Sudden Startup Setbacks—Surviving a Class Action Lawsuit
Like many entrepreneurs, I co-founded a company to satisfy a deeply irrational urge to help build a product and a business from scratch. Going into it, I expected to work harder than ever before. I expected the anxiety and stress of investor, product and people issues.
What I did not expect was to get sued. That only happened to big successful companies right? Not to Series A startups just 12–18 months away from the euphemistically named “dry well date”, the forecast for when the cash runs out and the whole operation goes up in flames.
This is the story of being a co-defendant in a class action lawsuit.
This is also a story without heroes or a happy ending. Like a lot of startup stories that get airbrushed out of the creation myths, it ends without catastrophe but also without a satisfactory conclusion.
Finally, it is a story of sudden startup setbacks — it’s not enough to deal with product/market fit problems, employees quitting and the steep learning curve of how to be a half-decent CEO. In addition to defending against the body blows we see coming, we must also learn to endure the occasional cold-cocked punch to the gut.
The Punch: The punch came one night in October 2013 inside a humble manila envelope. The cover page showed that an individual I had never heard of had sued us in a class action in federal district court of LA and listed us as co-defendant alongside what appeared to be a small business in LA. The documentation alleged that we had violated TCPA — the Telephone Consumer Protection Act, natch — and that we, operators of Big Bad Business, were about to pay a hefty price for our wanton criminality. Not only were we
getting sued — we were in a class action. Class action! Wasn’t that reserved for the really egregious stuff, like poisoning the water before Erin Brockovich came rampaging into town or faulty Toyota accelerators?! Apparently not.
The documentation also included the name of the suing law firm — a quick Google search showed what looked like a small shop focused on class action lawsuits. You know those cheesy billboard ads where the lawyer is sitting at his desk on the phone, supposedly fighting for the Little Guy, too busy to get off the phone but still staring right into the camera? These guys looked like That Guy.
My heart sank. The constant background hum of anxiety that is the founder’s daily existence exploded into a full-blown panic attack for a few minutes until I calmed myself. To make matters worse, this was a lawsuit that was potentially preventable in hindsight.
You see, our company sold marketing software for small businesses — we helped businesses like day spas and go-karting tracks run marketing campaigns over email, Facebook, Facebook Ads, Twitter and SMS all at once, out of the box. We helped these local businesses make money and serve their customers. For these types of businesses, the product frequently worked better than everything else in the market and we were proud of it. While email and Facebook were popular with customers, SMS was barely used. We were vaguely aware that the rules around SMS marketing were changing in October 2013 — whereas businesses could formerly send SMS as long as they respected the consumer’s desire to opt out of future messages (the annoying “Reply STOP to unsubscribe” tacked onto the end of a text before), the rules change mandated that businesses must explicitly opt in consumers up front before messages were sent.
Despite our rough situational awareness, we did not manage to get the product changes rolled out on time.
We did what many startups do every day as they fight for survival in a race for time against the dry well date. We followed the conventional wisdom of focusing all our energies on product/market fit — at the expense of everything else. As the original, now-famous essay by Marc Andreessen says clearly,
“Do whatever is required to get to product/market fit. Including changing out people, rewriting your product, moving into a different market, telling customers no when you don’t want to, telling customers yes when you don’t want to, raising that fourth round of highly dilutive venture capital — whatever is required. When you get right down to it, you can ignore almost everything else. I’m not suggesting that you do ignore everything else — just that judging from what I’ve seen in successful startups, you can. Whenever you see a successful startup, you see one that has reached product/market fit — and usually along the way screwed up all kinds of other things.”
As we evaluated our product roadmap, we decided that we should first finish a high-priority project that moved the needle on product/market fit, and then quickly come back to the SMS change. This might result in us getting the SMS fixes done a few days after the rules change date. But the risk of actual trouble felt low — only a handful of customers used SMS anyways and even the ones that did used it rarely and were naturally careful with their consumers’ trust. And finally, even if someone did, most consumers would either like or ignore the text and move on.
We were wrong.
Literally a few days after the rule change, I held in my hands a sheaf of bullshit legalese. In a short time, a suspiciously dizzying series of events had occurred — a business in LA had sent a campaign via SMS, an individual had received it, they had figured out how to be in contact with a firm that belonged to the TCPA lawsuit cottage industry, and that firm had slapped both us and the business with a class action lawsuit. All of this in a measly few days.
I called our board member and informed them. I then called our General Counsel and was put in touch with one of the firm’s litigators. I got on the phone with him, hoping for someone that sounded like The Wolf from Pulp Fiction. What I learned instead made me that much more worried.
First, I learned that this type of class action was opt in by default. So every consumer that had received a single SMS from any of our small business customers over the past several years was automatically enrolled into the class and eligible for compensation if things went against us. A quick database query showed that tens of thousands of messages had been sent over the years so the damages, at least in theory, could kill us many times over. I also learned that while the class may not get “certified” — as in, the court could decline to call this a legitimate class that could proceed to trial — just the legal wrangling in the early stages would run into hundreds of thousands of dollars in fees and change the dry well date by months. Before trial.
Time for another minor panic attack.
