Post Category → Legal Tech

Lawyers are Slow, But Firms Shouldn’t Be

TL;DR Nutshell: Don’t be fatalistic in assuming that working with good lawyers always means slow response times. But also don’t delude yourself into thinking that any particular lawyer, if she’s good, will be immediately available for your every need. Asking the right questions about responsiveness up-front will prevent a lot of frustration in your startup’s relationship with its lawyers.

In my discussions with founders re: what they look for in hiring lawyers for high-growth, investor-backed startups, I’ve found that everything usually boils down to 4 criteria (often in the following order from most important to least, but not always):

  • Quality – Top founders usually have a strong understanding that (i) decisions when the Company has $5K in the bank account can (and often will) have a material impact on the business when its hit $20MM ARR, and (ii) cleaning up legal mistakes is orders of magnitude more expensive than doing it correctly the first time.

Quality is typically the main reason that startups ‘upgrade’ from generalist lawyers. See: Startups Need Specialist Lawyers, But Not Big-Firm Lock-In

  • Trustworthiness/ Like-ability – Your lawyers will be (or should be) close advisors working with you on the most high-stakes, strategic decisions of your company’s lifecycle. That relationship will get dysfunctional quickly if you can’t trust them, or simply don’t like them as professionals.

Trustworthiness is typically the main reason startups switch lawyers/firms from those that their lead investors insisted they use. See: Why Founders Don’t Trust Startup Lawyers

  • Efficiency – Hiring good lawyers, like hiring good developers, will never be cheap. It’s a basic law of markets that top talent requires top compensation. That being said, there are a lot of ways that founders can ensure that their legal budget is paying for great lawyers and not for expenses/overhead that isn’t actually resulting in better value.

Efficiency is typically the main reason startups avoid, or stop using, very large firms with billing rates 4-5x of what top lawyers require in compensation. See: How Startups Burn Money on Startup Lawyers

  • Responsiveness – This usually comes last because many founders have, through frustrating past interactions with the legal profession, come to the conclusion that ‘dealing’ with lawyers inevitably involves long wait times. Sort of how I brace myself every time I have to enter a specialist doctor’s office, because I know a 9:30 appointment, which was scheduled weeks ahead of time, usually means actually being seen around 11.

Send your lawyer an e-mail and expect a response in 3-4 days, if he’s not too busy. That’s just what it takes to work with good lawyers when you’re a small startup with a modest legal budget, right? The big fish have their attention most of the time, so just get in line… It doesn’t really need to be this way. Understanding 3 concepts related to lawyer economics will help you avoid this scenario:

1. Appreciate institutional bandwidth – and why, for speed, firms > solos. 

If recruiting and motivating top lawyers requires competitive compensation, then with basic math you’ll see why great lawyers who work with early-stage startups must work with many startups, not just yours, to get paid. Good startup lawyers are busy people, because maintaining a strong portfolio of work allows a lawyer to get paid well without burdening any particular company with an excessively large bill.

However, while a solo lawyer who is very busy will have only one thing to tell her client when they need something done quickly – “wait” – lawyers in firms have institutional bandwidth. If I’m busy, and I often am, I have other lawyers (and staff) in my firm who can be assigned to keep work moving. Properly run law firms know how to manage bandwidth and ensure that work is “spread” throughout their roster, without a loss in quality. This allows great lawyers to stay busy (required for compensation), without burdening clients with ridiculous wait times.

This point is, however, related to a second important concept:

2. For your primary counsel, hire a firm, not a lawyer. But size of practice area matters more than the size of the whole firm. 

The old adage “hire lawyers, not firms” has a lot of truth in it, but that truth only applies with the right factual backdrop:

  • It’s usually said by in-house general counsel, who themselves maintain a roster of specific lawyers (at various firms) that they can task on projects to manage bandwidth. Founders do not have this, and trying to build it for them would be a waste of time.
  • It assumes that there is something very unique about a particular lawyer that you need that others in her firm cannot provide. If you are doing cutting edge niche legal work that is unique to your particular market – like perhaps a patent lawyer with a very deep understanding of your special technology that no one else on the market has, this may make sense. For general startup/vc law, this is flatly not true if the firm you’re working with maintains proper standards and training for its roster of lawyers.

