Following in the footsteps of popular user-driven websites such as Craigslist and Wikipedia, companies have been told to involve customers in generating content and suggesting (or co-creating) new products. What in the late '90s was fuzzily billed as "community" has become the harder-edged "collaboration." According to Larry Downes, a partner with Bell-Mason Group, a venture consulting firm focused on corporate investments in start-ups, customers want what they want: they don't generally care if your company gets sued for giving it to them. So is it possible to please everybody?

Downes has written prodigiously about IT, business strategy, and law. His book on the subject, "The Laws of Disruption," comes out from Basic Books in October. Inc. magazine's Leigh Buchanan spoke to Downes about why fast-forwarding entrepreneurs should be cautious of the legal system's approach to technological change.

How do innovators balance the promise and peril of customer participation?

This is a painful lesson, one just recently learned by the operators of Facebook. When company lawyers made what was really a modest change to its terms of service agreement, some users actually read the text and freaked out. (The terms of service—those agreements we click on to "Agree"--are written in the worst possible legal gibberish. For lay people, they sound much more draconian than they often are.) A Facebook community was quickly formed on Facebook to object to the changes to Facebook, and within a week 120,000 members had signed up. The CEO had to publicly proclaim he was withdrawing the change and apologize to the company's 200 million users. To the company's credit, it announced that the ToS would henceforth be developed on the open source model, with users writing the document to suit their needs.

There's a good reason for that about-face. Facebook's whole value is the content and applications created by users. If users aren't happy with the legal relationship that governs their activity (even—or especially—when they don't entirely understand the details), the company could lose all of its value very quickly. For social networking companies, the ToS is effectively the law of the land. If the citizens of the community feel oppressed, they will do what they do in the physical world—overthrow the government.

But here's a question every entrepreneur should ask herself—how far are we from Facebook? How much of our value relies on information provided by customers? The more companies build value on user input, the more users will demand a say in how that content is developed and monetized. And now they have all the tools they need to organize themselves into collective bargaining units in the blink of an eye. It's the perfect storm. Work with customers, and you can make the relationship even stronger. Dictate to them, and expect the fate of all dictators.

Presumably creating contracts to manage relationships between companies and their collaborative customers is the opposite direction from the one we should be going in. But as customers contribute more, and companies reap benefits from those contributions, should new rules or guidelines come into play?

The question is how our increasingly connected existence will be governed. Up until now, ISPs, website operators, and software providers have decreed the terms of our digital life. Take it or leave it. The Facebook story signals, I think, the beginning of a user revolution. Increasingly, the colonists are going to insist on writing their own constitutions. Think of how a simple disagreement about Internet traffic management blew up a few years ago and turned into the "net neutrality" debate, which wound up with its own television commercials and came up in the Presidential primaries. I'm sure most consumers don't understand what the fight is about. They don't need to. But it has persisted, shaking up the phone and cable companies, infuriating content companies such as Google and Craigslist, and turning normally-placid FCC hearings into the kind of activist happenings that haven't been seen since the 1960's (and never at the FCC) .

In the short term, innovators can be a lot smarter about how they interact with customers. I'm sure most CEOs have never read the warranties, terms of service, licensing and other agreements that are foisted off on customers. Most CEOs are not lawyers and wouldn't understand the documents even if they did read them. Modifications are usually made unilaterally by company lawyers.

But isn't it expected that these types of agreements will be written in legalese?

That has to change. These governing documents must be written in plain English, with user participation and meaningful involvement from the entire executive team. The biggest impact digital life will have on company structure is that the legal staff needs to be integrated into the business, much as the CIO was ten years ago when the Internet became such an important new tool. IBM, which fought government antitrust battles long before Microsoft was even born, was constantly at the mercy not so much of the Department of Justice but of its own lawyers. Former CEO John Open is reported to have said that the legal department was the only one in IBM that didn't have a budget, and it exceeded it every year. It might be funnier if it wasn't so true.

The company lawyer, up until now, has operated pretty much as a lone ranger or as a necessarily evil, depending on your point of view. Not anymore. If your general counsel isn't part of your strategic decision-making, you're asking for trouble. And if your general counsel doesn't know what strategic decision-making is—that is, if she doesn't understand business in general, let alone your business in particular—you're already in trouble. You'll be hearing from your users sooner rather than later.

It sounds as though of all the legal quagmires companies currently deal with, the one with the shortest shelf life is privacy. How long before everyone is comfortable revealing everything—or at least sufficiently motivated to reveal it? Also, how will that massive outpouring of customer data affect innovation? Will we see fewer failed product offerings?

The privacy problem is fascinating, because it brings companies used to thinking of customers in abstract categories and demographic models into a murky, psychologically-charged world of intimate behavior and thoughts. Very few companies—and even fewer lawmakers—are prepared to go down that road. But the technology has already taken us there.

I'm not sure when everyone will be comfortable revealing everything—but whether they're comfortable or not, everyone already does it. Legal commentators write about a so-called "privacy paradox"—consumer surveys reveal a high level of concern about the collection and use of private data, but in practice consumers don't hesitate to give up private information, even when they don't have to.

I don't see a paradox at all. Of course we're concerned with how our information is used, but not because of the intimate nature of that information. I might worry that someone will look at my rental history from Netflix, but really, who cares? The real problem is that consumers recognize that businesses attach value to information about our preferences, habits, and interests. Today, consumers give away that value without getting anything in return. To me, this isn't about privacy; it's about propriety. Where's the consumer's share of the new value?

That's a great question! I wonder why users aren't asking what's in it for them. But what could they realistically ask for?

The idea of negotiating and bargaining for every bit of information is absurd. But there are easy proxies for trading information for value. Club cards, affinity programs such as frequent flyer accounts, and other loyalty programs are in effect an exchange of private information for discounts and other perks. If your grocery store offers a 5 percent discount on purchases for card members, you can think roughly of 5 percent as the value of the extra information (connecting the purchases to a particular individual) to the merchant.

Of course much of the information collected goes into the black hole of the data warehouse. It's doing neither harm nor good. But as we collect more information, standardize it so we can combine and compare it with other data sources, and start to apply business intelligence and other analytic software to make sense of it, I suspect consumers will become less paranoid about privacy. Still, public education is key. If a website asks me for my phone number and it's not obvious why they need that, I get quickly suspicious of the entire transaction. Tell me why you are asking for private information and what you plan to do with it, as well as what's in it for me.