On tech startups, trust, and taking matters to Court.

Stability AI is an #AI startup. Cyrus Hodes was a co-founder.

In October 2021 and May 2022, Hodes sold his 15% stake in Stability AI to Emad Mostaque¹, a co-founder, for $100.

But just months later, Stability AI raised $101 million at a $1 billion valuation.²

Tough luck, perhaps? You win some, you lose some?

Well, not as far as Hodes is concerned.

Hodes is now suing Mostaque and Stability AI.³ He claims Mostaque had misled him into thinking that Stability AI was worthless, and accuses Mostaque of #fraud, misrepresentations, and breaches of #fiduciary duties.

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I won't comment on the likely outcome of the dispute.

However, I suggest 3 lessons for savvy founders and business owners.

1. Capture responsibilities and commitments in a written agreement.

Hodes and Mostaque are likely to go toe-to-toe on what were the exact duties owed to each other and the company. If these were not documented in a shareholders' agreement, then there will be significantly more uncertainty, which leads to:

- more areas of dispute;
- less ability to predict outcomes; and
- more time and legal costs incurred by all parties.

Founders and business owners often bemoan the cost of getting a shareholders' or partnership agreement drawn up. However, think of such agreements as a form of insurance - you may never need it, but one day, you might be glad you did it. If so, the question is whether it is worth paying an insurance premium of a few thousand bucks to potentially swing a future million-dollar disagreement in your favour.

2. Keep copies of communications.

Startups iterate and pivot all the time. Nothing wrong with that.

But in this case, Hodes claims (a) he was never told that Stability AI was pivoting to text-to-image generation; (b) Mostaque told him the focus would be climate change; and (c) he exited due to Mostaque's alleged misrepresentation.

If Mostaque's defence is that he did tell Hodes - well, he's going to have to prove it.

Want a surefire way to make a disputes lawyer sigh? Try telling them this:

"Well, I did tell my co-founder about this new project! But it was all verbal."⁴

Having the discipline to keep copies of communications can tip a future legal dispute in your favour.

3. Before any exit, consider obtaining representations and warranties.

Space does not permit a detailed discussion of such clauses, but think of them as a pinky promise that everything is as it seems with the company.

If an exiting co-founder asks for such clauses when exiting, and the remaining co-founder expresses reluctance, that raises a potential red flag that may invite re-consideration of the exit, or the terms of exit.

And if the remaining co-founder provides representations and warranties that turn out to be false, this provides another avenue for the exiting co-founder to seek recourse down the road.