Of course, your primary contact with a firm will be a specific lawyer. But if you want to avoid waiting days, or even weeks, for something as simple as a response to an e-mail, you need legal bandwidth, and that means a firm. Expecting a specific lawyer to handle everything you need is the fastest way to ensure you are going to wait a long time for that lawyer’s attention, unless you’ve got several hundred thousand dollars a year in your legal budget for him. That’s called “in house counsel.”

But take note: there are a lot of law firms with 500, 1000, even 2000 lawyers who are incredibly slow. Why? Because they don’t actually leverage institutional bandwidth. A lot of those lawyers inside these large firm are either (i) in completely unrelated practice areas and hence aren’t actually available to help your particular lawyer (useless to you), or (ii) working in silos (just sharing a brand) with no effective mechanism for collaborating with one another. There are deeper reasons behind this “silo” problem that span issues like technology and compensation structures, but that’s too deep for this post.

Keeping dozens of different specialties of lawyers under the same firm is massively inefficient – to use econ jargon, we can call it “diseconomies of scope.” But within a specific practice area, there are very large efficiencies – shared technology, training, templates, institutional knowledge, and access to client information  – that a focused firm has over a bunch of independent lawyers. That’s why the specialist ecosystem that MEMN leverages is made up predominantly of specialized boutique firms, not solo lawyers (although there are those as well), each with their own institutional bandwidth within their practice area. See: The Tech Law Ecosystem v. BigLaw. 

3. Don’t hire an M&A or IPO Lawyer who uses startups as lead gen. Hire a startup/vc lawyer.

There is a massive difference between a lawyer who focuses on M&A (large exit transitions) and simply pursues startup clients as lead gen for very large deals v. a lawyer whose focus is startups and venture capital. The technology law firms that have very good response times have segmented large exit transactions as a specialty that operates alongside, but separate from, emerging companies corporate work. On top of improving response times, this results in better startup/VC lawyers and better M&A lawyers.  Find one of those firms.

Compare these two lawyers:

  • Lawyer A is assisting this month on (i) a formation, (ii) two seed deals, (iii) a Series B and Series C financing, and (iv) a $500MM acquisition.
  • Lawyer B is assisting this month on (ii) a formation, (iii) three seed deals, (iii) 2 Series A financings, and (iv) a Series B and Series C financing.

If you’re a startup client w/ one of those seed deals or VC financings and have a question, or you’re just a client with a quick question on a new hire, who do you think is more likely to respond promptly to your e-mail? Lawyer B will.

Lawyer A, because of the fundamental fact that large, high-stakes, fast-paced exit deals tend to consume lawyers’ attention (for understandable reasons, big fees at stake) is going to take a lot longer. Hire Lawyer B over Lawyer A, and just ensure that Lawyer B’s firm has M&A specialists for when you need them… or hire Lawyer A and take a number.

Recap: Startups move fast. It is extremely frustrating to founders when their lawyers can’t keep up.  That doesn’t mean you should expect McDonald’s like responsiveness – these are highly skilled, busy professionals managing a portfolio of clients, not your in-house assistants – but if it takes days to even get a response to your e-mail, there’s an underlying problem that should be dealt with. For primary corporate counsel, find a firm with lawyers who focus on early-stage/emerging tech work, and with institutional bandwidth within that specific practice area.

And if you want the truth on how responsive a group of lawyers are, there’s no better place to go than that firm’s client base.  Believe me, if a founder CEO is frustrated with the responsiveness of her lawyers, you’ll have zero trouble getting her to talk about it.

Converting Your Startup to a Delaware Corporation, Correctly.

TL;DR Nutshell: If you’ve accepted that you need to convert your startup to a DE corp from a different entity type, then it’s also time to accept this: there is no off-the-shelf, “click a button and file” way to convert to a DE corp. It is highly contextual. The right lawyers can do it efficiently and correctly. The wrong ones will tell you it’s simple, screw it up, and require you to pay the right lawyers 5x more in the future to clean it all up.

