Post Category → Startup Lawyers

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 fluff. Modern 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.

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

TL;DR Nutshell: In the course of your startup’s life, you’ll need perhaps a dozen or more different kinds of specialist lawyers.  There is very little about the practice of law today that requires you to source all of those lawyers from one firm when the “right” lawyer (experience, rate, culture) may be a solo, at a boutique, or at another large firm.  Yet traditional law firms continue to push the “one firm for everything” full service model because it allows them to mark up specialist lawyers whom startups could otherwise hire for several hundreds of dollars less per hour.

Background Reading:

Most people have a good understanding of the importance of specialist doctors; that if you have a serious skin issue, you call a dermatologist, but if you have a serious heart issue, you call a cardiologist.  Biology is far too complex, and the stakes are simply too high, to rely on a single generalist who, while valuable at coordinating specialists and keeping an eye on the forest relative to the trees, couldn’t possibly be smart enough to cover every specialty without repeatedly committing malpractice.

Generalists v. Specialists

New founders typically have less of an understanding of how this generalist v. specialist divide also exists for lawyers.  If you’re a 3-person coffee shop that isn’t playing on a national scale, it may be OK to rely on a single general lawyer to incorporate you, file your trademark, and maybe handle your lease.  But if you’re a scaling startup seeking VC funding and making decisions on Day 1 that will influence your company’s prospects when it hits $25MM in revenue, you need solid specialist lawyers.

The category of “startup lawyer” is itself a specialty. It means a corporate lawyer who (you hope) specializes in working with early-stage technology companies and has closed so many angel and VC deals that she doesn’t need to be “educated” when your investors show up with a term sheet.  Startup lawyers also play the role of a generalist, sourcing and quarterbacking specialists as needs come up for their clients.

Here are just a few examples of specialist lawyers that startups often require as they grow:

  • Patent Prosecution – which itself contains dozens of sub-specialties depending on the type of science/technology. You don’t hire a patent lawyer with a background in organic chemistry to draft your IoT hardware patent.
  • Patent Litigation
  • Commercial Litigation
  • Trademarks
  • Tax – U.S., and Country-Specific
  • Tech Transactions – (Licensing, Reseller Agreements, OEM, Distribution Agreements, etc.) – subspecialties include hardware focus, SaaS focus, etc.
  • Data Security / Privacy – subspecialties include financial data privacy, HIPAA, etc.
  • Open Source IP
  • International Trade / Export Compliance
  • Employment / Labor Law – federal and state-specific
  • Employee Benefits and Compensation
  • DE Corporate Governance
  • Environmental
  • Real Estate
  • Securities Regulation
  • Immigration
  • Mergers & Acquisitions (M&A)

One of the main points that I’ve driven home in many SHL posts, and around which E/N’s tech practice has been built, is that no single law firm can or should attempt to employ all, or even most, of the specialist lawyers that a technology company needs over its life cycle. Apple is massive and employs dozens or hundreds of different types of engineers and executives. Why? Because without doing so it could never produce the iPhone 6. Take any specific type of developer or engineer out of Apple and have her work alone or at a much smaller entity, and she couldn’t possibly produce as much value as she can being integrated at Apple.

This is just not how law practice works. Lawyers in various specialties absolutely do collaborate to ensure clients are well-represented and that work performed by various people doesn’t conflict, but with today’s SaaS/collaboration tools (which weren’t available a few years ago), that collaboration occurs just as easily (and depending on the firm, more easily) between focused, specialized firms as it does under the same massive, bureaucratic structure.  

I can call a top trademark lawyer at a 5-person boutique or a similar lawyer at a 1000-lawyer firm, and their capacity to handle 99.9% of my client’s trademark needs is virtually the same, though the boutique lawyer will be $250+/hr less (yet make the same or more per hour), and generally give my client more attention. The core value produced by large law firms is concentrated in individual professionals who, unlike people working at integrated companies like Apple, hardly become less valuable when you change their address and sig block. 

The Driver of Big Firm “Lock In”

So why don’t large firms simply break up, allowing their lawyers to drop their rates and stop wasting clients’ money? Aside from fear and inertia, there is one very serious “glue” keeping BigLaw together: origination credit.  In law firm economics, lawyers make money not only from the work they do, but also from a % (their origination credit) of the work done by other lawyers in their firm for clients they source.  If I’m a startup lawyer at a large firm and can push my client to use my firm’s trademark lawyers, patent lawyers, litigators, etc. etc., I get a cut of all those fees. I don’t get a cut if I send them to another firm with better lawyers, lower rates, and more appropriate skills. 

Many founders are shocked to find out that, for the vast majority of lawyers in BigLaw, maybe 20-25% of the amount they bill ends up in the pockets of the lawyers doing the work. You’re billed $650/hr for a patent lawyer, but maybe $175 gets to that lawyer.  Most of the rest is: (a) bloat (see above), and (b) markup to feed the origination pyramid.  

