce but opportunity seems just around the next corner.  The plaintiffs had varying shareholdings in an early stage medical products company, called TriboFilm.  The honeymoon period among all the shareholders came to a gradual end and the two plaintiffs, holding between them about 40.4% of the equity in TriboFilm, found themselves on the outs. Once that happened, the majority proceeded to terminate the employment of the two minority shareholders (protected by the business judgment rule), authorize higher than usual salaries for themselves (problematic because of self dealing), caused the articles of incorporation to be amended to authorize significantly more shares without full disclosure of a legitimate business reason for this and then — you could see this one coming – issuing themselves sufficient shares ostensibly in forgiveness of accrued salaries, with the result that the plaintiffs’ equity percentage was diluted from 40.4% down to 4.8%.  The court found this series of actions to be self dealing to such a degree that they amounted to a breach of fiduciary duties for which the only remedy was a court-ordered dissolution of TriboFilm or a forced redemption of the minority’s original equity percentage.

Valuation Phase

In the valuation phase of the proceedings, the court struggled with how to value the illiquid shares in a company that was closely held and that had not yet started to generate any appreciable revenues, notwithstanding its potentially very valuable portfolio of intellectual property.  A court-appointed third party valuation expert rendered its opinion to the court after some difficulty in extracting necessary information from the defendants.   The court’s opinion on valuation is notable for walking through various approaches in valuing an early stage business for which intangible assets (intellectual property rights) that have not yet been commercialized in any substantial manner.  The court ultimately came to a sort of Solomonic resolution by awarding to each plaintiff a defined amount for a portion of the value plus an ongoing royalty on future earnings, thereby avoiding a windfall payment either way and also to allow participation by the minority shareholders in future upside potential that was merely speculative at present.

Copy of Initial Opinion in Vernon v. Cuomo (Liability Phase):  Vernon v. Cuomo (Phase 1 Opinion 2009)

Copy of Second  Opinion in Vernon v. Cuomo (Valuation Phase):  Vernon v. Cuomo (Phase 2 Opinion 2010)

The IEI and The Secret Ingredient for Innovation

April 25, 2010

Earlier this month I attended a thought provoking talk on the connection between creativity in the arts, innovation and entrepreneurship.  The occasion for the talk was the April meeting of the Institute for Enterprise and Innovation (IEI), which featured as its speaker Joe Bankoff, a former lawyer with King & Spalding in Atlanta and now the CEO of the Woodruff Arts Center.  Bankoff made a strong case for the relevance and necessity for arts programs in our schools and within a given community as a key foundational element for an innovative business environment. 

Bankoff posited that the secret ingredient to innovation was a diverse group of people – in a broad general sense and not in a “politically correct” sense of diversity — working together on some problem or undertaking.  This process of actually working with and having to depend on others is a learned process and a foundation in the arts (of whatever sort) teaches individuals the necessary respect for the abilities of others, which is critical when working in groups. 

The IEI has been the labor of relentless and good natured curiosity by its chief proponent, Mike Vollmer, whom I’ve had the privilege of knowing and working with on various projects over the years.  It is easy to appreciate the plain spoken enthusiasm that Mike brings to the mission of the IEI.  As is typified by Bankoff’s talk and so many of the IEI’s programs, the IEI makes a solid contribution to the ongoing knowledge sharing dialog among those interested in issues related to innovation and entrepreneurship.

Link to Institute for Enterprise and Innovation:

Workplace Communications and Employee Privacy Rights: Stengart v. Loving Care Agency and City of Ontario v. Quon

April 25, 2010

Consider this typical scenario:  an employer makes available to its employees computer and other communications devices to enable its employees to perform their roles for the employer.  The company adopts a broad computer use policy, which sets forth restrictions on the use of the employer’s equipment for non-company business, including a right by the company to review communications that pass through the company’s computer network.  Are there (or should there be) any exceptions to the employer’s right to review the communications made through mobile communications devices?  Or stated another way, when does an employee have a reasonable expectation of privacy with respect to such communications?  In the past month there were two notable case developments wrestling with these very issues.

