Aereo & the Rebel Startup Myth: Some Say “Not Where You Want to Be”

There is a certain mystique to playing the radical in an old, traditional industry. However, stirring things up almost guarantees the incumbents will push back—and push back hard.

If that tension leads to a legal spat, most startups do not have a war chest ready for a lengthy battle. Nor do they have the time. So, following in the footsteps of a company like Aereo, which has been defending itself all the way to the U.S. Supreme Court, is far from an ideal scenario. Just this Wednesday, Aereo got hit with an injunction in a federal court in Utah, blocking the service in that state as well as Colorado, Kansas, New Mexico, Oklahoma, Wyoming, and other locales.

New York-based Aereo debuted two years ago, offering access to miniature antennas that stream broadcast TV shows to mobile devices—all for a monthly fee of $8 plus tax for basic service. Part of Aereo’s legal argument is that the viewer already has the right to watch the programs at home. But one of the big questions raised at Aereo’s first press conference was whether broadcasters would cry foul since the startup was not paying for the content.

Eventually they did.

The major TV networks—including ABC, CBS, NBC, and Fox—struck back claiming Aereo’s service infringed on copyright and rebroadcasting regulations. The cases coiled their way through the lower courts, with Aereo claiming victory on some fronts. But last September, Brian Roberts, CEO of NBC’s parent Comcast, said in a PBS interview that he believes what Aereo does is flat out illegal.

Before taking on powerful incumbents, startups should think about the clout they are up against, says Michael Phillips, an associate with law firm Fensterstock & Partners in New York. He says startups need to know what existing rules are in play before those rules get used against them. “You don’t want your technology to look too much like regulatory arbitrage,” he says. “That’s the problem Aereo has run into.”

There is a fine line, Phillips says, between innovation and cleverness that has gone too far. On one hand, he says, Aereo looks like a savvy advance over old TV antennas. “But when you look at [their] satellite dish array and how every [user] is assigned an itty-bitty antenna,” he says, “it begins to look like this is just a strategy to work around the Copyright Act.”

Phillips thinks startups need to look hard at the risks of taking on an industry.

Phillips thinks startups need to look hard at the risks they face.

For all their ingenuity, sometimes startups must bend to the rules, Phillips says. That makes playing the rebel dicey, he says, if startups cannot adjust their technology to both satisfy regulators and be profitable. “For some, it’s the core of the enterprise or nothing,” Phillips says. “That’s Aereo’s circumstance. If the system they’ve set up violates the Copyright Act, then that’s it for Aereo.”

Aereo’s case is due to be heard this April by the U.S. Supreme Court. The company stated it welcomes the chance to resolve the matter once and for all. Its CEO, Chet Kanojia, seems to be looking forward to some finality to the fight.

But Phillips believes Aereo might be a bit wary that the highest court in the land took on its case rather than defer to the lower court rulings. If Aereo loses before the Supreme Court, he says, the brand might still have some market appeal—but it would not be the same service anymore. “That’s a scary risk for any startup or its investors to take on,” Phillips says.

The allure of being the rebel, he says, can be a persuasive way to quickly build a client base. Apple is a classic example. But Phillips says startups should think about being more subtle and careful about what they want to revolt against. “With the Aereo case, some of the judges look at it as rebelling against the law,” he says. “That’s not where you want to be.”

So far Aereo has come out ahead in some of  its legal quarrels, but a rival startup called FilmOn X has not, says Andrew Goldstein, a partner with law firm Freeborn & Peters in Chicago. Britain-based FilmOn X, which previously went by the name Aereokiller, also offers streaming content from TV broadcasters. Goldstein says FilmOn X lost some of its courtroom fights, stalling its plans. (Incidentally, FilmOn X recently requested to have a voice in Aereo’s case—a request Aereo is fighting.)

Indeed, the consequences of building a business around supposed loopholes in the law can be harsh. Goldstein wonders if other startups taking this approach understand what they are getting into. “It could be a house of cards,” he says. “If you’re in this scenario, someone is likely going to test your loophole; your whole business could come tumbling down.”

Goldstein says Aereo’s fight differs from other startups battling within an industry because Aereo has Internet mogul Barry Diller as a backer. However, the outcome of the case could be a lesson for all. “If the Supreme Court rules in favor of Aereo, victory for the entrepreneur,” he says. “If not, they spent a lot of money on nothing.”

