Post Category → Venture Capital

When it’s time for your startup lawyer to shut up.

Hypothetical scenario at doctor’s office:

Me: Doc, I’m here for my annual kidney checkup. (note to reader: I donated a kidney)

Doc: Sure, Jose, I’ll take care of that for you. But while you’re here, let’s cover a few other things just to be thorough. How have you been feeling emotionally? Any signs of depression? And what about your sleep habits? Getting 8 hours a day? Your back looks a little arched. We should check for a spinal problem.

Me: I came here for a kidney checkup.

Doc: Your hair seems to be thinning out prematurely. That could be a sign of a hormone imbalance. Your skin also seems a bit pale. Are you getting enough sun? We’ll check you for a Vitamin D deficiency. And how about your sex life?

Me: Please shut up.

Overlawyered.

The billable hour is to startup law what fee-for-service is for most of healthcare. In some contexts it’s necessary, but it often creates incentives for overtreatment; or in the case of law, overlawyering.  There are lawyers who properly see early-stage transactional law through the eyes of their clients: a mechanism to get a deal done, while ensuring that the contract drafting, negotiation and diligence performed are appropriate for the context. And then there are lawyers who, notwithstanding the needs of their clients, try to achieve some kind of legal nirvana on everyone else’s time and dime.

You want to spend hours ruminating on arbitration provisions, or ensuring that the registration rights language in your docs is air tight? Awesome. Go work for Wachtell and get the hell out of early-stage work. This here’s startup law, son, and this deal needs to close.

Perfection v. Materiality

Now, this definitely doesn’t mean that closing the deal is all that matters, and that legal counsel’s role is purely mechanical.  Experienced entrepreneurs understand the transactional insurance mechanism that good lawyering provides.  The point here is that a high quality startup lawyer isn’t the one who drafts perfect contracts, understands every nuance of securities law, and can spot every minute issue while diligencing the deal.  The best startup lawyers build a deep understanding of what’s material to their clients and their business, and aren’t afraid to close the deal knowing that there may be issues in the docs that would make a law review editor cringe. Good enough? Close the deal. These people have a business to run.

An ounce of prevention.

Business Judgment and Experience Matter

This is also not an argument for going with the cheapest lawyer you can find. Remember, the hourly rate is only half the equation. If anything, I’ve found that boutiques (lower hourly rates) are more likely to run the clock in the name of (air quotes) “higher quality”, knowing they can get away with it and that it drives their BigLaw counterparts nuts. BigLaw attorneys (higher rates), without thought-out processes in place, are incentivized to do the opposite: cut corners and close the deal sometimes too quickly.  This is a topic for a later post.

It is, however, an argument for caring very strongly about the business judgment of your attorney, and steering clear of those whose sense of materiality seems wildly disconnected from your own.  You won’t always see eye-to-eye, and that’s a good thing.  Having been to the rodeo many times before, a good lawyer can see risks that you’d miss.  But if you’re paying attention, you’ll notice fairly quickly when mountains are being made of molehills.

A focus on early-stage work is also crucial.  A lawyer with a history of billion-dollar deals or public company work will likely waste everyone’s time far more than a true early-stage lawyer who understands what’s worth negotiating, what’s standard, and when it’s time to shut up and close the deal.

Set Deadlines

This should go without saying: always set an expected closing date.  It doesn’t need to be insanely aggressive, but if your lawyer isn’t capping her fees, at least cap her time. If it needs to be extended, that’s fine, but a sense of urgency can go a long way toward focusing everyone’s eyes on the material.

Read the redlines; Require explanations

Don’t just let your lawyers go through rounds of redlines without business guidance. After the first round or two, get on the phone and start asking questions about comments that are being made. How is this material? What is the likelihood that this is going to actually become a problem? If it becomes a problem, how much would it cost? Is the language clear enough to prevent litigation if there’s a misunderstanding? You’ll pick up very quickly on whether (a) real business needs are driving these comments, or (b) your attorney’s aesthetic sensibilities are.  If the latter, it’s time for him to shut up.

Startup Law is not for law review editors with OCD. It’s for closers. Anyone who thinks otherwise is likely overshooting the needs of early-stage entrepreneurs/investors, and wasting a lot of time and money in the process.

