Luddites v. Tech Utopians: 409A and Legal

Background Reading:

TL;DR: Luddites pretend that technology can’t out-do them at anything. Tech utopians pretend tech can do everything. The truth lies in the middle.

In my sphere of the world, I interact with two profiles of people, both of whom I find somewhat obnoxious.

The first are luddites; often lawyers. These people cannot fathom the idea of clients wanting anything less than hand-crafted, white-glove attention to every legal matter. The compromises on quality and customization brought about by software and automation tools are an offense to their professionalism. They’ll walk you through 10 ways in which they can beat a piece of software, completely oblivious to the fact that 99.9% of the market doesn’t give a damn, if the software’s output is good enough.

The second are the opposite of luddites; what I’d call tech utopiansoften young founders or engineers. To these folks, effectively everything legal professionals do is hand-waiving non-sense, charging hundreds of dollars an hour to fill in forms.  Build a simple automation tool, or DIY checklist for them, and their eyes light up; enraptured with how ‘smart’ they are for not ‘wasting’ money on legal services. And I happily admit to a bit of schadenfreude when they end up paying 10x later for cleanup, as part of their education in the value of legal counsel.

Luddites are in self-denial regarding how much of their work can actually be done quite well, and sometimes better, by technology. Tech Utopians are in denial about how much work still requires, and will require for a very very long time, highly-trained, highly-intelligent people who can analyze and deliver things that even the most advanced technology cannot. And yes, those people are way more expensive than software.

The bottom 25% of most professions is probably dead in the water relative to software; think TurboTax and LegalZoom. As AI becomes more sophisticated, that will probably move up to something closer to 50%. This is quite visible in law as lower ranked schools (many of which are a racket) are getting sued by debt-saddled graduates who can’t find jobs, and the credentials of lawyers at well-paying firms edge up each year.  To some extent, it’s never been better to be an elite lawyer. It’s never been worse to be any other kind.

Tech-Enabled Lawyers

The truth about almost every profession, at least when you move beyond the lower rungs, is that technology is a supplement, not a replacement, for people. It’s a tool. And a very powerful one for those who can figure out how to leverage it.

E/N’s recruiting process is designed to systematically filter out luddites. That’s because, not only do I simply not have the time or desire to waste hours of my life trying to train them, but technology (automation, machine learning, communication tech, project management, etc. etc.) is so deeply integrated into our workflows that to add anyone who doesn’t ‘get it’ into the mix would cause a total breakdown. Before I look at emotional or analytical intelligence, or communication skills (all of which are important), I want to know what kinds of technology this person already uses in her/his life.

When lawyers from other firms ask how they might operate and scale leanly like E/N, my answer is as swift as it is depressing: “first, you have to fire half of your payroll.” They usually start laughing, until they see the dead serious look on my face. The legal profession is full of luddites, everywhere; even among the younger generation and in firms that service tech clients. And there’s no room for them in tech-enabled law firms. “Get it” or get out.

And yet with all of the technology that we leverage, I tell every single E/N client that we are not cheap, and never will be. Cheaper than our true competitors, certainly. And dramatically more responsive. But talent costs money.

409A: Trim that fat

When I wrote 409A as a Service: Cash Cows Get Slaughtered a few years ago, highlighting how eShares was using their own technology to trim the fat in an industry that (in my opinion) really was in many cases extorting startups, the response from the luddites was predictable. “Here are 10 reasons why you can’t automate a 409A valuation.”

Over the years, eShares as a platform has grown (as I knew they would), and many of our clients have been thrilled to take advantage of their service. Tech-enabled 409A; not fully automated. They recently published a blog post called The art and science behind an eShares 409A breaking down how automation is used in their reports, and how it’s not.

The future of professional services belongs to people who embrace technology and let it do what it does best, without diminishing the areas where human intelligence and creativity are superior, and will continue to be so for a very long time. Not tech-less. Not tech-only. Tech-enabled. 

The Tech Law Ecosystem vs. BigLaw; Except in Silicon Valley

Question: Why is it that, despite being the epicenter of championing innovative business models, dynamic markets, and the disruption of bloated institutions, Silicon Valley remains dominated by a handful of very large, expensive law firms built on century-old delivery models?

The Blunt Answer: History and Bribery “Sponsorships.” Those large firms have dedicated biz dev people whose job is to write checks to incubators, accelerators and other players with heavy influence on the “pipeline.”  Sponsorships have enabled BigLaw to entrench itself.

