Post Category → Startup Law Firms

Startup Law Pricing: Fixed v. Hourly

TL;DR: There are very natural reasons – inherent in the dynamics of complex, high-end legal services, including for startups – that explain why flexible time-based billing is still the most common pricing structure among law firms specialized in emerging companies (startup) law. And there are very real downsides and limitations to “fixed fee” pricing that founders all need to be aware of; including, most importantly, that flat fees reward law firms for reducing the quality and flexibility of their work (such as not negotiating key terms, and delegating to junior professionals) in ways that first-time entrepreneurs are often unable to detect. Aggressive investors particularly like promoting flat fees as a way to incentivize your lawyers to not negotiate.

First-time entrepreneurs, who’ve usually never hired serious lawyers before, understandably get heart burn when thinking about the cost of legal services. The goal of this post is to provide some clarity on how legal billing for startups works in general, and to also bust a few myths circulating around ecosystems on the topic.

First, I strongly suggest reading: Lies About Startup Legal Fees. A few highlights:

  • Long-term, client-facing legal technology does not dramatically cut legal spend for startups.
    • As a legal CTO who regularly tests and adopts new legal tech for our boutique firm, I have a very clear understanding of what technology, including cutting edge machine learning/AI, is capable of accomplishing in high-end, high-complexity legal services. In the very early days, where complexity and cross-client variability is minimal (like formations) tech can and does play a key role in keeping costs down, but in startup law its utility breaks down fast. I am a very early adopter, but one thing I don’t adopt is techno-BS.
    • In the long-term, given the high, often irreversible cost of errors and the significant variability between clients, legal technology plays only a small role in cutting overall spending. This is, at the end of the day, a highly trained human judgment/skill driven business, with targeted technology in the background. Anyone trying to make this area “LegalZoom-y” will eventually crash right into the fundamental realities of the business.
    • While some techies will certainly tell you otherwise, the most “disruptive” developments in law aren’t in adopting software or technology, but in eliminating unproductive overhead, simplifying firm structures, and implementing project and knowledge management more consistently and deeply; enabled by off-the-shelf tech that is hardly earth shattering. These strategies cut the cost of legal by hundreds of dollars an hour, while improving responsiveness and quality; which exactly zero pieces of tech can even get close to doing. See: The Boutique Ecosystem v. BigLaw. Subtractive, not additive, innovation.

Sidenote: there are big market opportunities for AI/ML and other legal tech in serving very large clients with hundreds/thousands of related contracts and transactions, all on top of a single corporate structure. I call this “vertical” legal tech. It’s in “horizontal” legal tech (automation across companies) that much of legal tech’s promise has been overblown. After automating secretary/paralegal work, it hits a hard wall of customization, complexity, and high error cost that renders the most cutting edge technology virtually useless.

  • DIY almost always costs more in the long-run – “Legal Technical Debt” is real. The cost of fixing legal errors compounds over time, and saving $1 today will very often cost you $5-10 in a few months or years, no matter how many blog posts you’ve read or templates you’ve downloaded.
  • Compensation and institutional infrastructure drive legal quality and scalability, which controls costs. – Great lawyers, just like great software developers, expect to be compensated for their talent. Oh, and btw, Law School costs about $200-250k and 3 years of your life. Very large firms and smaller firms can both have high-quality lawyers if they pay them properly, with the real difference being the additional overhead on top of compensation. Larger firms have much higher overhead to pay for infrastructure needed to represent unicorns in very large deals. Boutique firms are lower-overhead, and better designed for “normals.” Solos are best for small businesses.

Second, another Startup Law myth worth busting is the idea that fixing legal fees (as opposed to more flexible hourly billing) “aligns” incentives between entrepreneurs and their lawyers. I touch on this topic a bit in Standardization v. Flexibility in Startup Law.

It’s become lazily fashionable to criticize the billable hour as the main source of inefficiency in law. But the reluctance in traditional law firms to adopt technology and improve processes is driven, at least among startup-focused firms, far more by the decision-making structure of the firms, and the inertia that creates, than the billable hour. Partners in those firms often have so much control over how their clients are served, that the firm as an institution is incapable of mandating large-scale change. The egos of partners hold back the profession far more than billing structure.

The idea that time-based billing means lawyers are just going to maximize how much they charge clients, and never optimize, is economically ridiculous and ignorant. The lawyer-client relationship is very long-term, and smart entrepreneurs can easily get info in the market if they feel their lawyers are over-charging. Switching to more efficient firms is not that difficult.  Costs in Startup Law have been going down significantly over the past decade, with hourly billing still being the norm. There is a very short feedback loop on law firm pricing, which incentivizes firms to reduce truly unnecessary costs. A team can very easily take an invoice and ask other founders/startups whether it is inflated relative to market norms. The feedback loop on qualitative issues, like poor negotiation or errors, is far longer and more opaque, because those issues often aren’t discovered until years later, and even then its hard to compare apples to apples between companies. 

If you (cynically) think that hourly billing gives your lawyers a strong incentive to over-work, then fixed billing gives your lawyers an even stronger incentive to under-work. By guaranteeing a law firm a price on a transaction, regardless of how long it takes, you’ve tied their ROI to how little time they spend on it; narrowing optionality, delegating to less trained people, and rushing through material issues all become drivers of profitability. In the world of serious legal services, where speed/cheapness are hardly the only concern of clients, and there are very material, difficult-to-detect qualitative variables in service output, the idea that this is “aligning” lawyers with their clients is nonsense. Fixed fees do not align incentives; they reverse them.