DIY Startup Legal Tools: Self-Diagnosis v. Self-Treatment

Image by Barbara Krawcowicz via Flickr

I have an awesome idea for a startup. Let’s call it LunaDoc. LunaDoc will be a website where you answer a series of algorithm-based questions about a health-related issue you’re dealing with, and then it will suggest to you a diagnosis. Sounds great, right? That’s probably why dozens of these exist already.

But let’s go one step further. After diagnosing you, LunaDoc will generate a prescription and send it to your pharmacy of choice, after which you can pick it up without the hassle or expense of ever having to talk with an actual physician.

If you’re half sane, you should have suddenly thought something along the lines of, “Whoa there, tiger.” Why is that? Because self-diagnosis, or educating someone enough to better understand their problem, is great. But self-treatment, or turning that new knowledge into a high-stakes action with potentially permanent consequences, without consulting a professional, can be absolutely nuts.

Sidenote: As I’ve done many times before, I’m going to leverage this healthcare example into a metaphor for the startup law context.  I truly believe there’s a lot that people in startup law can learn from the healthcare profession, so I’m going to milk this metaphor until the cows come home.

Self-Diagnosis

For years entrepreneurs have been fortunate enough to have an incredible amount of accurate, well-articulated, and free knowledge about startup law issues on the web; some in the form of blog posts and some in the form of articles. I’m a huge fan of recommending online resources to clients as a way to educate themselves without being billed hundreds of dollars an hour for it. And it makes the time that I personally spend with them more efficient (and cost-effective) because we can get right down to business without having to go through basic stuff.

Startup law blogs and articles are the legal equivalent of healthcare websites that help with self-diagnosis. Their role is simply educational, and can help a client (patient) better engage a professional in turning the diagnosis into a solution. While some doctors might complain about patients becoming “google doctors,” a more educated client base is uncontroversially a net positive.

Self-Treatment: Guided v. Unguided

Lately, however, we’re starting to see the web do what it always does: provide tools that attempt to dis-intermediate an economic relationship and let people completely handle things themselves. Self-diagnosis is evolving into self-treatment.

Major law firms have started posting standardized contracts on their websites for free.  Capography, a really cool new tool, lets entrepreneurs manage their own cap tables and even run a limited number of waterfall analyses to see how funds would flow in an exit. Docracy has emerged as an incredible source for hundreds of free contract forms for a wide variety of contexts, and they even let you execute the contract from the comfort of your own home, without ever having to go through the hassle or expense of talking with an actual lawyer (sound familiar)?

The much greater danger with these kinds of tools, much like with LunaDoc, is the issue of permanence. Education is flexible and easily correctable, but treatments are forever. Or perhaps better said, contractual and transactional mistakes are often extremely expensive to fix, if they’re fixable at all.

While everyone knows how much of a fan I am of standardization, automation, and any tool (toy) that allows attorneys to avoid repetitive, boring tasks, the fact of the matter is that tech startups are not coffee shops, and startup contracts are not wills. As I’ve mentioned before, startup law is a multi-specialty, highly contextual sport.  There are countless tax, employment law, securities law, and other state law issues that might come into play in your particular context, some of which need to be handled in the contract, and others that are completely separate from it. Signing the wrong contract, or taking the wrong legal action, isn’t that different from taking the wrong pill.  The side effects may be serious, or even lethal.

But, wait, aren’t law firms themselves putting up these standardized forms? Read the terms of service, my friend. Zero liability. Their skin isn’t in the game. Just yours. Those are marketing tools.

Attorney-Directed Self-Help

There’s a slightly different approach that a few companies are taking to allow entrepreneurs to do some things themselves and minimize their legal spend, while ensuring that a professional who understands the context is guiding the process. Brightleaf has a brilliant concept called a Leaflet. After speaking with a client and understanding what they’re trying to do, an attorney can easily turn a form into a self-help, automated tool. For example, you can turn the Company’s board-approved Option Grant form into a leaflet that allows the client to input the name, date, etc., and auto-generate option grant forms without bothering his law firm. Of course, every time you generate a form, the attorney sees it. Self-help, but with an experienced and invested professional making sure you don’t blow something up.

VCExpert’s Private Company Analysis Tool (PCAT) allows a law firm to input and update a Company’s capitalization info, and a client can then run any number of reports using that data without having to consult the attorney. Again, someone’s there making sure the inputs are correct and that things don’t go awry, but the client doesn’t have to ask his attorney to generate a different report (often hours of work) every time he wants to see the vesting status of options or the funds flow of a potential exit.

