A Startup Lawyer is Not a Founder’s Lawyer

TL;DR Nutshell: It’s extremely important to hire independent counsel who isn’t incentivized to favor, because of existing relationships, the interests of your investors above those of the company.  But it’s also important to understand that company counsel represents the best interests of the company, including all stockholders, and that can often conflict with the personal interests of individual founders.

Background Reading:

A core message that I’ve focused on via SHL can be summarized as follows: many influencers for a startup, particularly investors, will often push founders to use their own preferred lawyers as company counsel, but given the amount of confidential information your lawyers will have access to, and the degree to which you will rely on their counsel for key strategic decisions, ensuring your lawyers’ impartiality is extremely important.  Naval Ravikant put it well in Lawyers or Insurance Salesmen?

Don’t just go with the lawyer that the VCs insist upon. These lawyers will work with the VC on a hundred financings and with you on only one. Where do you think their loyalties lie? Get your own lawyer, and don’t budge.” -Naval Ravikant

This post is about a related, but very different point: hiring a law firm that impartially represents the company is not (and cannot be) the same thing as hiring a firm that represents the founders. Company counsel is not founder counsel.  An analogy may be helpful for explaining the difference:

Imagine a family that is going through some tough times – the spouses are in constant disagreement over issues like work-life balance and parenting responsibility, and it’s starting to impact their children. They seek the advice of a family therapist.

The family therapist does not represent one spouse or the other, nor does she represent the children. She represents the family, as an entity/unit that exists apart from the individuals that make it up. Like a family therapist whose priority is the well-being of the family above the individual members, company counsel’s responsibility is the interests of the company as a whole unit, including all of its stockholders, not just the interests of the founders, or the CEO who hired the lawyer.

At Formation

At the very early stages of a startup, this company counsel v. founder counsel distinction is often not terribly relevant, because the founders, as a fact, are the entire company; they make up the entire cap table. Though I have been in situations where disagreement among founders requires me to drive home the fact that, as company counsel, I do not represent one particular founder over another. Company counsel represents the pie as a whole, not any particular slice of it.

In a Financing

In negotiating a financing, the company v. founder counsel distinction is typically far less important than the company v. investor counsel distinction (the first point discussed above). Investors (who should hire their own lawyers) have a desire to maximize their ownership of the company and secure as much potential exit value as they can, at the expense of the ownership stake of the remaining cap table. Company counsel’s primary role in a financing is to advise the existing stockholders of the Company (particularly the common stockholders, making up founders and employees) on balancing their desire for investment with their desire to not give up significant ownership or control to outsiders.

Post-Financing and Exits

It’s after a financing that the company v. founder counsel distinction becomes very important. One of the primary fiduciary duties of a company’s Board of Directors is to maximize aggregate shareholder value (the entire pie), and Company counsel’s role, apart from day-to-day general counsel, is to advise the Board on various matters (like acquisition offers, strategic partnerships, etc.) that influence shareholder value. The reality is that advising the company/board on maximizing total shareholder value is often very much aligned with the interests of the common stockholders (including founders); more so than with investors.

Investors will have a liquidation preference that allows them to be paid something in an exit before any value goes to the common, so there are many scenarios in which they (investors) may favor an exit that the common stockholders do not support. A company counsel that is focused on advising for what maximizes exit value for all is usually indirectly working in the best interests of the common stockholders. Delaware  corporate law actually acknowledges this, by asserting that a Board’s primary fiduciary duties are to the common stockholders lacking liquidation preferences or special liquidation rights.

Nevertheless, there can be a number of situations in which company counsel’s focus on the best interests of the company and all stockholders (preferred and common) is not aligned with the personal interests of a particular founder. For example, a founder CEO may want to negotiate for an employment agreement that makes it extremely expensive, almost impossible, to fire her. While providing some protection to a CEO, so that she can focus on value creation and not her personal financial security, can be value maximizing for everyone (that’s why employment agreements are signed), there is definitely a point after which you’re giving too much to the CEO and just unjustifiably entrenching her.