And those same firms deliberately seek out VCs (not just companies) as clients, who tacitly understand that, in exchange for the firms’ not pushing too hard on VC deals (when they represent companies), the VCs are supposed to act deeply concerned when they don’t see one of the good ol’ firms at the table; even if the lawyer they’re poo-pooing has impeccable credentials, experience, and even just left one of the very same firms on their ‘preferred list.’ Sound incestuous? It is. See Don’t Use Your Lead Investor’s Lawyers and Why Founders Don’t Trust Startup Lawyers.

It’s well known among the tech law community that no tech ecosystem –not Austin, Seattle, Boston, NYC, etc. – takes law firm “brand obsession” to levels anywhere near those of Silicon Valley, in large part for the above reasons.

History

The full answer is of course a bit more complicated. See: When the A-Lawyers Break Free: BigLaw 2.0.  Before the Cloud and SaaS, big firms truly were necessary to deliver the tier of legal counsel that top tech companies needed, and Silicon Valley’s early growth period occurred largely in that era.  But at some point technology changes things, and the rules of the game shift.  I’ve staked my career on the view that this shift has occurred, and is accelerating.  I left a large, full service firm designed around the traditional “one stop law shop” model for a smaller firm that leverages technology and an ecosystem of top solo lawyers, boutique firms, and other services to replicate “full service” in a much more efficient and flexible way.

A Summary of Why The Ecosystem is Emerging (Outside of Silicon Valley)

  • There have always been second and third tier small firms that (i) picked up clients top firms were not interested in, and (ii) employed lawyers who either never met the criteria of top firms, or dropped out of those firms because they were fine accepting less interesting work and lower compensation for a more easy-going life.  An alternative to going in-house, these lawyers call themselves “outsourced general counsel.”
  • Top, well-funded clients that reached scale (the kind that seek out and are willing to pay for top lawyers) inevitably required a large set of legal specialties: tax, executive comp, IP, tech transactions, trademarks, etc. to handle all of their legal needs.
  • Lacking an affordable, third-party collaboration infrastructure (like today’s Cloud/SaaS tools) to coordinate all of these different lawyers, keeping everyone (dozens of different specialties) under the same roof to share the high fixed overhead costs was historically essential to getting large deals done smoothly and as efficiently (for the time) as possible.
  • Hence, top paying clients gravitated to large firms that could serve them, and as long as those large firms paid the most, top lawyers (in all specialties) were willing to accept the astronomical overhead, convoluted structure, and inefficiency of their large employers.
  • But now, virtually every proprietary resource that large firms once had exclusivity on is available as a SaaS tool or outsourced service, along with very affordable and extremely effective collaboration tools.
  • Therefore, those top lawyers, once locked into large firms, are realizing that as long as they can wrestle away top clients from BigLaw, they no longer have to put up with taking home only a small percentage of their billings.  They can drop their rates significantly, take advantage of their small footprint to optimize for their practice area, and take home at least as much, and often much more, as they did in large firms.  A win-win for lawyer and client – but a loss for “The Beast.”
  • End-Result: A growing ecosystem of significantly smaller, more flexible law firms and solo lawyers that (i) are at the top of their field, well compensated, and have much better quality of life, and (ii) by collaborating with one another, replicate BigLaw’s “full service,” without its soul-sucking bureaucracy.

Austin’s “Cut the BS” Culture: The Ecosystem Grows

In my opinion and based on observations from interacting with players in various ecosystems, Austin’s legal market is at the forefront of this emerging lawyer ecosystem.  Here the quality of attorneys outside of BigLaw – multi-specialty small firms, single-specialty boutiques, and even solos  – is extremely high and increasing, because the client base here isn’t anywhere near as brand-obsessed as in Silicon Valley.  We still have our own cronyism, but our strong “be authentic” cultural bent helps keep it in check.

At MEMN, we connect clients on a regular basis with experienced, top-tier corporate, tax, trademark, litigation, executive comp., patent, etc. attorneys outside of BigLaw, all with better credentials than the lawyers BigLaw throws to startups, and at rates often below inexperienced junior lawyers at large firms.  And, as far as I know, none of us took a pay-cut in leaving BigLaw.  I am fully convinced that this ecosystem will continue to gain traction, and we have every intention of pushing that traction outside of the Texas market, including connecting with firms in other markets doing the same.

