Handshakes and Smiles: Founder Feuds from Snapchat to Facebook

11111In 2011, Frank Reginald “Reggie” Brown, IV was an English major at Stanford University, living in the Kimball Hall dormitory. There Brown conceived of an idea for a mobile device application that would let people send pictures from one phone to another, but with a novel catch: the picture would self-destruct shortly after viewing, so the recipient could not save or forward it. The idea would become the lucrative Snapchat product, at one point valued at $15 billion (an astounding figure considering that customers do not pay for the service and a way to make profits had not yet been devised). But Brown, having failed to formalize a contract, had to fight for his share of the value.

          As spring blossomed in Palo Alto that year, Brown was hanging out in the dorm room of a friend, Thomas Spiegel, when he explained the app. Spiegel called it a “million-dollar idea.” After Spiegel asked Brown if they could work on it together, Brown said yes, and the two shook hands. That night, they began searching for a computer coder to help. After interviewing several candidates, they chose Robert Cornelius Murphy. Another Stanford student and friend of Spiegel’s, the three were all also Kappa Sigma fraternity brothers.

The trio then agreed orally to develop the app—which Brown initially called “Picaboo”, after the children’s game—and split profits among them equally. Control and management would likewise be shared, and each would have specific roles: Spiegel, chief executive officer; Brown, chief marketing officer; and Murphy, chief technology officer.

By early summer, the three were deep into the venture. They decamped to work and live together on the start-up at the home of Spiegel’s father, on Toyopa Street in Los Angeles, which Spiegel called the “start-up house.” Brown wrote the terms of use, designed the product logo (a cartoonish smiling ghost), and the promotional pages for social media sites. The three jointly designed the app’s features, including the camera button, screen layout, and colors. Votes were taken on important decisions. When they communicated with friends about the project, each author put all three names in the signature.

In July 2011, they launched the app, which instantly drew strong interest and repeat customers. Through August, the three continued to share the work, even as Brown and Murphy went to their respective family homes for the rest of the summer. That’s when things turned ugly.  During a phone call, Brown and Spiegel got into a heated argument that forever altered their relationship. Spiegel and Murphy shut Brown out by changing all relevant passwords and ceased communicating with Brown. They soon changed the app’s name to Snapchat and eliminated references to Brown as a cofounder in all publicity materials.

During their senior year at Stanford, 2011-12, Snapchat took off, with users sending hundreds of millions of pictures daily. But at this stage, the production was guided entirely by Spiegel and Murphy, who simply ignored Brown, as he went about his other business. Shortly before graduation, however, Brown reached out to assert his right to a share of the enterprise. Spiegel and Murphy responded by retaining Cooley LP, a prominent law firm, which on May 16, 2012, responded by denying Brown’s rights to share in any part of Snapchat. Around the same time, thanks to lawyerly advice, Spiegel and Murphy formalized their own arrangement, creating a separate corporate entity they jointly owned with clear delineation of respective rights and duties.

Brown eventually sued Spiegel and Murphy, asserting that these facts added up at least to the formation of a contract to operate a partnership in which the three were to share equally. The pair denied the allegations and rejected the idea that any legal obligations had arisen. In September 2014, the sides settled without disclosing terms. However, Spiegel acknowledged Brown’s role in the start-up and, while informed speculation suggested Brown did not receive the one-third he claimed, even a smaller share would be a bonanza.

Still, Brown and other entrepreneurs are usually better off clarifying the terms of their deal from the beginning by contract. Enthusiasm often leads them to ignore the important but easy-to-defer details. The result is uncertainty, as cases without contracts can go either way on basics like the duties owed and the profit split.  When rights are the product of litigation rather than negotiation, results can be skewed. The legal wrangling is exhausting and expensive.

Sufficient Definiteness: Urban Decay

The classic case of Holmes v. Lerner illustrates other reasons why new business developers may never adopt a formal contract.  In 1996, an established entrepreneur, Cisco founder Sandra Lerner, and her horse trainer, Pat Holmes, became friends. On a trip to the U.K. they planned a pub crawl when Holmes started experimenting with new nail polish colors. Pink and red were the dominant colors of the day but Holmes boldly imagined darker and moodier hues—like combining raspberry and black to form a new bruised shade. Back in the U.S., Holmes continued to toy with the idea and, speaking with Lerner one day, the two decided to develop the product into a business. They dubbed their venture Urban Decay.

The two enlisted the help of Lerner’s business advisor and proceeded to conduct market research, experiment with colors, and obtain financing. But while Lerner routinely assured Holmes of some role in the venture, she increasingly iced Holmes out of business development as she added professionals to the team. As Lerner and her business friends ironed out the details, Holmes felt left out yet uncomfortable requesting a formal contract. In numerous informal conversations, the two had spoken repeatedly of doing everything together but never stated any formal terms, such as how to share profits. Lerner assured Holmes with a smile that everything would be all right.

When Holmes later requested a fifty percent share in the venture, Holmes’ business advisor laughed, countering with an offer of one percent. Soon after that, Lerner and her team launched the product—branded as Urban Decay—with great success and subsequently denied that Lerner had any role in its conception or development. Holmes therefore sued Lerner. The issue was whether Holmes and Lerner had made a contract to form a partnership, and key sticking points were whether they had agreed with sufficient definiteness on material terms, such as how they would share profits.

Despite vagueness, Holmes persuaded a jury and judge that they had formed a partnership—meaning an agreement to carry on a business venture for profit. While many terms were unspecified, the most important, how to share profits, was implicitly agreed at an even split. Holmes thus walked away with about $1 million. In 2000, Lerner arranged for the sale of Urban Decay to Moet-Hennessy Louis Vitton for an undisclosed sum likely to be many multiples of that. (Urban Decay, which grew into a broad cosmetics line, has since been sold several times, most recently to L’Oréal.)

While it is easy to sympathize with Holmes on the facts as developed, the lesson for both sides is clear: it is better to try to work out details formally ahead of time than gamble on the outcome of a court battle. The start-up business setting is prone to such informality in part because entrepreneurs contribute mainly services, where business culture tolerates a far greater degree of informality than occurs when a financier stakes capital, a supplier furnishes materials, or a landlord provides facilities.  For another instance, consider Facebook–and go see the movie, The Social Network.

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Lawrence Cunningham, a professor at George Washington University, is in the midst of revising for a second edition his book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter, from which this is adapted. 

Sources

Verified Amended Complaint, Brown v. Snapchat, Inc. (original complaint filed February 21, 2013; amended October 23, 2013; case settled and dismissed September 9, 2014), 2013 WL 6474386 (Cal. Super.).

Holmes v. Lerner, 88 Cal. Rptr. 2D 130 (Cal. Super. 1999).

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