Meanwhile, plenty of other startups are embroiled in fights with regulators and industry giants. And a few of them have gotten pretty big while overtly flouting the rules. Perhaps that’s where the rebel startup mystique comes from.

Airbnb, for example, has been defending its platform for short-term rentals for users in New York. Regulators have said state law prohibits such activity but Airbnb said it believes the law was intended to prevent illegal hotels.

And then there is Uber, which like other companies that ran afoul of the NYC Taxi and Limousine Commission (TLC), cannot operate its own fleet of yellow taxis in this city (the black car service continues). Uber also has had other types of courtroom fights on its hands, but that is a whole other story.

Being willing to operate outside of the law can be lucrative for some, says David Mahfouda, CEO of Bandwagon in New York. Bandwagon created an app that matches up passengers headed in the same direction to share taxis. Though his startup has worked within the lines, he sees some tech innovators play regulatory arbitrage. “They’re making a bet that regulations will change,” Mahfouda says, “and in a variety of situations, they’ve been very successful.”

Bandwagon's Mahfouda says taking risks has been lucrative for some.

Bandwagon’s Mahfouda says taking risks has been lucrative for some.

Further, he says some folks in venture capital look for startups that pursue such gambits. “They recognize there is a lot of upside [potential] when the regulatory landscape changes,” Mahfouda says.

It’s worth reiterating, however, that Bandwagon’s app operates with the blessing of local regulators. Mahfouda says being more inclusive of industry stakeholders cleared away some potential roadblocks. “We’ve never faced the risk of being shut down by the TLC,” he says. Not going to court also means not having to build up a war chest to fund legal fights. “It’s helped us stay capital efficient,” he says. (Meanwhile, ride-sharing competitor SideCar Technologies bowed out of town after its regulatory run-ins with the New York City TLC.)

So, do “outlaw” entrepreneurs always know what they’re getting into? At least one observer says there are times when startups stumble into legal grey areas unintentionally. “They may not consider legal implications fully at inception, but think it’s a problem that they’ll need to address when they scale,” says Micah Kotch, director of innovation and entrepreneurship at Polytechnic Institute of New York University (NYU-Poly)

He says entrepreneurs would be wise to consult legal counsel early on; however, that is not always the case, and many startups can suffer for it. “For every Megaupload, there are probably 1,000 startups that are on the wrong side of the law and not making millions,” Kotch says. Megaupload was a file-hosting service that was shut down by federal authorities in 2012 over allegations of copyright infringement.

The crew behind Megaupload returned one year later with another file-hosting service simply called Mega, which is alive and running. However, its founder Kim Dotcom has done jail time in New Zealand stemming from the copyright infringement charges and continues to fight extradition to the U.S.

The saga of Megaupload made international headlines, but Kotch says entrepreneurs should think carefully about the path their startups will follow—especially if they want to work with NYU-Poly’s incubators. “Ending up in court may be a price they’re willing to pay,” he says. “But to be clear, as a program, we’re not interested in being affiliated with that risk.”

No question, startups often get crushed when they take on the behemoths of an industry. The original Napster was an early hub for file sharing on the Web—until copyright infringement lawsuits filed by music labels led to a court-ordered shutdown and bankruptcy. The brand reemerged under new owners, but that iteration of Napster was finally absorbed in 2011 when it was acquired by on-demand music service Rhapsody.

To avoid such a fate, founders need to think carefully about what they are getting into. “I have been counsel to, or investor in, a number of startups that had non-intuitive legal problems,” says Ed Zimmerman, chair of the tech group at law firm Lowenstein Sandler and head of the First Growth Venture Network.

If a startup plans to sell medicinal marijuana, he says, there obviously will be regulatory issues that need to be addressed. On the other hand, if a startup wants to bring a type of business normally conducted offline to the online world, they might tread on obscure, older laws.

Zimmerman says some investors want to avoid startups that pose regulatory risks, which add to other perils that go with the territory. “You’ve got tech risk, you’ve got founder risk, you’ve got fundraising risk, and you’ve got customer adoption risk,” he says.

But other investors may give them a chance, he says—if the founders can prove they understand the issue. “There’s a difference between a startup where the founder has to lead 20-somethings,” he says, “and a startup where the founder must also know how to cut through red tape at state or federal levels.”

In spite of the perils, he sees some proactive startups plan ahead to kick down doors on the legal front. “I’ve spoken to founders who’ve said among their first 50 hires, if not the first 10, will be a lobbyist,” Zimmerman says. “Someone with deep regulatory expertise.”

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