Fixing fees, when the circumstances for “fixability” aren’t really in place (more on that below), therefore raises serious quality concerns. In healthcare, a botched job is almost always quickly noticeable to the patient. In law, especially startup law (where the client often isn’t seasoned enough to detect errors/rushed work) big quality issues can, and often do, take years to surface, since they’re tucked away in docs that sit unused until a major event, or the inexperienced founders simply never realize that an option their lawyer could have brought up, wasn’t. This, by the way, is why the most experienced players in any market are always deeply skeptical of new legal service entrants promising low prices, even if they’re early adopters in many other areas. It takes real effort and quality signaling to get them off of reputable legal brands. That reluctance is logical, given the opaque and high stakes nature of the service; very different from most fields.

If your law firm has agreed to a fixed fee, and suddenly you find yourself spending a lot more time interacting with paralegals working off of checklists (instead of lawyers), now you know what “alignment” really means.  Fixed fees are not magical, and they come with very real tradeoffs. You can have the exact same end-price for a transaction between time-based lawyers and flat fee lawyers, and the flat fee lawyers will be rewarded for minimizing the work they perform, and reducing quality; especially when the client isn’t fully capable of assessing that quality, which is often the case with new entrepreneurs. 

In a high-stakes deal, guess who would love to see your lawyers rush and under-negotiate? Investors. Watch out for law firms with deep ties to the investor community. If they’re peddling fixed fees, it’s because their real clients (investors) are incentivizing them to.

The predominance of the hourly billing model among high-end law firms is, first and foremost, a reflection of the significant variability among client needs and expectations, and the fact that flexible hourly billing is the most effective way to tailor work for each client, without reducing quality standards.

  • Need a reseller agreement? We’ve drafted them for $1.5K, $5K, and over $20K. Unpredictable variables: strategic importance of the deal, dollar value, size of the company, location, who the reseller is, who the reseller’s lawyers are, industry, and a dozen others.
  • I see “seed stage” startups who spend nothing on legal for a full year, some that spend $10K, others $25K, and a few that spend $100K, all due to widely varying needs.
  • I’ve seen “Series A” financings close for $15K, $30K, and over $100K, and everywhere in-between, and all for perfectly logical reasons understood by the client in the context.
  • M&A deals are totally all over the place in terms of time and costs.
  • In short, companies are not like medical patients. Biology and medical science produce very clear “bell curves” that enable things like health insurance pricing and fixed-fee medical procedure costs. There is no underlying DNA/biology constraining variability among companies, and therefore far less rhyme or reason across a legal client base.  The drivers of legal cost variability are far wider, subjective, unpredictable, and randomly distributed, which makes fixed-fee pricing not feasible for many broad-scope firms and clients.
    • Name another field in which, on top of there being significant variability of the working environment (the legal/contract ‘code base’ for each company), there are also subjective drivers of cost on both the client side (your client’s preferences heavily drive time commitment) and also the third-party side (the counterparty/lawyers on the other side can dramatically increase time commitment). The level of structural uncertainty and variability is much higher than healthcare, construction, manufacturing, consulting, and many other industries.
  • Given the above, the only way to make fixed-fee pricing work economically in corporate law is to “tame” this variability, and that “taming” results in downsides that are often unacceptable both to firms and to clients.

So what are the variables that help “tame” client work enough to make fixed fee pricing viable in Startup Law?

A. Very early work – There is a reason that formation documents are the most heavily automated and price-fixed in startup law: the number of unknowns and idiosyncracies are minimized. When a startup has decided on a “standard” VC-track C-Corp structure (which, btw, we see this becoming a less obvious decision for founders – see More Startups are LLCs), there are no outside parties to negotiate with, or other lawyers to deal with. The scope is clear, and the circumstances in which costs could go off the rails are minimized. Most of our clients are incorporated/formed on a fixed fee.

  • Anyone who observes the heavily tech automation / fixed-fee driven nature of startup formations and extrapolates that across the full spectrum of legal work is incredibly naive as to how complexity and client variability increase exponentially immediately after formation; as circumstantial differences start to creep into the legal “code base.” The low hanging fruit for legal automation has been eaten (see Clerky), and people who understand both technology and law are rightfully skeptical re: what even the most advanced, cutting edge AI can really do for high-complexity corporate law for the next decade, outside of very *very* narrow applications.

B. Narrow the scope – Remember the point that fixed fees don’t align incentives, but instead reverse them? Fixed fees make it costless for the client to demand more work. This logically means the law firm has to start drawing hard boundaries over what is acceptable for the client to ask for (inflexibility). We recently started our Alpha Program offering a limited scope of early-stage work on a fixed monthly fee. While there’s definitely been interest, a lot of our best clients opt out simply because they prefer maximal flexibility in terms of what work gets done, and how it gets done. In their mind, the whole point of hiring serious lawyers, just like hiring serious software developers, is to not get boxed into a narrow approach.

C. Narrow the client profile – I know a decent number of firms that have built successful practices on heavy fixed fee utilization. The almost universal way they’ve accomplished this is by dramatically narrowing the type of client they take on. Specific industries, specific geographic locations, specific sizes or growth trajectories, etc. Pick a narrow niche, and own it. If you can make your clients look and act far more alike by limiting the type of client you take on, you can more easily create that healthcare-like “bell curve,” and then start pegging prices. But for many law firms that have a diverse client base with diverse needs – including firms that represent startups with varying industries, growth and funding trajectories, subjective preferences, etc. – this is simply not feasible. I have never seen a firm or lawyer successfully utilize fixed-fees at scale without significantly narrowing their target client profile; the economics otherwise don’t work.