In that kind of scenario, company counsel’s role is to make it clear to the founder that he’s looking out for the company, which certainly includes the founder, but also includes other stockholders. If the founder wants to negotiate heavily for an employment agreement that is biased in her favor, knowing that entrenching herself isn’t the best option for the company, she may want to hire her own lawyer (apart from company counsel). Many times in these scenarios (I’ve experienced) founders are fine not hiring their own personal lawyers, because on some level they too are interested in what’s good for the company as a whole.  There’s a certain dysfunctionality that tends to sink companies when founders have detached their personal motivations from the well-being of the company generally. But it depends heavily on the circumstances, including the composition of the cap table and the Board, the stage of the company, and the personal dynamics between the founder, investors, and even the lawyer(s).

In the same sense that we, as a firm, have a established a policy of not representing early-stage Tech VCs who invest in our clients (to preserve trust), we also avoid representing founders as their personal counsel. Apart from the fact that law firms are often overkill for that kind of personal representation (solo lawyers are usually a better fit), we prefer to make it clear to all parties that we are company counsel from Day 1.  When high-stakes situations require us to advise on what’s best for the company, we don’t want any side phone calls (from either side) asking for favors.

Quality founders who build strong companies should want company counsel who will speak with a high level of objectivity on key issues involving corporate governance, even if it’s not exactly what the founders would, personally, prefer to hear. No truly successful family has ever been built by people all fighting for their own interests at the expense of the whole. The same goes for startups and their founders.

Splitting Founder Equity: Avoid “Grunt Funds”

TL;DR Nutshell: If you plan on building a scalable, VC-backed company, you need to learn (early on) to have hard conversations. Fact. Your first hard conversation may involve figuring out the equity split among founders. A few people (who are good at SEO) are pushing a concept called “Grunt Funds” in which founder equity, instead of being negotiated and set from the beginning, continues to change month-by-month according to some overly complex formula.  I’ve never seen it work well in the context of high-growth tech startups. Have the hard conversation. If you can’t figure out how to split founder equity, good luck building a company. 

Negotiating the “equity split” among a pair or group of founders is an extremely important part of a startup’s formation process, and there is a lot of good web content available providing guidance on how to get it done. Below is a list of a few articles worth reading. I don’t necessarily endorse all of what they say, but it’s your job as CEO/Founder to read, make your own judgments, and act on them. Advisor Whiplash is part of the job.

Another piece of relevant reading on how to document founder splits: SHL: How Founders (Should) Break Up

The point of this post is to make one thing clear: if you are building the type of startup that will raise angel and VC money, stay away from “Grunt Funds” or anything that attempts to create a variable, constantly changing founder equity split. 

Figure Out the Numbers. Don’t Hide Behind Formulas. 

I’m not going to link to any articles promoting the “grunt fund” concept to avoid giving it any more air time on Google than it already has. The origin is a book called “Slicing the Pie.” Basically, instead of figuring out founder equity %s like a normal company, “grunt fund” founders set up a formula with half a dozen metrics that are measured on a monthly basis to gauge “performance,” “contribution,” whatever, and founder equity is accumulated over time based on those metrics. It is tedious, ends up costing more in legal fees in the long-run, and in my experience never survives scrutiny from investors. It has, every time I’ve encountered it (thankfully, a significant minority of cases) ended up being a waste of founder time and money.

Good Founder Docs Are Already Flexible

The core driver behind the desire for an always-changing equity split among founders can be boiled down to one question: “what if things change?” What if one person turns out to be a dud, and another unexpectedly a rockstar? What if someone’s personal life causes them to leave? What if the business changes and a particular founder’s skills are no longer valuable?  These are absolutely valid questions, and they require that founder equity have built in mechanisms to allow equity to be readjusted if needed.

Thankfully, there already is such a flexible mechanism in well-known, standard startup formation documents: it’s called a vesting schedule. If one person is no longer valuable to the startup, then they can leave, forfeiting their unvested equity. Or if they refuse to leave, they can be fired, also giving up their unvested equity.  Or if one person knows they’ve turned out to be more valuable than the % they got, they can force a hard discussion, with a credible threat to walk. If they are in fact as valuable as they think they are, the other founder(s) will change their %.

Is this set-up totally flexible? No, it’s not meant to be. Is it as egalitarian as a grunt fund? Maybe not, but nobody said successful startups are democracies. Brilliance is rarely built by committee. See Mark Suster on “The Importance of Benevolent Dictators.” Founder in-fighting probably ruins at least as many companies as flawed business fundamentals.

Smart Founders Figure it Out.