Empowering clients and unlocking information from artificial silos is awesome. Pretending that technology can completely replace professional judgment and contextual understanding when it simply can’t… not so much.

Yes, I understand that self-help tools are really about the under/un-served.

Of course, downloading a free contract form drafted by someone who at least knew what they were doing is light-years better than issuing stock with a 3-line contract written on a napkin.  And that’s why I’m not going to say that un-guided self-help tools aren’t a benefit to the startup ecosystem.

Much like how cheap, mass-market contract websites have made wills and basic corporate forms available to people who would never have contacted an attorney to begin with, I get that there’s an underserved market here that needs these tools.  Just keep in mind that how much effort and expense you’re willing to incur in protecting your startup is, in many ways, a reflection of how seriously you take its prospects.  If you’re sitting on a dud, who cares if your employment forms aren’t enforceable in your state, or if you didn’t fill out your stock issuance forms correctly? But if you think it’s a home run (and why would you waste your time on something that you think isn’t?)… well, you get the idea. Investors will too.

Why experienced entrepreneurs hire better lawyers.

There are goods and services for which quality is apparent to the consumer from the beginning, and then there are those where what you actually got for your money can take years to figure out.  Transactional lawyering is decidedly in the latter category, although it often takes a client some personal seasoning (or good advice) to figure that out.

Fundamentally, there are two “jobs” that a client will typically hire outside corporate counsel for in a transaction. The first is getting the transaction done. This is the job that all clients are aware of, no matter how much experience is under their belt.  As long as the client gets his/her desired economic terms, papers get signed, and wires get initiated, all seems to have gone as planned.

But the more experienced entrepreneurs (and unfortunately that experience often isn’t pleasant) know that good legal counsel will serve a second function. While not as simple to define as the first, let’s call it transactional insurance. Some illustrations would be helpful here.

Formation. You have a great startup idea, got together with some co-founders, and want to make it official. You incorporate, issue some founder stock, perhaps authorize an equity plan, and you’re good to go. Put the papers away and forget about them. No worries here, right?

  • What if one of the founders later claims that some of the Company’s IP is his/hers and not the Company’s?
  • What if some of that founder’s work was done on a prior employer’s time/hardware, and that employer now claims ownership of the IP?
  • What if one of the founders dies? Where does their stock go?
  • What if one of the founders gets divorced. Where does their stock go?
  • What if a founder decides to leave the Company after  a year? Where does their stock go?
  • What if someone sues the Company and you personally?
  • What if the IRS comes back 4 years from now and says you owe them a bunch of $ on your vested stock?
  • What if it turns out that a founder had a non-compete agreement with a prior employer with deep pockets, and working at your Company violates it?
  • Insert 3 dozen other scenarios here.

VC/Angel Financing: Everyone signed the papers and sent you checks. Awesome. No worries, right?

  • What happens if we decide to sell the Company early?
  • What happens if we want to raise a new financing, but not all of our current investors are on board?
  • What if an investor decides 5 years from now that he wants his money back?
  • What happens if the IRS claims 3 years from now that we issued stock at too cheap of a price and tax is owed?
  • What happens if an angel investor sues the Company claiming that we fraudulently withheld information from them?
  • What happens if the SEC claims that we sold stock illegally to unqualified investors? Wait, what does college football have to do with this?
  • Insert 3 dozen other scenarios here as well.

The quality of the process and legal drafting that took place in the above scenarios will determine whether a resolution could be as simple as (i) pulling up a document, (ii) pointing to Section 2.3(a)(i), and (iii) getting back to work, or something that could destroy years of hard work in an instant.

From the perspective of a lean entrepreneur who just wants Minimum Viable Lawyering, signing some papers provided for free or a few hundred bucks felt like success.  But experienced entrepreneurs typically have a better sense of the nightmare they may be inheriting by going with the attorney or firm who claims to do the exact same thing as the “overpriced” guys, but at a substantial discount.

Granted, there is a lot to be said for Job #1, and there’s no shortage of movement in the legal industry toward getting the transaction done quickly and cost-effectively.  That topic is the subject of perhaps 80% of my blog posts.  But something is only truly cost-effective when it efficiently accomplishes all of the tasks that you hired it for – not when it provides the trappings of a job-well-done, but kicks any number of disasters down the road.  

I can’t tell you how much time we spend cleaning up the work of bad lawyers who looked, at the time, like a bargain. Experienced entrepreneurs hire efficient lawyers. Inexperienced entrepreneurs hire cheap ones.