Putting aside how much this screws clients (founders), you cannot possibly understand how badly specialist lawyers would love to be able to bill clients $300/hr less, without taking a cut in their compensation. But many of them can’t, because leaving their large firms means being cut off from the deal-flow. The only specialists who are able and willing to break free are the ones with enough client loyalty (and chutzpah) that they can take clients with them. And those are the specialists E/N likes to work with.

Boutique Corporate Lawyers and the Specialist Ecosystem

When a startup works with a startup lawyer in a large firm and needs a specialist lawyer, 99% of the time the startup lawyer will push work to his own firm’s specialists. Never mind that the specialist he chooses may be over-kill, or over-priced, or simply a poor fit. That’s his firm’s specialist, and the firm expects him to “cross-sell” into other specialties. He wants his cut.

When a startups works with an E/N startup lawyer and needs a specialist lawyer, we assess the various options in our network (or elsewhere) and let the client choose what he/she thinks is the best fit. For example, we could go with a solid solo lawyer billing in the $200s who’s excellent for straight-forward work.  If it’s a more serious issue we could go with the slightly more expensive boutique w/ high-end specialists in the $300s or low $400s.  Or if it’s a bet-the-company issue we could go with one of the top specialists in her field who formed her own firm recently and bills at $500/hr (she was $800 at her former firm).

Granted, sometimes the absolute right lawyer is, unfortunately, still in BigLaw, and we work with her, but every year that becomes a rarer occurrence as the specialist ecosystem grows.  And I always favor lawyers outside of BigLaw because of the risks they’ve taken, the better attention they give to clients, and the fact that they are building a legal market that is less soul-sucking for the country’s top legal talent.

The point is that we leverage our vetted network of specialists to ensure clients get “full service” legal counsel, without misaligned economic incentives muddying the relationship. Clients aren’t “locked in” to any particular set of specialist lawyers, so we’re free to choose from a much broader pool. While this represents a loss in origination credit for our lawyers, it also significantly enhances their value proposition to clients, helping overall with business development.  Short-term loss, long-term gain.

Founders should be mindful of the incentives behind how their startup lawyers source specialists, because they can and will have an impact on the bottom line, and could even result in major screwups from a mismatch between what the startup actually needed and the specialist who was put on the job.  While the overall market is evolving to favor flexibility, transparency, and efficiency, a lot of traditional firms still tout b.s. about the importance of “big firm resources.” Smart founders know that “big firm resources” is, for the most part, just code for “we’re going to keep milking clients with overpriced specialists until the music stops.”

Why Founders Don’t Trust Startup Lawyers

“We received a term sheet from a competing VC syndicate, and if I go to our current lawyers, our existing investors will find out about it before I want them to.  Our law firm does a lot of work for our VCs.”

“Our VCs told us that if we used their preferred law firm, they’d close more quickly and even save us money by not hiring their own lawyers. But if we went with another firm, there ‘could be delays.'” 

“I went to my Board to disclose this highly confidential issue that only our lawyers and I knew about, and I realized that our VCs were already aware of it. No one but our lawyers could’ve disclosed it.”

“The lawyers that our investors connected us to said that the valuation in our term sheet was about market. It was only after closing that I found out we got totally hosed.”

The above are quotes or paraphrases of statements that we, as a firm, have heard directly from founders/executives as they explain their reasons for changing law firms. The unifying theme should be obvious, and it relates to the broader issue of why so many founders have such dim views of startup lawyers in general. In short, by playing fast and loose with conflicts of interest in the pursuit of maximizing short-term revenue, many startup lawyers and law firms have squandered their most valuable currency: trust.

Related Reading: How Founders Lose Control of Their Startups

What is Counsel?

No one who reads SHL or interacts with E/N’s tech practice would argue that our approach to the practice of law is “old school” in any sense of the term. The significant drivers of our growth include rethinking major facets of law practice, including organizational structure, compensation models, project management and technology adoption. However, while I am very much a tinkerer with respect to the delivery of legal services, I am quite old-school in my view of what lawyers fundamentally are, or at least should be: trusted counsel.

In a heated, high-stakes lawsuit or investigation, virtually everything you’ve ever said in writing to investors, to other executives, to friends and family, can be forced out into the open for everyone to review except for confidential communications with the Company’s lawyers (attorney-client privilege).  Take a moment to let that sink in. Nothing that you ever do or say as a company is more secure from forced disclosure than what you say to your lawyers.  That is, of course, unless the lawyers themselves disclose it.

Ask many founders whether they really trust the lawyers representing their company, and some will flat out say that, to them, their lawyers are just subject-matter experts there to paper deals and ensure the company doesn’t blow up from legal issues; highly-educated paper pushers and fire extinguishers.  Others will say that they do trust (in a sense) their lawyers, but when pushed into a serious, high-stakes situation in which total objectivity and confidence is paramount, the reality of their superficial relationship will surface.