  • Note: I have made the argument many times that part of “BigLaw’s” problem is that it simply does too much, and that the “subtractive innovation” brought about by lean boutiques with more specialized practice areas that can collaborate ad-hoc is a meaningful transformation of the legal market. But virtually every specialized high-end boutique we work with still heavily utilizes time-based billing, for all the reasons described here. For fixed-fees to work, you need far narrower specialization than by practice area; like “small businesses under 40 employees” or on the opposite end “very high-growth SaaS companies raising top-tier traditional venture capital.”
  • The need for very narrow specialization driven by fixed fees will create problems for clients who engage a firm that isn’t a 100% good fit. They will inevitably find themselves pushed to mold their company to the rigid capabilities of the narrow firm, which will feel like putting the cart before the horse. What this means is that the decision to keep many law firms more generalist, with more flexible time-based billing, is for many clients a feature; not a bug. 

Our approach to pricing legal services for our startup clients is the result of sitting down and talking to founders about what their concerns really are. What we’ve found is that, more than fixing prices (with all of the downsides that entails), clients just want to prevent surprises, and to not feel like they overpaid. If something takes longer for very good reasons, it’s OK for it to cost more. If it can be done faster, while fulfilling all the client’s goals, then cost-savings should go to the client. Happy clients generate more work and referrals. When combined with transparency and open dialogue, there’s a symmetry and fairness in this approach that is often much more aligned with the “partnership” nature of the long-term lawyer-client relationship than the inflexible dynamics of buying a hardened product. 

So we’ve implemented a number of processes to accomplish that – including regular (more frequent than monthly) billing reports, transparent budget ranges based on our historical client data, and flexible payment options. We’ve found that these go very far toward helping startups get comfortable with their legal bills, without deluding anyone into thinking that you can somehow universally fix the costs of services that are inherently unpredictable to everyone. Our Net Promoter Score (NPS) as of today is 77.

Tying this all together, entrepreneurs should understand that there are very logical, client-centric reasons for why the billable hour remains the dominant billing model for serious law firms working with diverse clients; notwithstanding what lazy arm-chair commentators say about the billable hour. Law is hardly the only industry that utilizes “cost plus” billing, which is what the billable hour is. Occasionally I run into founders who struggle to grasp this, and then I’ll find that they’ve engaged a software developer as a contractor who, lo and behold, is paid by the hour. Many startup lawyers refer to their job as “coding in Word.”

That developer didn’t go to Stanford to practice cookie-cutter programming, and I didn’t go to Harvard to practice cookie-cutter law.  Fixed fees are not – at all – a magical panacea that suddenly smooths out all the challenges of engaging serious lawyers. To the contrary, they create their own major problems.  Open dialogue between client and law firm will keep costs reasonable, and minimize surprises, without getting stuck with all the downsides of productizing something that fundamentally isn’t a product.

Checklist for choosing a Startup Lawyer

A friend mentioned to me the other day that, as much great content as there is on Startup Law, there isn’t a simple list of things a founder team should assess in choosing their own company counsel. So here it is, leveraging past SHL posts in a distilled form.

Background Reading: Startup Lawyers – Explained.

Are they actually a “startup lawyer”?

The number of lawyers over the years who have attempted to re-brand themselves as startup lawyers – meaning corporate lawyers with a heavy specialization in emerging technology and venture capital – has gone up significantly. Law has numerous specialties and subspecialties, much like healthcare, and you want to ensure that, if you’re building an early-stage technology company looking to raise outside capital, your main lawyer(s) has deep experience in exactly that.

See: Startups Need Specialist Lawyers. The last thing you want to end up with is a litigator, patent lawyer, or small business lawyer who thinks that, because he stayed at a Holiday Inn Express, he suddenly knows startup law.

If you’re unsure, ask for a list of deals they’ve led and closed in the last 6 months.

Are they sufficiently experienced (Senior Level)?

See: How Paralegals and Junior Lawyers Can Hurt Startups. 

Some firms use what’s often referred to as “de-skilling” to significantly water-down the services they offer to early-stage startups. That means literally connecting you with advisors who are less skilled; making your main legal contacts junior professionals or automation software. Having junior and non-legal staff as the main legal contacts for a founder team can be extremely problematic, and will go off the rails the moment the startup runs into a complex, high-stakes context where they need fast senior-level advisory; which often happens in the early days.

Talk to a Partner or Senior Attorney with at least 5+ years of experience with complex transactions, and non-cookie-cutter contexts. Make sure they, as a person, feel like a good fit (personality, values, experience) for your company and team; not just the firm broadly. Paralegals and junior lawyers are great for “routine” items, and every good firm has them in the background, but you do not want them as your main legal contacts. If a firm puts layers of junior staff and other support professionals in-between you and senior legal help, that’s a red flag. We’re talking about your closest legal advisors on your most high-stakes issues; not the purchasing of a piece of productized software. The individual people matter.

Do they have access to other specialist lawyers that you’ll need?

In line with the above, the first lawyer you’ll need is a startup lawyer, but once the business gets going, you’ll quickly need others, including commercial/tech transactions lawyers, tax lawyers, data/privacy lawyers, patent lawyers, trademarks, litigation, etc. They do not need to be under the same firm (and you often benefit if they aren’t), but a serious startup lawyer who represents scaled companies must have direct access to these kinds of specialists to provide responsive counsel to their clients.

A simple “yes, we have access” is not enough. Ask for names, info on how they normally engage, and do your diligence.

Is their infrastructure / cost structure right-sized for what you’re building?

Be realistic about what your company will look like over the next 5 years if things go as planned, and hire a lawyer/firm that can serve that company, without scalability problems. Are you building a narrow app for which a successful exit would be a few million dollars? A solo lawyer would probably be a good fit for you.