How BigLaw Will Respond

Of course BigLaw is responding, but it’s important to keep in mind that “BigLaw” is a set of many different players, each with their own perspectives on the old model.  The big winners of the traditional law firm model were (i) the many layers of in-house administration and management needed to coordinate dozens of specialties and hundreds of different kinds of lawyers, and (ii) the power rain-makers sitting atop the pyramid extracting a significant amount of billings from lawyers doing the work, including all the specialists. These constituencies will absolutely do everything they can to protect the old model.

The main marketing message that will emerge from these groups will be one of “integration.”  They will argue that keeping everyone under a single structure provides benefits that make up for the overhead and inertia. In other words, they’ll try to portray themselves as the “Apple” of law.  Expensive and huge, but “worth it.” I love my iPhone 6.

Without getting stuck on this topic because this post is long enough, anyone who thinks about it will be skeptical of an analogy between software-hardware integration and the ‘integration’ of lawyers in dozens of different specialties, especially as technology continues to erode the friction in cross-firm collaboration.  A better analogy would be something like the Mayo Clinic, but of course that would mean that BigLaw must accept that only the absolutely most complex transactions (think billion-dollar, multi-national mergers) truly require its “integration” – and The Ecosystem would be more than happy to unburden BigLaw (which would then not be nearly so big) of the other 99.9% of the market.

While management and top rain-makers will work to protect The Beast, the rest of the BigLaw pyramid will, over time, come to realize that The Ecosystem is more of a liberator than a competitive threat.  Finally, a way to practice your specialty much more effectively, do interesting work, get paid well for your talent, and not have the significant majority sucked up to pay for “stuff” that doesn’t enhance your work.  Much like how technology has created an explosion of interesting, well-paying work outside of large organizations in many “knowledge worker” industries, The Ecosystem is simply an extension of that process to law.

A Message to BigLawyers

Ask yourself: if you’re billing $625/hr at a large firm and have developed strong relationships with clients, what will those clients say if you tell them you can do the exact same work for them, but charge $400/hr instead – the only real change being the signature block on your e-mails? Certainly The Beast, including the deal lawyer who ‘controls’ the relationship, will do everything it can to push the work to another $625/hr attorney in the firm. But what will the Client say?

Viewed this way, BigLaw today can be accurately described as a mechanism by which rain-makers who (lower-case c) “control” client relationships force the “labor” lawyers to stay in one large firm, accepting only a small percentage of the value they produce in exchange for “deal flow.” And by having the talent pool controlled in this way, clients who need top lawyers have to pay the higher rates to feed The Beast and the rainmakers.  The Ecosystem, and the fact that no one really controls clients (who won’t be forced to pay $625/hr when they can find the same lawyer for $400), throws a wrench in this structure.

A Message to Lawyers Building The Ecosystem

  • Collaborate;
  • Optimize;
  • Don’t fall back on generalism, but resist artisanal lawyering;
  • And absolutely do not underestimate ever the importance of branding and marketing.

Start talking to each other and sharing work.  Being solo has many inefficiencies, and for many specialties the “optimal” structure will likely be more focused firms that effectively leverage their institutional knowledge with targeted, efficient tools and processes.

Take advantage of your small footprint to experiment and iterate on process, technology, pricing, etc. that was never possible under a large firm – you are a startup.  Resist the urge to price yourself as a generalist who does boring, cheap work, but also don’t design your firm in a way that is so “high-touch, high-end” that it can’t scale.  If you’ve hit on something that works, scale it and liberate more BigLawyers.

And absolutely never, ever pretend that all it takes to succeed is to simply “be a good lawyer.”  Clients care about brand and prestige, including the deal lawyers who connect you to clients. No one can find you if you don’t know the slightest thing about marketing yourself. Serious companies won’t want to hire you if your website looks like it was built overnight by a middle schooler. Learn.

The Ecosystem will be built by the most entrepreneurial of BigLaw, including those who are confident enough in their personal brand to break free from The Beast. Once a path has been laid, the more timid will follow.

And a Message to the Gatekeepers

So you say that you’re all about disruption and transparent markets, yet you continue to hand out referrals to firms that write you checks and send attractive blondes offering steak dinners.  I’m not mad at you.  I know how the game works.  Upstanding doctors fall prey all the time to Big Pharma’s biz dev tactics, so I totally understand your inability to resist being a hypocritical little sh**.