  • Is the valuation they’re offering appropriate for our company, geography, and market?
  • Is this provision dangerous? Is it standard?
  • Some local people are pushing us to X accelerator, but we’re not sure it’s right for us. What should we do?
  • We need to make a major strategic shift that some of our stakeholders will want to block – what are our options?
  • My company is going under if I don’t get this deal done, but X investor says he will block it. Can he? What are my options?
  • We just got an acquisition offer, and I’m not sure whether it’s fair to me and my management team. What should we do?
  • One of our senior executives just got arrested. No one can find out about this until we know more. What do we do?

These are just a few of the kinds of questions that trusted counsel gets asked.  But trust, particularly the kind of trust we’re talking about here, carries a high price tag: independence and objectivity.  How can you trust my opinion about whether an acquisition offer is fair to the Company if the investors pushing you to sell have me on speed dial, and just sent me an invitation to their pool party? How can you trust me to give an honest assessment of a term sheet, or even a comparison of one term sheet v. another, if I’ve closed 20 deals for the VCs who submitted one of those term sheets, and have 3 more in the works? You are one deal. They are 25. Lawyers aren’t that bad at math.

Let’s be real: you can’t. Not possible. Founders know it, and in a world in which so many lawyers have given into the incestuous biz dev practice of playing both sides of the VC table, the result is a deep cynicism toward startup lawyers. Do I choose X firm or Y firm? Whatever. They’re all the same. I’ll just go with the cheaper one, or whatever one makes closing my financing easier. Some lawyers who regularly represent startups have even strategically made VC fund formation a core component of their firm. Smooth.

What “Alignment” Really Means

To the majority of lawyers (outside of the startup space) and investors (outside of the startup space), the above views are totally uncontroversial.  Make sure your own lawyers are independent and objective? Umm, yeah, thanks Captain Obvious. And even within the smaller sphere of startup/VC work, I know several investors and lawyers who draw a hard, ethical line to ensure that their reputation is not muddied in the pursuit of short-term revenue. If their investor-client is investing in a startup, they don’t shimmy over to the other side of the table with a smile on their face and a conflict waiver in-hand. They insist that the startup get their own lawyers. Trusted counsel.

But then there are the other people. “Deals get done faster” – “Startups save money on legal fees” – and (my favorite) “We’re all really aligned here, so why do we need two sets of lawyers?” Seriously?

I like to take complex issues and distill them into very simple statements totally free of B.S., so here’s one for you: when someone buys your startup for $200MM, there’s ultimately two places that money can go: in your pocket (and of your co-founders, team, etc.), or the pocket of your investors.

What was that about “alignment” again? And to be clear, the price tag gets negotiated in the acquisition, but guess where the % distribution between Pocket A and Pocket B gets largely negotiated? Financings. 1% of $200MM is $2 million.  So you’re negotiating whether millions of dollars in an exit will go into founders’ pockets or VCs pockets, and you’re telling founders they should just use the VC’s lawyers to close the round – because it saves maybe $10-20K in legal fees? Right. Thanks for ‘looking out’ on the legal budget.

Founders and their investors have shared interests in building a highly successful, profitable company. That much is doubtlessly true. But anyone who uses “alignment” as a justification for founders not worrying about the independence of their company’s lawyers is either (a) totally lying or (b) laughably lacking in even a basic understanding of human nature. 

This is not to say at all that founder-investor relations should be viewed as adversarial. Clearly not. I’m all for honesty, respect, transparency, and the like in company-investor relations.  It’s an important long-term relationship.  However, healthy relationships are built on reality. And the reality is that VCs have limited partners for whom they are legally obligated to maximize returns. It doesn’t at all make them bad people. It just means that they, like the rest of us, have a job to do. They are not your best friends, they are not your mom, and they are most certainly not fully “aligned” with the company’s economic interests. Hire your lawyers accordingly.

Drawing a Firm Line

In Austin, you frequently hear the mantra “be authentic.” No, not authentic in some anti-corporate, hipster sense, but “be who you say you are. do what you say you’re going to do.” Don’t hide behind excuses like “this is how it’s always been done before,” or “this is how the game has to be played.” Change the game. Rewrite the rules.

A while back the tech/vc attorneys at E/N sat down together over lunch to discuss the above issue. We’ve all dealt with it at prior firms we worked at, and there was no possible way of doing anything about it there. But there’s a funny thing about leaving big, corporate environments for smaller, focused firms (like startups) – it’s much easier to establish a set of firm principles, infuse them into the group’s culture, and protect them as the group grows.  And here we are: E/N, as a firm, does not and will not play both sides of the Tech VC table.

Everyone here understands it, is committed to it, and anyone who wants to join the firm will have to as well. And many of our clients are well aware of high-profile early-stage investors whom we’ve, politely, chosen not to represent as a result of this policy. Loss in short-term revenue? Sure.  But this is a long-term play. Rather than following other lawyers and firms in chasing anyone who will write us a check, we believe deeply in preserving our clients’ trust, and have chosen to bet on it.  If you want a paper pusher, I’m happy to make some recommendations. We provide legal counsel.