Do you legitimately see yourself as on a potential IPO or >$500MM exit track, and targeting a $15-20+MM Series A in a year or two? Law firms that represent “unicorns” may be a good fit for you, even if they’re much more expensive. Don’t go cheap, and don’t trust upstarts claiming to be able to handle hyper-growth startups. You need a trusted marquee brand with infrastructure already built and validated for hyper-growth.

Are you realistically on more of a $3-10MM Series A, and $50-300MM exit path; or maybe you’re more interested in scaling on revenue alone? You’re going to get too big for a solo, fast, but “unicorn” firms are overkill for you and will potentially (i) not prioritize your needs, given you’ll be small potatoes, and (ii) shorten your runway significantly because of their high rates. Try a high-end boutique law firm.

See: When a Startup Lawyer can’t scale and Lies about startup legal fees.

Are they familiar and aligned with the norms / expectations of your likely investors?

In line with the idea of hiring a right-sized law firm, if you’re not on the unicorn track, you will run into problems if you hire lawyers who generally represent (and target) companies who are.

We see this often when, for example, law firms from Silicon Valley represent a tech startup raising local money in, say, Texas or Colorado. Ecosystems of different sizes often have very different norms and expectations, and you can run into cultural or even process conflicts when your lawyers simply don’t speak the same language as your investors, or other stakeholders. The largest deals in the largest tech ecosystems – SV and NYC – have much closer market norms, and smaller/mid-size deals in smaller ecosystems like Austin, Boulder, Seattle, etc. often behave similarly among themselves.

See: The problem with chasing whales.

Are they not “captive” to investors you’re likely to raise money from?

Entrepreneurs, and especially first-time entrepreneurs, lean heavily on their startup lawyer(s) for core strategic guidance in navigating negotiations / issues with their main investors. Experienced, independent counsel can be a young startup’s most important “equalizer” when dealing with people who are 50x as experienced as the founding team on deal structuring and corporate governance; which is why aggressive VCs will often go to such great lengths to convince, or force, a set of founders to use their preferred (captive) lawyers as company counsel.

Don’t use lawyers with any dependencies on the money across the table, or you’ll compromise one of your most strategic assets in navigating all the high-stakes complexities of fundraising and board management. In fact, if your lead investors seem very interested in you using a particular firm or set of firms, now you know exactly which firms you should not use. Talk to other specialized, experienced firms except for those.

See: How to avoid “captive” company counsel or Relationships and Power in Startup Ecosystems. 

Finally, do they “not suck”?

After all of the above, do these folks actually answer their damn e-mails quickly enough? Do they have good technology / processes in place to make your life easier and work efficiently? Do they give real strategic advice, and not make tons of costly mistakes that you end up having to pay for in the long run?

See: Lawyers and NPS.

There are lawyers who will check all of the above boxes, and yet after you talk to their clients, you’ll find that they just suck to work with. Do your homework / research on the more objective checklist items, but in the end never forget to choose lawyers who actually care about doing all the subtle human-oriented things that result in good service.

post-script: A few questions that don’t belong on the checklist:

  • Is the lawyer in my city? – Nothing about local city law applies to startup lawyering. Think regionally, or focus on their client base resembling what you’re building.
  • Can they introduce me to investors? – See: Why I (still) don’t make investor intros.  There are far more effective ways to get connected to investors than through intros from a law firm.

Lies About Startup Legal Fees

It usually takes experience in the market for business people to truly understand the realities of hiring and working with lawyers. I can’t tell you how many times I run into first-time founders who’ve been fed absolute nonsense from ‘advisors’ ‘mentors’ or similarly named people about their ‘secrets’ for managing legal spend. The truth is that unless you’ve taken a company from seed to Series A, Series B, Series C, to an exit in which a serious party on the other side actually diligenced the legal history your ‘secrets’ put together, your theories about lawyers are hot air.

Failed companies never pay the price for poorly managed legal; unless the failure was the result of the legal problems, which does happen. Successful companies, however, pay deeply for legal mistakes. It’s  just a question of timing. There are definitely steps you can take to prevent legal spend from getting out of control, but it requires separating reality from delusion. The below is my attempt at doing that.

1. Software automation (or free templates) will not replace your lawyers, or dramatically cut legal spend.

See: Luddites v. Tech Utopians. New market entrants in technology have a tendency to come out with guns blazing, promising their ability to cut out enormous amounts of waste as reason to adopt them. Sometimes they’re telling the truth. Other times it’s well-calculated hyperbole.

Virtually every serious automation tool that has emerged with “cut huge amounts of legal spend” as its primary selling point has evolved into a tool for lawyers. Why? Because, contrary to some popular opinion (and marketing talk), good lawyers really aren’t charging hundreds of dollars an hour to just fill in numbers or check off boxes. Good tools are very helpful for making lawyers/firms more efficient, and you want lawyers who use those tools, but a piece of software isn’t going to replace your lawyers any more than a piece of software will replace your software developers.

Yes, there is form-filling and box-checking ripe for automation, but it’s not nearly as large of a percentage of legal spend as some let on; and the low-hanging fruit is already eaten by software like Clerky or Ironclad.

2. Handling it yourself won’t save you legal fees.

I could write an entire book listing all the “hold my beer” moments I’ve encountered with someone on a management team thinking that they were wisely saving legal fees by taking an issue into their own hands, and it then predictably blowing up in their faces.  Part of it boils down to simple sloppiness. Other times it’s a clear case of someone not knowing what they don’t know.

There’s a related dynamic here to the first point about technology companies overstating their ability to cut legal spend. Anyone selling anything (a product, a service, themselves) has to justify it somehow, and “those damn lawyers” are a great bullseye. A COO / CFO wants to justify his salary, and an easy way to do that is by claiming to ‘save’ you legal fees via DIY legal work. You’re not saving anything. You’re magnifying your fees (cleanup is $$$), but deferring them temporarily.