Thankfully, every ecosystem (Austin included) has enough gatekeepers who believe in true meritocracy.  The Ecosystem is growing and will continue to grow. Companies will find a much more vibrant, dynamic legal market.  Top lawyers will find interesting, well-paying work in non-soul-sucking settings, and the most innovative will be rewarded with scale.  I’m not pretending to be Mother Theresa and absolutely have an economic dog in this fight.  But knowing all the benefits that accrue both to startups and to lawyers (my people) from it, supporting The Ecosystem is absolutely part of my mission.

Your Startup’s Legal Bill: The Printer & The Cartridge

A client of mine recently used an analogy to explain why he dropped another small, local law firm for MEMN: their printer is cheap, but their cartridges are really expensive.  That statement explains perfectly why many founders, because of their lack of understanding of basic law firm economics, can get really screwed by firms touting their low hourly rates as evidence of their “efficiency.” The core problem is this:

  • In the short term, your legal bill is a two-part equation: hourly rate * time spent. Naturally, that means that a lawyer billing $225/hr can generate a substantially larger bill than a lawyer billing $375/hr if the “cheaper” lawyer takes 3x the time to do the same task as the more “expensive” one.
  • In the long-term, “time spent” is itself a two-part equation: time spent to initially complete the task + time spent fixing mistakes (if the mistake is even fixable).  This should come to no surprise to a CEO who’s spent time interviewing and hiring developers. One developer wants a $60K salary, and the other wants $100k. Is the $60k one a bargain, or overpriced sh**?

The above two points should help make the analogy between printers and lawyers clearer:  a printer can seem like a great deal because the manufacturer locked you in with a low cost of adoption, but you should really pay attention to how much the cartridges cost, and how many you’ll have to use – and whether it flat out sucks. Because that’s where the real expenses are. It’s the exact same thing with lawyers: an exceptionally low hourly rate can seem like a great deal, but how many hours will this ‘bargain’ rate be multiplied by? And what exactly are you getting for that rate?

The “Hourly Rate” Issue

As mentioned above, it is absolutely the case that a lawyer billing $400/hr can produce a dramatically lower legal bill than a lawyer billing $225/hr; meaning that, under the right circumstances, you should be willing to pay more if the value is truly there.  But are there circumstances in which a lower rate does not mean lower quality? Yes, as I discussed in “When the A-Lawyers Break Free: BigLaw 2.0” a lot of clients are shocked to find out that when an attorney at a large firm bills them $675/hr, only maybe 20% (if she’s lucky) of that rate actually makes it to the lawyer (the talent). The rest goes to pay for all the background infrastructure necessary to support a firm full of dozens of different practice groups, offices, summer intern programs, etc.

Thanks to new technology and business models now viable because of that technology, a new breed of law firm is emerging that (unlike their predecessors who attracted attorneys by offering jeans, MacBooks, and a more relaxed atmosphere at the cost of lower compensation) can compensate their attorneys on par with and in many cases better than larger firms.  And those small, focused firms have dramatically lower overhead costs than larger firms. The end result is that, even with significantly lower hourly rates, the attorneys are still highly compensated.  Again, in law as in the world of developers, you get the talent you pay for.

Nutshell: make sure your hourly rate pays for legal talent, not an outdated delivery model.

The “Time Spent” Issue: The Problem with Generalists and Solo Lawyers

Moving to the second part of the equation: what allows a lawyer or law firm to do something more quickly, and with fewer mistakes, than another firm?  The first and most obvious answer is of course: better lawyers (and paralegals). No shocker there. Better, more experienced doctors work more efficiently and with fewer mistakes than crappier ones.  But there’s actually more nuance here than meets the eye.

Focus

You’ve developed a strange rash on your arm, and you need someone to help you treat it. Who do you suppose will be able to get it done more efficiently and effectively – a cardiologist or a dermatologist? It seems like a stupid question, but many people don’t understand the concept of legal specialization.  Focused repetition leads to specialized domain knowledge, which leads to higher quality and efficiency.

There are an endless number of business lawyers, corporate lawyers, even IP lawyers, running around touting themselves as startup lawyers. The reality is that they’ve spent 95% of their careers doing absolutely nothing related to the venture-backed startup space, but because they either stayed at a holiday inn express or because they know someone connected to startups, they’ve started to dabble in the area. How complicated could it really be? I’ll keep my answer short: get ready to be schooled.

