The news recently carried a story about Ceglia v. Zukerberg and Facebook, a case where Paul Ceglia claims that he owns 84% of Facebook based on a 2004 contract. 

According to Mr. Ceglia, he contracted with Mr. Zukerberg to produce the software and website known as "thefacebook.com" that eventually became the social networking giant Facebook.

The news contained some strange statements about the contract.  So, I took a look at the complaint and the contract.

When I saw the contract I immediately thought of other contracts that I'd seen early stage entrepreneurs sign and that they later came to regret.

According to the "work for hire" contract it was Mr. Ceglia who hired Mr. Zuckerberg to perform work for two projects.  The first project was for a database.

The second project was to develop software and to "purchase and design" a website to provide "a live functioning yearbook with the working title of 'The Face Book.'"  The design was to be based on a project Zuckerberg had already started.

Regardless of the merits (or lack of them) of Mr. Ceglia's claims, the lawsuit is a lesson about two mistakes that early stage entrepreneurs often make.

Giving Away Equity Before Getting the Benefit of the Services.

If, as the contract states, Mr. Zuckerberg had already initiated the website development, why did he agree to give Ceglia a one-half interest in the Facebook intellectual property and the business? 

The contract doesn't really state anything that Mr. Ceglia is to do to help build the Facebook business.  He wasn't required to make an investment or even provide advice.  He was only required pay Zuckerberg $1,000 for the database development. 

I have a theory about how this happened to Zuckerberg because I've seen it happen to other entrepreneurs.

In 2003, Zuckerberg was a struggling entrepreneur looking to launch Facebook and apparently taking programming and website development work to pay the bills.

He, like most entrepreneurs at this stage, was most vulnerable.  The choice is between letting the dream die or doing anything to keep it alive.

Struggling entrepreneurs looking for funding, a team or just trying to keep the venture alive will often encounter a consultant, investor or other 'advisor' who claims to be their savoir.  This advisor knows how to get this thing off the ground, knows investors who will invest and knows how to grow the venture into a multi-million dollar enterprise and agrees to help the entrepreneur in exchange for an equity stake.  Sometimes it's a 20% or 33%.  Occasionally, it's 50%.

The struggling entrepreneur sees light at the end of the long tunnel.  He figures: "What the heck.  It isn't worth anything now.  I may as well give up worthless equity to get the help and contacts of this seasoned advisor." 

So the entrepreneur agrees and the 'advisor' shows up with contract in hand.  The contract is long on obligations of the entrepreneur and his company and short on obligations for the 'advisor.' 

Having no money, the entrepreneur can't afford to get legal advice, so he signs the contract as-is.

Then, there's a flurry of activity.  It may last a couple of weeks or a couple of months, but rarely does anything develop and eventually the 'advisor' is on to another promising venture. 

The 'advisor' fades into the background having done little or nothing of what was verbally promised to the entrepreneur.  The entrepreneur moves on to continue to build the business, usually entirely forgetting about the 'advisor' contract or naively thinking that, since the 'advisor' didn't come through, the contract was a non-issue. 

If the venture ultimately dies, the contract isn't an issue. 

But, if the venture becomes successful, the 'advisor' finds the contract and makes his claim.

Again, I'm not saying that Mr. Ceglia's allegations have merit or not.  Mr. Ceglia may have been instrumental in the development of Facebook and be entitled to his interest in the company.

But on its face this looks a lot like one of these 'advisor' deals.

The key to avoiding this problem is tying the equity to clear and objective milestones to be provided by the advisor.  If the milestone isn't met, the equity does not vest.

Of course, the devil is in the details.  This approach requires a well defined scope of work for the advisor with specific completion dates.  You won't find these provisions in contracts provided by the advisor, though.

Intellectual Property Ownership and Protection.

Next is another common mistake - not clearly defining ownership and protecting intellectual property rights.

As a technology based venture, the software and related intellectual property is one of the key assets of Facebook.  The contract transfers 'a half interest (50%) in the software' to Mr. Ceglia.

Unfortunately, I see this very often with software and web development companies in particular.  Their contracts will transfer rights to customers that the developer should keep.  When the developer sells (rather than licenses) its software, it's only because the customer doesn't enforce its contract rights that the developer can continue to operate its business.  But, if they ran into the likes of Mr. Ceglia, the game could be over.

In the case of the Ceglia - Zuckerberg "work for hire" contract, giving Ceglia an interest in the business entity would have been sufficient and should be the only interest transferred. 

The dual transfer of both an interest in the business and an interest in the intellectual property is like giving stockholders ownership of the company truck.  Why does a stockholder also need to own part of the company truck?  He doesn't.

The real problem here is that the transfer of rights to the software gives Ceglia the right to use the software outside of The Face Book business enterprise. 

In other words, he could use the software to legitimately create a competitor to the company!

It'll be interesting to see how this lawsuit proceeds.  So far, its been moved to Federal Court. I'm sure the lawyers that Mr. Zuckerberg has hired (with his billions of dollars) will give Mr. Ceglia and his attorney a run for their money.