3. Quickly hiring an “in house” lawyer won’t save you a dime.

CEO: “We’re thinking about hiring an in-house lawyer to save some legal fees.”
Me: “Great. What’s his/her starting salary?”
CEO: “$95K”
Me: “Going to be complete shit, and will cost you 10x more long-term.”
CEO: “What? That’s more than some of our execs make.”
Me: “Senior lawyers worth having won’t even talk to us if we’re recruiting with less than $200K. And our lawyers have fantastic work-life balance. You’re recruiting in the same legal talent market I’m in. You really think you found some magic button that cuts the market rate in half?”

Look, I get it. Good lawyers are expensive. Really good lawyers are even more expensive. Fact: Talent is expensive. Everywhere. Make it incur three years of opportunity costs (law school) and a small mortgage (about $200-225k for law school, all in) before it can hit the market, and it gets a whole lot more expensive. 

Last time I checked a solid software developer will cost you six figures in salary; ignoring equity. And ‘coding’ mistakes are 10x more fixable, and potentially less costly, than legal mistakes. It is absolutely the case that a small portion of the tech community arrogantly believes that engineering talent is the only talent really worth paying for. Good luck with that.

I’m not trying to defend what lawyers make here (I don’t need to), but what I am saying is hiring lawyers has the exact same talent market dynamics of hiring any other kind of professional.  So you say you’ve found a lawyer willing to work for a lot less. Congratulations, you caught lightning in a bottle; found a rupture in the space-time continuum.

Or you just found a lawyer completely lacking in the experience/skillset needed to actually replace the work outside counsel (including a set of specialists) is doing for you. There is definitely a time to hire a general counsel, but for it to actually make sense mathematically and not result in extremely expensive mistakes, it’s usually much later in the company’s history than you think. Past “startup” territory.

4. Flat/fixed fees don’t “align” incentives with your lawyers. They lead to rushed work and poorly negotiated deals. 

Take two law firms that charge you the exact same amount to close a deal: one firm bills by the time they actually worked, the other on a flat fee. The flat fee firm is rewarded for (i) not negotiating deal terms, (ii) delegating to inexperienced staff who are “cheaper” (to them), and (iii) working off of rigid rules/checklists that can be automated, instead of flexibly assessing the context. In other words, flat fees incentivize lawyers to rush their work, which is dangerous for high-stakes legal issues where the “client” (often at early-stage an inexperienced entrepreneur) doesn’t know how to fully assess quality.

For more on this, See: Startup Law Pricing: Fixed v. Hourly. Flat fees don’t “align” incentives with your lawyers. They reverse them, often making them more dangerous. For low-stakes, highly standardized work (like formations), fixed fees can be generally benign. For high-stakes and high-complexity work where the “client” doesn’t have the experience to assess quality, don’t reward lawyers for cutting corners.

5. A few real truths about legal spend. 

A. Compensation and specialization drive talent quality. Quality prevents errors, and therefore controls fees long-term.

Fundamentally, two things drive lawyer recruitment (I know, because I recruit for E/N): compensation and quality of life. Very large firms generally have terrible quality of life for their lawyers, for a number of reasons too complex to discuss here. But that’s why large firms have to pay their lawyers the most.

In-house positions and boutique firms are recruiting pipelines for what I call “BigLaw refugees”; talented lawyers looking to still get paid well, but take a moderate pay cut (sometimes) in exchange for the ability to keep their marriages in tact, and their kids out of therapy. But as discussed above, to get the full-time attention of those lawyers, even with great work-life balance, you still have to pony up in amounts virtually no true startup can afford. That’s why outside counsel (‘fractional’ lawyering) is valuable.

And working with lawyers who specialize in emerging tech/VC work will ensure you’re paying for talent experienced in the kind of legal work you actually need. See: Startups Need Specialist Lawyers.

B. Law firm “overhead” increases legal spend above base lawyer compensation, but enables scalability and quality. 

On top of the money paying a particular lawyer’s salary, you have the ‘institutional overhead’ of the firm that employs the lawyer. For a deeper discussion of law firm overhead, see: Startups Scale. Solo Lawyers Don’t. 

Companies who think only large firms with the highest rates have the best lawyers (compensation) are ignoring the interplay of overhead and compensation. If you cut overhead intelligently, you can still pay lawyers very well, but at lower rates to clients. The issue is how much overhead to cut out.

Institutional overhead, properly structured and right-sized, is not wasted money any more than the ‘overhead’ (on top of salaries) of any company is wasteful. In law, it enables recruitment, technology, training, staff, and other infrastructure that turns a set of lawyers into an integrated legal services provider, with bandwidth that can be optimized to keep work moving.

Think about what type of company you want to build long-term, or at least expect to be for the next 5 years, and ensure you engage a firm with the right institutional infrastructure (overhead) to serve that company. Very very large firms are designed for unicorns, and require the most ‘infrastructure,’ and therefore overhead.  In fact, the majority of what you pay large firms is paying for infrastructure. Are you planning to be a unicorn?

We are quite honest in saying that, as a high-end boutique firm, our target client is looking to (realistically) exit at under $300MM. We don’t work for unicorns; nor do we try to.  But we also don’t work for small businesses hoping to sell for a few million.

We pay our lawyers compensation that is highly competitive with large firms, which (again, a talent market) ensures quality. Our lawyers also bill about 25% fewer hours per year than BigLaw lawyers, which improves their quality of life (helps recruiting/retention).  But because we have dramatically lower institutional overhead, our rates are lower; although nowhere near the lowest.