Process and Technology

Being a generalist forces you to reinvent the wheel when specialists have already-developed forms, processes, and technology in place to minimize time burn.  A new client of MEMN recently said a prior firm charged $1700 to draft a form contract for hiring developers (which, btw, was garbage).  The startup lawyers who just read that are laughing because they know that a client who asks them for that kind of document gets billed literally 5% of that, if anything at all.

Process and technology are at the core of why the hourly rate of a law firm or lawyer says very little about what you’ll end up paying.  I’ve seen solo lawyers and boutique firms talk about “overhead” as if it’s something to be absolutely kept to a minimum at all costs.  The problem, of course, is that if you don’t invest in technology, knowledge management resources, etc., it is 100% certain that you are going to be incredibly slow and inefficient compared to those firms who do, even if those firms have higher hourly rates.  This is the core problem with solo lawyers.  Yes, their hourly rate is low, but they practice like it’s 1995. And that’s expensive.

While we’ve done everything we can at MEMN to cut out fat and bloat, I have zero qualms about investing in technology that will enhance quality and efficiency. That’s not “overhead.” It’s called running a 21st-century business.  We also have an amazing espresso machine. Treat your talent well.

Conclusion: When you hire talent for your own startup, you don’t immediately go with the person asking for the lowest hourly rate. If you do, you’re a moron. Remember that lawyers and law firms are like printers (and developers).  What looks cheap could end up being the most expensive mistake of your life.

409A as a Service: Cash Cows Get Slaughtered

Background: 409A is a set of tax rules passed, in part, to stop companies from avoiding taxes through issuing underpriced (cheap) equity as compensation.  While well-intentioned, it spawned a cottage industry of third-party valuation firms/i-bankers who charge companies, including startups, thousands (sometimes tens-of-thousands) of dollars to get ‘409A valuations’ for their stock to avoid tax penalties in setting their stock’s Fair Market Value.

Anyone who deals with 409A valuations on a regular basis knows that they are the quintessential ‘cash cow’ for valuation firms and small i-bankers; evidenced by the number of those firms that are constantly inviting lawyers and influential tech players out to lunch in order to get referrals (btw, sorry guys, I’m blogging right now). And if they’ve dug a little deeper, they’ve found that, particularly at the early stage, these valuations are generated in an almost entirely automated fashion. Hence, cash cows: premium price, lots of hand-waiving to make them seem difficult to produce, but ultimately with a low marginal cost.

The Necessary Evil

In practice, startups have been advised by lawyers and their advisors to avoid a 409A valuation until a Series A. Pre-Series A there’s usually not much on the balance sheet and no arms-length price on the Company’s equity to generate a meaningful valuation, so startups just wing it.  Post Series A, however, the vast majority of startups pony up $3-10k to get their valuation, and it has to be refreshed (i) every 12 months, (ii) if there’s a material change in the startup’s financials, or (iii) if a new equity round is done; otherwise it goes ‘stale’ and no longer provides a safe harbor on FMV.

That can get expensive quickly, though any serious company looking to get acquired by a large company or eventually go public knows that the consequences of not doing this can be substantially more expensive.

409A-as-a-Service: The Slaughtering

Finally, eShares (the paperless stock certificate and capitalization tracking company) has pulled off something brilliant: 409A as a Service. Priced as a continuous service (which makes total sense given the on-going need for re-doing a valuation) and supported by well-known and established valuation firms, startups get continuous 409A valuation services at a monthly fee: $159/mo for a post-Series A startup – higher for later stage.

Doing the math, that’s $1,908/yr: easily a 40-50% discount on even the most ‘sweetheart’ deals offered by local valuation firms for post-Series A startups. If you need a refresh within a year, you’re in 90%+ discount territory. Add in the fact that (i) it’s done paperlessly via the web, and (ii) the valuation will be updated for major changes in capitalization or financials (no huge cost to avoid going stale), and we have ourselves a game-changer.

The pricing for Series B, Series C+ valuations is even more competitive relative to market rates for 409A services.  It’s also a brilliant feature for eShares because of how it ties in directly with their existing capitalization tracking platform.

Something tells me that this slaughtered cash cow is going to net eShares and Preferred Return a lot of steak dinners in the future.  The cottage i-bankers who’ve built practices off of milking 409A as much as possible? Not so much. The better i-bankers of course do higher-value things that justify their costs, so they have nothing to worry about. Yes, there are serious parallels to startup law here.