In my experience, successful startups are generally built either by a single founder or by founders who, more or less, know their place in the hierarchy. They have a common vision, often have strong, trusting relationships (friendships), and have a pretty good feel for whose skills really are more valuable to the startup than others. The CEO is the CEO, and the other founders know exactly why he/she is CEO. They have the tough conversations early-on, and if circumstances warrant a change from the original split, they figure it out. Ultimately, a solid founder group cares far more about building a successful company than about burning time in nonsensical formulas every month trying to see whose % went up.

I’ve seen all kinds of equity splits: 50/50 (generally a bad idea, but not always), 60/40, 33/33/33, 51/49, 80/20, all kinds of iterations. The “right” split is highly circumstantial. But in the end, the founders figure out the numbers, paper them with solid docs, and move on.

Does this mean “grunt funds” don’t work for anyone? No, I didn’t say that.  I work with the segment of the startup space that goes after scale and (usually) large amounts of outside investment needed to reach that scale. Founders jumping on that train know from the beginning that they are in for a very bumpy ride, and that anything short of complete trust and unity of vision among the team will result in a train-wreck. I’m sure GFs work in some contexts, just not in high-growth tech startups.

Have the hard conversation, avoid tedious formulas, and then get to work.  

How Startups Burn Money on Lawyers

TL;DR Nutshell: There’s a lot of bad advice floating around startup ecosystems about how lawyers work, and how founders should go about minimizing their legal burn. Much of that advice, which is given without ever actually consulting lawyers, ends up costing founders more in legal fees in the long run.  Below are some thoughts (from someone who actually knows how startup law works) on how to not burn money on legal, while also not blowing up your company.

First off, let’s go ahead and get this out of the way: I am a startup lawyer.  Some would claim that this discredits me in writing about startup legal fees, because clearly I’m just going to write whatever maximizes my compensation. Right? Never mind that I spend 90% of my time on SHL writing about how startups can or should, for example:

If your attitude is that all lawyers are money-grubbers with no ethics beyond maximizing legal bills, then (i) this blog is not for you and please don’t ever e-mail me, (ii) I’m 99.9% confident that you’ve never actually built anything successful in business, and are not likely to, which is why you’ve never known good lawyers, so again please (iii) never contact me.

Now that we have that out of the way, here is a starting fundamental principle: when you put aside the issue of institutional overhead (which is a massive issue), the economics of lawyers closely aligns with the economics of developers: great developers, and great lawyers, expect great pay. If you’ve come to accept the reality that building a company on quality, scalable, durable software code requires paying the money to bring in great developers, it should not stretch your imagination to grasp why building a company on quality, scalable, durable contract drafting (which, when you think about it, is a lot like software code) requires paying the money to bring in great lawyers. And lest you forget, it does not cost $250,000 in education to become a software developer, but sadly (very, very, deeply sadly) that’s the going rate of top-tier law schools. :: deep sigh ::

Software code may determine whether your company ever makes money, but legal code determines whether you ever make money. That’s why founders who actually know what they’re doing hire great developers and great lawyers. 

With all of that in mind, the startups who burn money on lawyers fail to follow these basic rules:

1. Hire an actual Startup Lawyer, early.

Not an M&A lawyer. Not an oil & gas corporate lawyer. Not an IP lawyer. And certainly not the schmuck hanging around your coworking space or incubator who, because he’s friends with someone, decided to re-brand himself as startup lawyer without ever having seen a real VC deal. If you have a heart issue, you call a cardiologist. If you’re building a startup that will raise venture capital, you hire a lawyer who specializes in (guess what?) startups and venture capital.

There is a very simple test for determining whether the lawyer you’re talking to is actually a startup lawyer, notwithstanding what his LinkedIn profile says:

  • A. What were the last 3-5 Series A deals you closed, as the lead lawyer?

If the lawyer doesn’t pass the above test, you will never forgive yourself after going through the world of pain he will bring to your company.

And separately, cleaning up the mess of a bad lawyer ALWAYS costs 10x what it would’ve cost to have it done correctly on Day 1. You are not being capital efficient by letting your “lawyer friend” handle your formation, with plans to get a real lawyer when you’ve raised a little seed funding. You’re just accepting a smaller legal bill early on for a much much larger one a bit later.