In my experience, the size of your Series A round is usually a pretty good indication of the type of company (exit size) you’re trying to build; companies truly going for unicorn status raise much larger rounds. Pre-Series A, the majority of serious tech companies require some accommodation to manage their legal budget; no matter how efficient their lawyers are.

If Post-Series A, your company’s legal bills still seem completely unmanageable, that’s often a good indication that the law firm you hired is too big for what you’re building (non-unicorn-track using a high-infrastructure unicorn law firm); assuming your expectations on what the bill should be simply aren’t unhinged. Remember, small firms can have very high quality lawyers, because they aren’t paying them less. They just have a leaner infrastructure designed for non-billion-dollar clients.

C. Flexible pricing / payment from a quality firm is 1,000 times better than “going cheap.” But be realistic about the budget. 

If you get anything from this post, it is this: good, scalable legal counsel costs real money, like any talent. There is no magical software, recruiting strategy, or template on google that will get around that. Anyone who thinks they are cheating this rule, and have somehow found bargain-basement counsel that works, is just not yet hearing the ticking of the time bomb they’ve turned on in their company.

The absolute best strategy for engaging serious legal counsel, but not going bankrupt on legal fees is to ensure that:

  • you’re working with lawyers who have the right specialization for what you need;
  • at the right quality level, and with right-sized overhead for the scalability you need; and
  • who will flexibly work with you on budget/payment at the very early stages.

Law firms who specialize in emerging tech work are not new to the challenges of very early-stage startups trying to manage a legal budget; at all. It is deeply engrained to each lawyer’s expectations. And there are a lot of levers that those firms can and will pull for clients they want to work with: discounted fees, deferred fees, equity arrangements, etc.

The key part is “clients they want to work with.” They are selective, because they have to be.  Serious law firms are not in the game to work on mickey mouse fixed-fee or discounted projects to eternity; nor can they afford to be. They do that to scale down for valuable prospects with the right potential lifetime value (LTV) as clients, but who need help when the budget is slim. That’s why any early-stage, limited budget company that approaches a serious law firm should be ready to “pitch” their company to the firm.

For high potential companies, great tech/VC lawyers will be flexible on budget and payment as long as the founders are reasonable in their expectations. And the best way to be reasonable is to follow the points in this post. Accept that you need good legal talent, badly. Accept that it costs real money, and that you likely can’t afford the full cost up-front, and that’s normal.  If you’re as good as you hope you are, you will find a way to navigate that reality.

How to Avoid “Captive” Company Counsel

TL;DR: Given the often substantial imbalance of experience between first-time entrepreneurs and the investors/VCs they are negotiating with, experienced startup/VC lawyers are often the most important “equalizer” at the negotiation table; both on deals and on high-stakes board-level issues.  Smart repeat players (investors, accelerators) know this, and therefore often directly or indirectly push startups to hire lawyers (as company counsel) that they can manipulate with their leverage over ecosystem relationships/referrals.  Those “captive” lawyers are, due to their conflict of interest and dependence on repeat players, incapable of representing the company and common stock objectively; and early common stockholders often get hurt long-term as a result. The market needs to stop tolerating and promoting this unacceptable mechanism of control.

Related Reading: Relationships and Power in Startup Ecosystems and When VCs “own” your startup’s lawyers

This post is going to make some people uncomfortable. People who work with me know that I’m not the type who likes to irritate others just for the fun of it. But I’m always willing to say something that needs to be said, and I’ve always structured my business relationships and life in a way that I’m not prevented from saying it.

“It is difficult to get a man to understand something when his salary depends on his not understanding it.” -Upton Sinclair

“One Shot” Inexperience v. Seasoned “Repeat” Veterans

Founders, particularly inexperienced first-time founders, face enormous uncertainty and opacity as they build their companies. In that environment, they’re tasked with making complex long-term decisions, on behalf of themselves and other stakeholders, with very high-stakes implications; including distributional implications as to who gets what share of the limited pie.

More so, as founders raise capital, they engage with highly experienced, sophisticated, repeat player parties who have gone through the same process dozens of times; and know the numerous subtle ways of manipulating that process. Those parties (investors) are typically aligned with the common stock in the sense that they want the company to be a success, but there is significant misalignment in the fact that each side wants their share of the pie to be larger than the other, they often disagree on how to grow the pie, including how much risk to take in doing so, and each side also often disagrees on when it’s time to start eating. In the case of institutional investors, they have a legal obligation (to their own investors) to get as high of a return for their investment as possible; in other words, to get as much of the pie for themselves (and as large of a pie) as they can.

Repeat players (institutional investors) are highly experienced, wealthy, diversified, and have downside protection. “One shot” players (founders, early employees) have their net worth highly concentrated in one company, without downside protection; and they’re often highly inexperienced. The misalignment is obvious, never goes away, and feeds into numerous long-term disagreements regarding growth strategy, recruiting, financing, and exits. Very often, investors who were once entrepreneurs themselves will use their entrepreneurial histories as smoke and mirrors to get now new entrepreneurs to ignore how highly misaligned they are.

Counsel should level the playing field. 

In this environment: inexperienced founders/management working with highly seasoned third-parties with significant misaligned financial motivations, founders/management have to rely on trusted advisors to level the playing field; to ensure that their inexperience is not leveraged unfairly to their detriment. 

Without question, one of, if not “the” core advisor that startups turn to for leveling the playing field in interacting with highly seasoned investors, particularly at early stage, is Company Counsel; the lawyers hired to represent the company. Startup lawyers have a front-row seat to deals/activities in the market that cover a much broader, and larger, area than any particular investor sees, and they leverage that expertise to help startup teams navigate what, to them, is brand new territory.