Nutshell:  Startups historically had to pay $3-10k for a valuation after closing a Series A in order to protect themselves from 409A issues, and they had to keep re-paying it on an on-going basis to keep it from going stale.  eShares has changed all of that by offering 409A valuations as a continuous service (as they should be) and pricing them in a manner that aligns more closely with what it costs to produce them.  Cash cows, particularly when visible to techies who like to disrupt things, eventually get slaughtered.

p.s. Like all of the other tools I recommend to startups for saving their capital, I have no financial interest in eShares.

The Economic Deflation of Startup Law

News.  Two big issues have been floating around the startup law space lately. First, Yokum Taku introduced “convertible equity” in an attempt to address the potential downsides (for entrepreneurs) of convertible debt, which set off a debate that Antone Johnson spectacularly Storified. More interesting to me, however, was AngelList’s announcement that seed rounds can now be closed, soup-to-nuts, on their platform.  The real news there, for lawyers at least, is that Wilson Sonsini will close those rounds for free.  Yes, as in nothing.

Startup Law – Deflation Accelerating

Much has been written about the “deflationary economics” concerning startups and the web, with Mark Suster’s post probably being one of the best articulations that come to mind.  Not as much has been written about the indirect effects that industries experiencing economic deflation can have on other sectors they interact with.  Wilson Sonsini’s AngelList pronouncement is, in my opinion, the clearest sign that the portion of the legal sector working with technology startups is itself experiencing rapid deflation — and not because lawyers have suddenly shed their luddite tendencies and read ‘The Innovator’s Dilemma’ (though they should).

What’s happened, essentially, is that with literally every other service used by their clients becoming radically cheaper, and the resulting downsizing of investment rounds, startup lawyers simply couldn’t maintain their usual fees and keep a straight face.  This deflation started out with what you might call Stage 1 deflation, with standardized docs emerging, fixed fee packages, etc.  Startup Law was just efficient at this stage, especially compared to other areas of the law.  But with free, dynamically generated documents from high-end firms available online, and now with one of the best firms in the country saying they will close seed rounds for free, I’d say its reached Stage 2, where commoditized is the more appropriate adjective.  And I’d argue that this has some serious implications going forward.

How We Got Here

First, it’s worth reflecting on the different steps that startup law firms have been (or should be) taking in order to compete in this deflationary environment.  I’d break those steps into 3 categories: contractual, technological, and operational.  These steps could also serve as a model for other parts of the legal field that, while not as aggressively deflationary as startup law, will likely eventually follow a similar path.

Contractual. 

  • Standard Firm Docs – In order to make contract drafting more efficient, firms started modularizing the language of their own documents.  If an investor gets a 1x participating liquidation preference with a 3x cap as opposed to the 1x non-participating currently in the document, ‘drafting’ involves mostly cutting and pasting bracketed language, with minimal tinkering.  While this cut down on internal drafting, it still left room for bickering about language with the other side of the deal.
  • Universal Standard Docs – Going one step further, standardized investor docs like the Series AA and the NVCA Model docs emerged, allowing for parties on both sides to have a common language framework to work from.

Technological.

The contractual efficiencies developed in startup law still required the usual process of opening a word document, filling in blanks, moving around language in a very straight-line fashion, and then proofing to make sure everything is coherent.  Closing required creating signature packets, then tracking signatures and assembling them back into fully executed copies.  But then technology emerged to streamline a lot of this process.

  • Proofing Software – A significant amount of time on a transaction used to be spent by junior attorneys flipping through pages to make sure names are properly spelled, commas are in the right place, and defined terms are properly in place.  Software like Deal Proof emerged that can scan a document and generate a proofing list for an attorney, cutting down on that proofing time by anywhere from (my estimate) 50-75%.
  • Document Automation – Companies like Brightleaf have emerged to turn the cut-paste-and-proof process of working with form docs into one of simply clicking certain options in a form.  Want that 1x participating LP w/ 3X Cap? Just click the right box in your template, and the language will get filled-in automatically, and every other area of the document that is impacted will also be modified. No need to proof.
  • Electronic Closing.  –  With multiple parties often signing dozens of documents, the usual closing process involved creating “signature packets” where you PDF’ed the signature pages of each contract, and created single files containing all the pages that each individual party had to sign.  Without doing this, mistakes would be inevitable.  With electronic signature software like Docusign, this process is largely removed.  Put the ‘Sign Here’ tabs for each person in the appropriate places, and Docusign will (1) guide them to where they need to sign, and (2) generate fully executed documents.