But all was not lost. The reality was that 98% of all cases settled and that most of these firms weren’t interested in full-blown litigation either. What they were after was a quick settlement from a company moneyed enough to pay something but not moneyed enough to fight back with an army of lawyers. So Google was too big and our small business customers were too small — our company, the Goldilocks in this slow-moving train wreck, was unfortunately just right.
I agreed to let our litigator reach out to the other firm and start a dialog. Knowing their early settlement calculus, we offered them a mediation session at JAMS San Francisco and they quickly accepted. They were even nice enough to split the $10,000 one-day session cost with us. What a bunch of angels.
For the uninitiated, JAMS is an organization that holds mediation sessions for companies in dispute. A retired judge will hear out both sides and attempt to get the parties to resolve the issue without litigation by helping them reach a contractual arrangement that settles the dispute (yes lawyers, I know this is over-simplification).
And so the stage was set — we prepared income statements and balance sheets, and I rehearsed how I’d articulate our version of events, cleared my calendar, quieted the pit in my stomach and walked into JAMS with our lawyer.
We were first introduced to the judge, a gentle old soul with a courtly demeanor. We were also introduced to The Guys from LA. There I was, standing two feet away from a couple of guys dressed in ill-fitting shirts and ties, grinning at me with outstretched hands for a handshake like we were about to be Business BFFs as soon as the little matter at hand was resolved. Screw you, I thought to myself as I shook their hand joylessly and settled into my seat.
Oh, also — the actual consumer that suffered such grievous mental and emotional injury with that one text message from that small local business? Nowhere to be found. What a surprise.
What followed was surreal. The judge made his opening remarks that made it clear that he had little idea of how Facebook or SMS actually worked but that he’d help figure this out anyways, reasoning from first principles. This scared me unto itself. He then allowed the plaintiff to present their version of events. In no time, out came a PowerPoint onto the projector that violated every presentation design rule in the book. Text-heavy slides? Yep, got ’em. Shitty ClipArt graphics? But of course. Subpar voiceover? You better believe it.
I tried my best to ignore my moral outrage about being so offended over the damn PowerPoint and focused on their key messages — they wanted millions of dollars paid out for all consumers and they thought we should pay because we had well-known and probably deep-pocketed VCs. In fact, in a stroke of legal research brilliance, they had Googled the company and pulled up a TechCrunch article announcing a $5.1 million fundraise from 2012. They even observed that our lawyer worked at a big well-known firm and wore a Rolex, a detail that had escaped me until that moment. Surely a rich and powerful corporation like ours could entertain a starting bid for a few million dollars?
I would’ve laughed at their ignorance of Silicon Valley if this had happened to someone else. Instead, I sat there and stewed, waiting my turn.
The Counter-Punch: On our end, we quickly worked to let the air out of the balloon by explaining Startups 101, much to the amazement and horror of Judge and Jerks both. The company was not profitable. In fact, it was burning through cash at a rapid pace and was on track to run out of money in a year or less. The fancy lawyer with his fancier Rolex? Yeah, he hadn’t been paid yet. In fact, his firm was owed the last few invoices. Our VCs were deep-pocketed, sure, but there was no guarantee of future investor support — companies died all the time from lack of insider support. And yes, all of this was exceedingly normal and we had income statements and balance sheets to prove it. Welcome to Silicon Valley.
They were dumbfounded.
In that moment, they looked like every Business Owner uncle of mine who stared at me stupidly because their brain circuits overloaded upon realizing that we, and everyone around us, were burning through cash with no profitability on the immediate horizon and no chance of the founders being thrown into debtors’ prison if things went sideways.
Now that each side had laid out their positions, the judge moved on to shuttle diplomacy like we were about to negotiate the Middle East peace process. The Guys were moved to a different room and we were left in place. The judge literally shuffled between rooms taking offer and counteroffer back and forth, persuading both parties to see reason. After a few increasingly heated rounds, he let slip that the other guys were upset that they had flown up here expecting to hook a bigger fish and found a stupid unprofitable minnow. They needed an offer that saved face at the firm for them to go away. Would we offer it? We gritted our teeth and made a best and final offer.
Coda: The offer took and we reached a financial settlement. It was a difficult but not-bankrupting amount of money. As we suspected all along, the consumer received a small fraction of the proceeds and the law firm pocketed the rest. And to add a final, dark comic twist — I demanded that the settlement be spread out into six payments over 18 months, interest free. I laughed bitterly to myself at how the installment plan felt like a lease payment for a very expensive imaginary car I’d never even get to drive.
The day’s business concluded, I went home and spent the night berating myself and ranting on the phone with friends and family at the ridiculousness of what I had just witnessed.
The next morning, I tried to compartmentalize and went to work like nothing had happened — most people in the office were blissfully unaware and I intended to keep it that way. Soon enough, I was back to worrying about product/market fit and trying to push the business forward. Our board member and investors were first-class actors through this and that certainly helped us get past this too.
As I said earlier, there was no happy ending. In the fog of war for survival and maybe even some success in the face of terrible odds, we made a small gamble and we were penalized heavily for it. The Guys kinda won. We licked our wounds and moved on. These are the unexpected setbacks that are so tough to swallow, the ones that sting to this day, four years after the fact.
But over time I could take solace in the fact that we tried to wage the good fight every day and sometimes things did break our way. I can look back years later, battle-hardened and no worse for the wear. I can tell the tale to help others in my wake. And recognize that those are all worth their weight in gold.