Company counsel’s job is not to represent the founders personally – see A Startup Lawyer is Not a Founder’s Lawyer – nor the investors, but the entire company, including all of its stockholders as a whole. The best analogue I can think of is a family therapist, who doesn’t represent the parents or the children, but is looking for the well-being of the family unit.  If someone is threatening the well-being of the family (the company), or trying to unfairly dominate it in a counter-productive way, the therapist (company counsel) helps address it. Sidenote: my job really does resemble that of a therapist sometimes.

The best company lawyers combine a “win-win” attitude (grow the pie) with a long-sighted, subtle skepticism over each individual actor’s motivations; monitoring how actions could result in unfairly taking one person’s part of the pie and handing it to someone else. They pay particular attention to how the more powerful and experienced players can, through numerous subtle tactics, take advantage of the most exposed and inexperienced stockholders on the cap table (early common stockholders, typically).

Many startup lawyers are “captive” to institutional investors. 

So the founders-investor relationship is inherently imbalanced in favor of the seasoned, experienced investors at the table, and company counsel is supposed to play a strong role in correcting the imbalance. Clearly then, any factors that raise doubts as to the independence of company counsel; factors that might make him/her ‘captive’ to the interests of the money at the table, are cause for serious concern.

In “Why Founders Don’t Trust Startup Lawyers” I described how the business development practices of certain startup/vc lawyers give companies every reason to be worried that their company counsel is inherently incapable of providing that ‘balance’ that they are supposed to rely on.  Many lawyers know that if they can win a relationship with a VC fund or accelerator, that relationship can be worth dozens of deals/clients to them in a manner of just a few years; far far more efficient biz dev than going after companies one by one. So building economic ties with those investors becomes a major source of business for lawyers, including lawyers who act as company counsel. 

I don’t waste any breathe or time trying to actually convince anyone that this scenario is a serious conflict of interest problem; certainly not lawyers. See the Upton Sinclair quote above.  I simply explain to founders/management in very clear terms how things in fact work, and let smart people arrive at their own conclusions. Sunshine is a great disinfectant.

Chess: Losing the negotiation before it starts. 

Negotiation strategy and psychology is a fascinating area to study. Winning a negotiation and getting what you want in a deal is, to those who are observant, an intricate game of human behavioral chess. To get what I want, I could simply negotiate very aggressively at the negotiation table. That can work. But there’s a cost to it. It spends social capital that I’d prefer to keep. I come off as overly self-interested, when as a long-term player I’d prefer to be seen as a friendly, trustworthy guy; in line my PR/marketing efforts.

A much more effective strategy is to win by preventing the negotiation altogether.  A simple checkers player wins by brute force negotiation. But a ‘chess player’ in business wins by controlling the environment of the negotiation, and the people involved, and in many cases preventing negotiation entirely. Ensure companies are using my preferred lawyers, swell guys that they are, and who I know won’t step out of line with the financial ties I have on them. Then deliver an (air quotes) “standard” term sheet. The founders then take that term sheet to those lawyers, maybe there’s a little back-and-forth for good measure, and we move forward, with ‘our guys’ on the inside long-term.

By convincing founders/management to use captive company counsel, investors can get what they want – both in a financing and long-term – without even having to negotiate much for it. When requesting certain terms, making certain decisions, or engaging in certain behaviors, independent company counsel will properly advise the team on how to respond or defend themselves; but captive counsel will just say it’s all normal and standard, lest he anger the people really funding his salary. 

I know some people will try to stop me right there. I’m being overly cynical here, they’d say. This is just how the business works. Surely no serious investor would actually use their influence over company counsel to push things unfairly in their favor.

Oh really? Many VC lawyers, including myself personally, have observed situations in which a negotiation is not going in the direction an investor would like, and off-the-record phone calls to company counsel get made. “We’re hoping to preserve our long-term relationship here, beyond just one deal.” “Our fund is actively seeking firms to partner with long-term.” “If this deal goes *as hoped*, we’d love to explore other opportunities to work together.”  To a lawyer who plays both sides of the table, you are one deal, while a VC fund’s “favor” can mean many, many deals.  Don’t delude yourself into thinking that favor is free.

I am happy to have a discussion about the issues I bring up here, and to be clear, there are many well-respected investors who respect the appropriate boundaries.  But please don’t try to feed me or companies candy-coated bullshit about the angelic “professionalism” of business parties when 7, 8, 9 figures are on the line, and a few easy phone calls and veiled threats (or bribes) can ensure they stay in the ‘right place.’ If your investors would never make those phone calls, then there shouldn’t be a problem with selecting company counsel with which they can’t make those phone calls. When you respond to investors that, while you appreciate their recommendations, you prefer to select your own independent company counsel, a common response is that you are perhaps not being “trusting” enough, or too “adversarial.” There is no tension between being a friendly, “win-win” person in the business world, while insisting that your backside is covered with trustworthy advisors. Anyone claiming otherwise is simply trying to disarm you, with “friendliness” as an excuse for adopting a strategy that gives them substantial power. 

I’ve lost count of how many common stockholders have told me that they closed a so-called “standard” deal, and with a very light review of their history any independent lawyer can identify numerous terms and actions they’ve taken that were hardly “standard” in many meaningful sense of the word, but they were sold as “standard” to the inexperienced common stockholders by lawyers and investors taking advantage of their inexperience. See: The Problem with “standard” term sheets. Convincing entrepreneurs that closing fast and signing so-called “standard” terms is in their best interests (often claiming it “saves” fees and time) has become a dominant strategy for sophisticated repeat players to get their way, while appearing to be generous.

Cost control as sleight-of-hand. 

Notice the subtleness in how certain investors (including some blogs) talk about lawyers and legal fees. Why can’t we just close a deal for a few thousand dollars? This stuff has become so standard, let’s just keep the negotiations “between the business parties” and close this thing quickly.

