“We received a term sheet from a competing VC syndicate, and if I go to our current lawyers, our existing investors will find out about it before I want them to. Our law firm does a lot of work for our VCs.”
“Our VCs told us that if we used their preferred law firm, they’d close more quickly and even save us money by not hiring their own lawyers. But if we went with another firm, there ‘could be delays.'”
“I went to my Board to disclose this highly confidential issue that only our lawyers and I knew about, and I realized that our VCs were already aware of it. No one but our lawyers could’ve disclosed it.”
“The lawyers that our investors connected us to said that the valuation in our term sheet was about market. It was only after closing that I found out we got totally hosed.”
The above are quotes or paraphrases of statements that we, as a firm, have heard directly from founders/executives as they explain their reasons for changing law firms. The unifying theme should be obvious, and it relates to the broader issue of why so many founders have such dim views of startup lawyers in general. In short, by playing fast and loose with conflicts of interest in the pursuit of maximizing short-term revenue, many startup lawyers and law firms have squandered their most valuable currency: trust.
Related Reading: How Founders Lose Control of Their Startups
What is Counsel?
No one who reads SHL or interacts with E/N’s tech practice would argue that our approach to the practice of law is “old school” in any sense of the term. The significant drivers of our growth include rethinking major facets of law practice, including organizational structure, compensation models, project management and technology adoption. However, while I am very much a tinkerer with respect to the delivery of legal services, I am quite old-school in my view of what lawyers fundamentally are, or at least should be: trusted counsel.
In a heated, high-stakes lawsuit or investigation, virtually everything you’ve ever said in writing to investors, to other executives, to friends and family, can be forced out into the open for everyone to review except for confidential communications with the Company’s lawyers (attorney-client privilege). Take a moment to let that sink in. Nothing that you ever do or say as a company is more secure from forced disclosure than what you say to your lawyers. That is, of course, unless the lawyers themselves disclose it.
Ask many founders whether they really trust the lawyers representing their company, and some will flat out say that, to them, their lawyers are just subject-matter experts there to paper deals and ensure the company doesn’t blow up from legal issues; highly-educated paper pushers and fire extinguishers. Others will say that they do trust (in a sense) their lawyers, but when pushed into a serious, high-stakes situation in which total objectivity and confidence is paramount, the reality of their superficial relationship will surface.
- Is the valuation they’re offering appropriate for our company, geography, and market?
- Is this provision dangerous? Is it standard?
- Some local people are pushing us to X accelerator, but we’re not sure it’s right for us. What should we do?
- We need to make a major strategic shift that some of our stakeholders will want to block – what are our options?
- My company is going under if I don’t get this deal done, but X investor says he will block it. Can he? What are my options?
- We just got an acquisition offer, and I’m not sure whether it’s fair to me and my management team. What should we do?
- One of our senior executives just got arrested. No one can find out about this until we know more. What do we do?
These are just a few of the kinds of questions that trusted counsel gets asked. But trust, particularly the kind of trust we’re talking about here, carries a high price tag: independence and objectivity. How can you trust my opinion about whether an acquisition offer is fair to the Company if the investors pushing you to sell have me on speed dial, and just sent me an invitation to their pool party? How can you trust me to give an honest assessment of a term sheet, or even a comparison of one term sheet v. another, if I’ve closed 20 deals for the VCs who submitted one of those term sheets, and have 3 more in the works? You are one deal. They are 25. Lawyers aren’t that bad at math.
Let’s be real: you can’t. Not possible. Founders know it, and in a world in which so many lawyers have given into the incestuous biz dev practice of playing both sides of the VC table, the result is a deep cynicism toward startup lawyers. Do I choose X firm or Y firm? Whatever. They’re all the same. I’ll just go with the cheaper one, or whatever one makes closing my financing easier. Some lawyers who regularly represent startups have even strategically made VC fund formation a core component of their firm. Smooth.
What “Alignment” Really Means
To the majority of lawyers (outside of the startup space) and investors (outside of the startup space), the above views are totally uncontroversial. Make sure your own lawyers are independent and objective? Umm, yeah, thanks Captain Obvious. And even within the smaller sphere of startup/VC work, I know several investors and lawyers who draw a hard, ethical line to ensure that their reputation is not muddied in the pursuit of short-term revenue. If their investor-client is investing in a startup, they don’t shimmy over to the other side of the table with a smile on their face and a conflict waiver in-hand. They insist that the startup get their own lawyers. Trusted counsel.
But then there are the other people. “Deals get done faster” – “Startups save money on legal fees” – and (my favorite) “We’re all really aligned here, so why do we need two sets of lawyers?” Seriously?
I like to take complex issues and distill them into very simple statements totally free of B.S., so here’s one for you: when someone buys your startup for $200MM, there’s ultimately two places that money can go: in your pocket (and of your co-founders, team, etc.), or the pocket of your investors.
What was that about “alignment” again? And to be clear, the price tag gets negotiated in the acquisition, but guess where the % distribution between Pocket A and Pocket B gets largely negotiated? Financings. 1% of $200MM is $2 million. So you’re negotiating whether millions of dollars in an exit will go into founders’ pockets or VCs pockets, and you’re telling founders they should just use the VC’s lawyers to close the round – because it saves maybe $10-20K in legal fees? Right. Thanks for ‘looking out’ on the legal budget.
Founders and their investors have shared interests in building a highly successful, profitable company. That much is doubtlessly true. But anyone who uses “alignment” as a justification for founders not worrying about the independence of their company’s lawyers is either (a) totally lying or (b) laughably lacking in even a basic understanding of human nature.
This is not to say at all that founder-investor relations should be viewed as adversarial. Clearly not. I’m all for honesty, respect, transparency, and the like in company-investor relations. It’s an important long-term relationship. However, healthy relationships are built on reality. And the reality is that VCs have limited partners for whom they are legally obligated to maximize returns. It doesn’t at all make them bad people. It just means that they, like the rest of us, have a job to do. They are not your best friends, they are not your mom, and they are most certainly not fully “aligned” with the company’s economic interests. Hire your lawyers accordingly.
Drawing a Firm Line
In Austin, you frequently hear the mantra “be authentic.” No, not authentic in some anti-corporate, hipster sense, but “be who you say you are. do what you say you’re going to do.” Don’t hide behind excuses like “this is how it’s always been done before,” or “this is how the game has to be played.” Change the game. Rewrite the rules.
A while back the tech/vc attorneys at E/N sat down together over lunch to discuss the above issue. We’ve all dealt with it at prior firms we worked at, and there was no possible way of doing anything about it there. But there’s a funny thing about leaving big, corporate environments for smaller, focused firms (like startups) – it’s much easier to establish a set of firm principles, infuse them into the group’s culture, and protect them as the group grows. And here we are: E/N, as a firm, does not and will not play both sides of the Tech VC table.
Everyone here understands it, is committed to it, and anyone who wants to join the firm will have to as well. And many of our clients are well aware of high-profile early-stage investors whom we’ve, politely, chosen not to represent as a result of this policy. Loss in short-term revenue? Sure. But this is a long-term play. Rather than following other lawyers and firms in chasing anyone who will write us a check, we believe deeply in preserving our clients’ trust, and have chosen to bet on it. If you want a paper pusher, I’m happy to make some recommendations. We provide legal counsel.
Also published on Medium.