Background Reading:

The purpose of this post is not to debate whether your startup should be a Delaware corporation. While we do work with a decent number of VC-ish backed Delaware LLCs (sometimes LLCs really do make sense), the vast majority of technology companies that raise venture capital either start or end up as Delaware corps. And the moment a lawyer starts playing contrarian with me, talking up why Delaware isn’t needed, or C-Corps are tax inefficient, I quickly end the exchange by asking how many VC-backed companies she’s actually worked with. We are talking about scaling tech companies and venture capital. Not small businesses or companies funded by local, non-institutional investors.

So for purposes of this post, we are going to take it as a given: you need to be a Delaware corporation, but you aren’t one right now. Converting is simple, right? Just file a form?

Converting from any kind of entity to a DE Corp is not “standard.” Ever. 

Properly forming a DE corp startup from scratch has, thanks to standardization and automation, become a relatively straightforward process.  The reason, of course, is that you’re starting from nothing, and nothing is the easiest condition to automate from; no messy context throwing a wrench in the system. Conversion, however, involves a history with any number of possible permutations, and that means all the shiny templates and technology must give way, partially, to human judgment.

  • What are your state’s rules around entity “conversions”; is a “statutory conversion” allowed, or will you need to do a merger or possibly even an asset sale? It depends. 
  • What approvals does your state’s rules require? It may be a majority of all equity, it may be 2/3, it may be unanimous. It depends.
  • What specific documentation (like a “Plan of Conversion”) and filings (often in both states, not just DE) do the rules require? It depends.
  • Are there any existing agreements in place that might require a separate consent to be obtained before the entity can convert? Ok you get the idea.
  • Does the company’s existing capital structure require a (hopefully quick) discussion with tax counsel regarding possible tax hits (phantom income) resulting from the conversion? This is a crucial issue to consider when converting an LLC to a Corp. 

Converting a Non-DE Corp to a DE Corp (Corp to Corp) is generally simpler than converting an LLC to a Corp. Converting any entity in a state that allows for statutory conversions (TX and CA do, NY does not) is generally simpler than having to do a statutory merger.  Whatever the context, you will screw it up trying to do it yourself. In fact, I’ve lost count of how many law firms have screwed it up, requiring founders to pay us 5-10x in cleanup costs than they would’ve paid if they had just hired competent counsel from Day 1.

The reason you will never just push a button to receive medical treatment is that every person is different, and tailoring high-stakes treatment to individual differences is precisely what professional judgment (supported by tech, of course) handles best.  Startup law is no different. Technology and tools absolutely cut down on waste, and yes there is a lot that is standardized even in conversions.  But in the end the institutional knowledge of the law firm you choose will determine whether it gets done efficiently and correctly, or whether you’re just deluding yourself into thinking that the guy promising a cheap, simple conversion actually knows what he’s doing.

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.

When the A-Lawyers Break Free: BigLaw 2.0

Nutshell: The world of transactional tech law used to be divided into A-Player lawyers earning the gold at large firms and everyone else making a decent living at second-tier small firms. SaaS eliminated that world, and small can now mean better, faster, and more lucrative; which means A-Lawyers are breaking free.

No one who operates in the startup space needs to be told that bigger does not always mean better.  In fact, the opposite is often the case. Being large often makes you slower, more bureaucratic, and inefficient. Just try getting a piece of new technology adopted at a major law firm, or getting a secretary to learn that technology.  I’ve been there.

Big Was Better

If bigger leads to better performance, there must be something about the nature of the product or service in question that requires a large organization.  In law, that “something” was historically (i) expensive, proprietary resources to properly service clients (barriers to entry), (ii) the need for collaboration among multiple specialties, and (iii) high amounts of friction in effecting that collaboration.

Before the days of SaaS and Secure Cloud Storage/Collaboration, top-tier transactional law required at a minimum (i) a law library, (ii) internal word processing, (iii) teams of administrative support and attorneys, and (iv) dozens of legal specialties under the same roof.  Without that, you would be slow and inefficient.  In that world, choosing a small firm usually meant, as a fact, that you were dropping down a tier in quality.