Yes, let’s move fast (read: not discuss the terms much) and keep it “between the business parties”; where one side is inexperienced and doing it for the first time, and the other side has done it 50 times. That’ll keep it “fair.”

We’re negotiating and discussing transactions where even small changes could mean millions of dollars in one pocket or another, but let’s “control the legal fees” to save $10-20K right now. Yeah, gotta watch the legal budget. Really appreciate your (air quotes) “concern” there, champ.

If you are building a company on a trajectory to be worth at least a comfortably 8 or 9-figure exit (which if you are talking to serious tech investors, you are), the idea that you should minimize time spent working with counsel, because it’s all just boilerplate and you’re better off keeping the legal fees for something more valuable, is a mirage set up to keep teams ignorant of what they’re getting into, and how they can properly navigate it. Telling a company “don’t ask your lawyers about this” sounds suspicious. “Let’s save some legal fees” sounds much better. But there’s no difference. You are being played. 

Balanced, but also competent. 

Stepping back a bit, it’s important to also clarify what I am not saying in this post. I am not saying that investors and other stakeholders in a company should not have an interest in ensuring that company counsel is competent and trustworthy. Founders do occasionally engage lawyers, typically for affordability reasons, that simply do not understand the market norms of venture capital financing. Using those types of lawyers ends up being a disaster, because they will slow down deals and offer all kinds of comments that aren’t about ensuring fairness and balance, but are simply the result of their not knowing how these types of deals get done. That will drive the legal bill through the roof, with little benefit.

Company counsel should have strong experience in venture capital deals.  Sometimes when investors request a change in company counsel, they have valid concerns about that counsel’s competence. Assess the merits of those concerns. However, it is one thing for your investors to say “this lawyer won’t work,” and then leave it to the company to find new, independent counsel. It is a completely different, and far more questionable, thing for them to insist that you use their preferred lawyer. 

Avoiding captive counsel. 

Here are a few simple questions to ask a set of lawyers to ensure they can be relied upon as company counsel to fairly represent a VC-backed company, particularly one with inexperienced founders:

  • What venture funds / investor funds do you personally (the lawyer you’re directly working with) represent as investor counsel, and how many deals have you done in the past 3 years for them?
  • What about your law firm generally? (for very large firms, this is less important)
  • How many of your firm’s clients are portfolio companies of X fund, and how did you become connected to those companies? May I reach out to some of those companies’ early common stockholders to confirm?
  • Can I get your commitment to not pursue investor-side work for X fund while you are our company counsel, and to not pursue a referral relationship with them?
  • Are there any other financial ties to VC funds that would potentially compromise your ability to represent and advise us fully in negotiating with those VCs?

Larger ecosystems and larger law firms are generally less prone to this problem, because it is harder for individual players to really throw their weight around as a percentage of a larger firm’s revenue. That is to say, if the lawyer you’re working with doesn’t personally represent/rely upon X fund, but some other lawyer in the large law firm does, it’s less likely that company counsel can be “squeezed” (pressured into not fully advising/negotiating) by the money. Although even in Silicon Valley and NYC BigLaw I’ve seen situations in which a fund will ‘nudge’ a set of founders to their preferred partner at a large firm. 100% captive.

In smaller firms, which are significantly more exposed to this problem due to their size, you’ll sometimes find that a single fund accounts for a massive percentage of that firm’s pipeline revenue. Those lawyers will slap their mothers if the fund asks them to, and companies are wise to avoid using them as company counsel.

The costs to companies of having captive counsel can be severe. Rushed, unfair sales because a particular fund’s LPs suddenly decided they need liquidity. Refusals to pursue other potential investors because the ‘right’ term sheet from ‘friendly’ investors has been delivered. Executive changes installing ‘friendly’ new management without an objective recruiting or vetting process. Early firing of founders without reasonable opportunities for coaching. The list goes on.

This is not theoretical. When company counsel is captive, their passivity will allow the preferences of a portion of the cap table to dictate the trajectory of the entire company, without the checks and balances that a properly governed company should have. And yet the sad fact is that inexperienced founders often don’t even have the frame of reference to know it is happening, or that it wasn’t supposed to happen that way. Many just assume, wrongly, that “this is how these things work,” when really that’s only how it works when you hire advisors who can’t, no matter how much they protest basic facts of human behavior, be objective. 

“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, Lawyers or Insurance Salesman?

This issue is not about labeling one group of market players as ‘good’ and the other as ‘bad.’ Hardly. There are many, many investors in the market who are phenomenal people with deep ethics. They should have nothing to worry about in ensuring their portfolio companies hire competent, independent counsel. And the best companies always maintain transparent, friendly relationships with their investors. It’s the investors who act deeply concerned when you communicate a preference for hiring independent company counsel – who can objectively represent the common stock without being incentivized to rush negotiation or condone nonsensical “standards” desired by the money across the table – that are signaling their reliance on a strategy of leveraging entrepreneurs’ inexperience against them.

This issue is about acknowledging that no one in any tech ecosystem has more “skin” in a company – financially or emotionally – than first-time entrepreneurs and their earliest employees – not even close. And yet at the same time, their inexperience means that their closest advisors play an outsized role in helping them navigate the various relationships and risks that they are exposed to. Pushing startups to use their investors’ preferred lawyers as company counsel is, plainly, an unjustifiable mechanism of control; one that anyone who supports entrepreneurship and tech “ecosystems” should not tolerate. 

People with far more experience and power than tech entrepreneurs will demand that their company counsel be independent and objective, because the fairest outcomes result when everyone at the table is well-advised. Ignore all attempts to argue the contrary. Founders should demand the exact same for their companies.