Operational.

One obvious end-result of the contractual and technological developments has been that drafting simply takes a lot less time, which naturally means less money billed.  But what they’ve also done is made the drafting and closing process a lot simpler.  To modify a vesting schedule or a liquidation preference, you don’t really need to understand the actual mechanics of the language. Just click the box.  And to get a deal signed up, you don’t need to create complicated signature packets and coordinate signatures.  Just drop the Docusign tags in the right place, and it’ll do the rest.

Firms have taken advantage of this simplicity by pushing work down to junior attorneys and even paralegals, who bill a lot less per hour.  Where it might have previously required an experienced attorney to draft and close a seed financing, an innovative firm might have a paralegal do 95% of the work, with zero drop in quality.  A partner or senior attorney might spend a few minutes discussing very high-level issues with the client, but that’s it.

The Next Step: Deal Platforms

I have zero doubt that Wilson Sonsini is taking advantage of all three of the above categories.  But the key to really get the kind of deflation reflected in the free AngelList closings is the next step of legal technology: Deal Platforms.  Rather than just the initial drafting of docs being automated, with negotiation over terms and language to follow, the automation becomes bilateral.  If the investor wants a better liquidation preference, he simply fills in a field or checks a different box, and if the Company disagrees, they uncheck that box.

Contract language becomes completely secondary – commoditized – on a deal platform.  One can easily envision a time in which the negotiation of a full venture deal, not just a convertible note financing, involves nothing more than checking boxes and filling in a few fields, with full documents automatically generated and then electronically signed.  The chances of closing such a deal for free are practically zero, but all that automation could make a ~$10K legal bill for a full institutional venture capital financing a reality, which would be about a 50-80% cut on current rates.

Takehome: Nobody should be myopic enough to expect AngelList-like automation to stop at the seed deal stage.  Again, The Innovator’s Dilemma, legal version.  See below from AngelList’s Q&A.

Does Docs support Series A rounds?

No. Docs only supports seed rounds right now. (emphasis added)

Implications: Freemium Startup Law

There are a number of ways that this rapid deflation has and likely will impact the structure of startup law practices.  One result of the already-occurring deflation has been the growth of boutique firms competing with BigLaw by offering similar, albeit more limited, services at lower billable rates.  I wrote about this previously: ‘In Startup Law, Big Can Be Beautiful.

The economic advantage of a boutique practice is that firms can avoid the high billable rates necessary to sustain the breadth and overhead of large law firms, while still offering their experienced attorneys comfortable salaries.  That works well in an environment where the demand is for cheaper seed financings and venture deals. But what happens when free or practically free becomes the dominant expectation?

Cross-subsidize.  As Wilson Sonsini’s move has made absolutely clear, large firms have their own economic advantage with respect to legal fees: cross-subsidizing low-end work with profits from larger deals.  Large firms don’t just handle formations, seed financings, and venture deals, they also handle cash cow M&A and IPO transactions that are not experiencing anywhere near the kind of deflation going on at the low end.  Those deep pockets make offering free startup work a lot easier, provided enough of the loss-leaders generate big deals down the pipeline.

This model of offering a lot of stuff for free and profiting off of the high-end users should look very familiar to techies: it’s the freemium model, applied to law.  And it distinctly favors large, brand-name firms.  Boutique firms lack the institutional capacity to handle the large transactions that a larger firm can use to cross-subsidize free work.  Without more radical change, their only hope is to make up for deflation with volume.  But [insert large number] * free doesn’t pay the bills.  Commoditized deal work favors the cross-subsidization of large firms over the lower labor costs of boutique practices.

Conclusion: Move Fast, Move Up, or Move Out

At this point (when deal platforms become ubiquitous), I see smaller startup law practices having to either (A) get used to operating at much lower margins, or (B) find a way to move up-market and take a piece of the larger deals.  I wrote previously about the possibility of boutiques using technology to scale for large transactions here: The Ad-hoc Law Firm? Granted, I don’t have much visibility into how boutique practices are doing, though I’d love to hear from other attorneys or knowledgeable people on how they see the future panning out.

As for large firms operating in this space, the choice is much more straight-forward: either become radically efficient with your commoditized startup work in order to keep the pipeline flowing, or get out.  I’ve seen firms here in Austin completely exit startup work for exactly this reason.  Thankfully, we’re going with the other option.