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

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 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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