And then things changed. Your “library” is now a subscription SaaS service. Word processing you can outsource by the hour. Same thing for admin support.  People working remotely often collaborate more easily than people working within the same law office, if they use the right tools. When BigLawyers step back from their billing timer and realize this, two very important thoughts come to mind:

  • Why are you all here? – Why do we (all kinds of different lawyers working in different areas that require different processes) need to still work under the same structure? I’m tired of having to justify to a bunch of litigators or IP lawyers that some software that I NEED for MY practice needs to be put into the budget. Why can’t I come to work in jeans if my clients don’t care? Why do I even have to come in to work today? All I do is stay in my office anyway.
  • Where the f*** do all my billings go? I bill $600 an hour. I take home like 20% of that. Wait, you mean all of this obsolete, bloated, bureaucratic infrastructure is the reason 80% of what my clients pay disappears? They hired me, not your brand. Why am I here?

Focus Always Wins

Every variable that once made the large, full service law firm necessary and optimal has been turned on its head by the web, SaaS, and the cloud. Now, a corporate lawyer at a small firm can staff a deal just as quickly, if not more quickly, utilizing a network of smaller, more focused, more efficient and (yes) better lawyers and law firms. It doesn’t take a Harvard MBA to understand why a top trademark lawyer operating out of a trademark boutique that does nothing but trademarks is going to be vastly superior at (guess what?) trademarks than a lawyer who works alongside dozens of other types of lawyers. Focus trumps being a generalist; and that applies equally to lawyers and law firms. 

But the reality of how SaaS has changed the landscape isn’t exactly news, at least not to people who follow these topics. Why then has it still seemed as if large firms have a lock on the best lawyers?

Money

In every profession, the best expect to be paid according to their talent. This is not rocket science, nor is it surprising. A-Lawyers have stayed in BigLaw for one very simple reason: it paid the most. Notice the past tense.  When big really did mean better, the better clients went big, and that means big paid more.

But it was only a matter of time that enough top lawyers started asking themselves “where the f*** do my billings go?” and realized that BigLaw’s overhead and bloat leaves an enormous amount of room to cut out fat, charge less, and still take home WAY more.  Yes, my friends slaving away in BigLaw trying to hit your 2000-2150 billables quota so you can earn that nice little bonus amounting to 3% of your billings, the cat’s out of the bag. Many of us at small firms earn more than you do. A lot more. And we do it with better technology, a more flexible schedule, and often working from wherever we want. All while our clients pay a lot less. Who, long-term, do you think is going to win at attracting talent?

You know what’s better than profits-per-partner? Profits in your wallet.

Networked Law: BigLaw 2.0

Examples of specialists we (corporate lawyers at a small firm) use to staff deals (i) a former silicon valley BigLaw tech transactions partner (head of his group) now operating a solo practice, (ii) a T100 in Texas trademark lawyer operating out of a trademark boutique, (iii) one of the country’s leading open source specialists operating a solo practice, and (iv) a veteran venture capital paralegal working virtually from Palo Alto. Everyone bills 40-60% less on an hourly basis than they would at a major law firm, which doesn’t even account for their ability to optimize pricing, process, technology, and staffing for their practice area. And, yes, everyone takes home more than they would in BigLaw.

You know what that’s called? D-i-s-r-u-p-t-i-o-n.  I don’t use that word lightly. This is not a piece of software that large firms can ultimately pay a consultant to help them adopt, but a fundamental restructuring of how top-tier transactional law operates.

The Future

Small firms are not just for the mickey mouse club anymore. The A-Lawyers are asking “Why are you all here?” and “Where the f*** do all my billings go?” and are doing something about it. Focused, faster, efficient, networked, and now with much bigger paychecks. Small law has been around for a while. But BigLaw 2.0 is just beginning to ramp up. As more A-Lawyers set themselves free, most of BigLaw will have to face the reality that all the branding in the world can’t save a bloated, overpriced, and now completely unnecessary delivery model.

p.s. We’re hiring.

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.