2. Hire a law firm (not a solo lawyer), but not one too big (unless you plan to be a unicorn).

Now I’m ruffling some feathers, but SHL is not about making friends. Background reading:

Hire a solo lawyer, and you will (i) end up paying for a massive amount of inefficiency that an intelligently structured law firm would’ve avoided by adopting the appropriate technology, processes, and staffing, and (ii) max them out quickly. A $200/hr rate is not efficient if it’s multiplied by 3x the number of hours. If you are building a small company for which maybe a 6 or 7-figure exit is the end-game, a solo lawyer can be a great, even optimal fit. But companies going after big exits outgrow solo lawyers very quickly, and switching lawyers is very expensive.

Hire a very large firm, however, and you will pay for an enormous amount of bureaucracy and overhead that will not add a single bit of value to your company.  You’ll pay $600/hr, and $150 will make it to the lawyer, if she’s lucky. The fundamental principle requires paying for lawyers, not a bunch of unnecessary fluffModern software/SaaS has rendered the institutional structure of large firms completely unnecessary.

And be careful with referrals w/o your own verification. Out of hundreds of people I interact with, there are only a handful whose opinions on referrals for various services I actually trust as objective and based on merit. There are so many side-deals, “I scratch your back, you scratch mine” arrangements, and general cronyism in startup ecosystems that should lead you to be skeptical of any particular person’s lawyer recommendations. See also: Why Founders Don’t Trust Startup Lawyers. 

Sidenote: there is an exception here for companies truly on a billion-dollar track. BigLaw, with its extremely high rates, is designed for massive scale. If you legitimately see yourself as the next unicorn, then perhaps BigLaw really does make sense.

3. Use Specialists.

Background reading:  Startups Need Specialist Lawyers, But Not “Big Firm” Lock In

If a single lawyer says he can form your startup, close your seed financing, draft your real estate lease, draft your provisional patent, and apply for your trademark, run like the wind. This should be self-explanatory.

4. Do your homework, but don’t pretend that you can DIY.

If your startup law firm offers some very early work (like a formation) on a fixed fee (and they should), they are not doing it out of the kindness of their charitable heart. They are doing it because it (hopefully) makes economic sense for both sides. If you expect your lawyers to spend hours explaining to you the ins-and-outs of vesting schedules, IP, how convertible notes work, etc. etc., and yet somehow magically fit it all into an affordable fixed fee, you’re only going to select for crappy lawyers who have no choice but to accept such an unprofitable arrangement. Remember the fundamental principle.

The best founders I work with do their homework, and when they come to me with a request, they have already developed a working grasp of 75% of the concepts. Reading startup/vc law blogs, books, articles, etc. is to building a startup what reading WebMD is to being a medical patient. You will save money, make fewer mistakes, and get an overall much better end-result.

But the flip side of this is – accept that, no matter how much startup law might seem totally simple, even easily automatable, this is some complicated sh**. Very very smart people hire smart lawyers because they are smart enough to know what they don’t know.

You may think “I just want to issue some stock. That’s simple, right?” without having any clue as to all the steps that need to be taken, questions that need to be answered, and processes that need to be followed to actually accomplish that goal in a way that doesn’t create huge regulatory or contractual problems.  If you’ve hired the right lawyer(s), trust them to do their job. You will mess it up. 

5. Be Organized, and Make Clear Requests.

Related to “do your homework,” go to your lawyer(s) w/ clear action items or, at a minimum, clear questions that will help you arrive at clear action items.  You will burn a lot of legal funds asking your lawyer for one thing on Monday, changing the request on Wednesday, and then asking for tweaks on Thursday, than if you’d just waited until you knew exactly what needed to get done before making the request.

6. Be Realistic.

Good developers try everything they possibly can to avoid clients/CEOs whose views on how much time it actually takes to accomplish a task are totally detached from reality.  Good lawyers do the exact same thing with clients.  If (i) you have vetted your lawyer(s) and determined that they are trustworthy, efficient, and highly knowledgeable, then (ii) you should not be badgering them every month about why the bill is higher than you wanted it to be. It could backfire.  It would be ridiculous for me to walk into a company and tell the CEO how to run it, with zero domain expertise. Don’t be just as ridiculous with your lawyers and their practice.

Newsflash: you will ALWAYS pay more for lawyers than you want to pay. Remember the fundamental principle.

Hire an actual startup lawyer, at a firm that isn’t too big. Use specialists. Do your research, but trust your lawyers. Stay organized, and stay realistic.  Follow these principles and you will not get that Series A financing for $5,000 like you always wanted, but you will easily save 6-7 figures in legal fees over the life of your startup, and have a much healthier relationship with some of your closest advisors.