Stengart v. Loving Care Agency

 In Stengart v. Loving Care Agency, A-16, Sept. Term 2009 (N.J. Mar. 30, 2010), the New Jersey Supreme Court addressed the issue of whether an employee that used a company-issued laptop computer to access an e-mail account maintained with a third party e-mail service (a Yahoo e-mail account) had a reasonable expectation of privacy with respect to communications she had with her attorney.  This court answered that question in the affirmative.  The plaintiff, Ms. Stengart, anticipated filing a claim against her employer, the Loving Care Agency, prior to her resignation from the company and engaged a lawyer to review potential claims that she might bring against her employer.  She filed an employment discrimination claim shortly after her departure and her employer hired a forensics expert to record all files contained on the laptop she had been using.  Among the files recovered were hard disk copies of numerous messages between Ms. Stengart and her legal counsel, which the company’s counsel used in preparing its defense of the company and who divulged access to the e-mails only after routine discovery requests in the case.

In evaluating the contrary positions of employee and employer, the New Jersey Supreme Court engaged in a thorough analysis of the developing case law of employee privacy with respect to workplace communications, including, in passing, considerations under the Fourth Amendment to the U.S. Constitution, which addresses the individual right to be free from unreasonable governmental searches.  The opinion is worth reading for this discussion alone.  What seemed most relevant to the court, perhaps because it was looking for a narrow ground upon which to decide the case, were two facts:  (i) the communications at issue were subject to the attorney-client privilege, which could not be considered under these facts (particularly with attorney-client privilege notices posted in each e-mail) to have been waived, and (ii) the employer’s policy did not directly address use of third party e-mail accounts in any way.  The court seemed to suggest that but for the attorney-client privilege issue an employee might not have a reasonable expectation of privacy in a non-work-related personal e-mail account merely because an employer’s computer was used to access the e-mail account over the Internet.

City of Ontario v Quon

On April 19, 2010, the U.S. Supreme Court heard oral arguments in the City of Ontario v Quon(08-1332), a case in which some of the salient facts resemble those in the Stengart case.  In Quon, a SWAT team sergeant in the city of Ontario, California used a text pager issued by the police force to send numerous personal messages, including many that were of a sexual nature.  As in Stengart, the city, as the employer had a broad electronic communication policy prohibiting usage of city-issued communications devices for personal use.  However, the policy was not clear about whether pagers were covered and when an official announced that they were the official also noted that so long as any personal usage was paid for by the individual officer that such uses would not be subject to review for whether they were personal uses, it not being clear whether the city was more concerned with issue of cost as opposed to personal pager usage.  So, during a subsequent audit of the phone messages of sergeant Quon it was revealed that his usage was in violation of the city’s policy both for the personal use and because of the sexual nature of his messages.  Quon and several of the message recipients subsequently sued the city for a violation of their rights.

Just as in Stengart, the principal issue was whether the individual officer and those with whom he communicated using the pager had a reasonable expectation of privacy in the messages sent through the pager.  Because the employer is a city government, the issue of Fourth Amendment coverage was invoked.  Although the trial court found for the city, the U.S. Court of Appeals for the Ninth Circuit, found for Quon and the other plaintiffs on the grounds that the city’s policy had in effect been countermanded or modified by the contrary statements made by the police official who first announced that pager use would now be within the scope of the city’s communications policy.

It is almost always difficult to discern case outcomes from the tenor of oral arguments in the Supreme Court.  The Justices appear to enjoy the opportunity to engage in as much devil’s advocate type questioning as you will see in any court.  However, to read the transcript of the oral arguments, it is fair to note that counsel for Quon and the other plaintiffs had a greater challenge keeping their arguments and responses consistent throughout the questioning.

The Takeaway

Both Stengart and Quon provide good examples of how the law frequently has to race to keep up with technology.  It is likely that the Supreme Court’s eventual decision in Quon will have implications beyond the government employment context and will be one that will be instructive to private employers as well.  However, regardless of how the Court decides that case, the situations presented by both these cases should cause employers and employees alike to pause and exercise even greater care with respect to workplace communications and how they should interact in that arena.  An employer should reexamine its policies to ensure they are sufficiently broad top cover the types of communications used by its employees and that these policies are not unintentionally undermined by those speaking out of school.  Employees should also be cautious about their expectations of privacy in the face of such broad business communications policies and exercise an extra degree of common sense in such matters.


Copy of N.J. Supreme Court Opinion in Stengart v. Loving Care Agency:  Stengart v. Loving Care Agency

Link to Transcript of Oral Argument in City of Ontario v. Quon: