Lies Damned Lies and Startup Legal Fees

first_imgLies, Damned Lies, and Startup Legal FeesFebruary 12, 2019 by AlleyVoice 318SHARESFacebookTwitterLinkedin Spend enough time working in startup ecosystems across the country, and you’ll hear a whole spectrum of conflicting advice on working with lawyers; some of it great, and some of it total nonsense. The goal of this post is to spell out some of the latter, to help founders avoid costly headaches.Lie #1: Automation and Legal Technology will save you a ton of money. Virtually every law firm with a strong Startup/VC practice knows how to leverage templates and software automation to streamline drafting.  It’s table stakes.  What the honest ones will tell you, though, is that over the course of a company’s history, the amount of legal work that templates and software cut out is spectacularly small. Legal tech is actually “eating” the work of paralegals (simpler, more standardized) *far* more than the work of experienced lawyers. Startup formations are the most standardized and easily automate-able, because you’re starting from scratch, and there are no outside parties (or other lawyers) and messy histories to deal with. Once you move past formation and maybe a cookie-cutter SAFE financing, the amount you can streamline with technology (without screwing things up) drops very fast. Clerky and Gust Launch are the two most common platforms we’ve seen that founders use when keeping formation and very early legal costs to an absolute minimum is a top priority, and Carta has become the dominant platform for streamlining option grants and capitalization tracking.  They can be very reliable, in the right contexts, and we’ve been big supporters for a long time.But the whole reason startups engage highly-skilled law firms, and not simply productized software offerings, is that there’s a ton about structuring your company, hiring, raising money, and interacting with other people who have their own subjective preferences and priorities, that makes flexibility essential.  It’s a tiny portion of startups for whom a highly standardized, high-growth Silicon Valley-style approach to ‘legal’ actually works long-term.  Flexibility means complexity, which requires strong drafting and analytical skills; especially given that contracts are, unlike software code, permanent. This combination of the need for flexibility and potential for high-cost, irreversible errors is precisely what makes serious automation of startup legal mostly a pipe dream. But showing off a shiny new piece of half-usable, over-priced software does make for good law firm marketing.  Lie #2: All serious startups hire the “BigLaw” firms that high-growth unicorns use. There are a handful of large law firms with hundreds of lawyers who have built their well-deserved brands representing iconic tech companies on IPOs and billion-dollar deals. Many founders of young startups have been told that hiring anyone but those firms means inevitable legal disaster. Here’s a reality check on that.The senior associate you’re talking to in “BigLaw” charges you, say, $650 per hour. 25% of that, give or take a few points, goes to the lawyer. That’s the amount necessary for the firm to recruit and retain that lawyer, with the training and skills you need, in the highly competitive top-tier legal talent market. What does the other 75% pay for? Very highly-paid senior partners managing unicorn deals, for one. Also extremely pricey real estate, armies of staff, and other overhead. I call all of this “infrastructure.”Legal infrastructure is real, and necessary, to a point. Solo lawyers – the opposite of BigLaw, just single lawyers with no infrastructure at all – can’t really represent scaling startups long-term on corporate work. They’re better for “small businesses.”  Complex deals require coordinated teams, shared resources, institutional knowledge, etc.But still, 75%? That’s 300% overhead above the cost of the talent. How much legal work really needs that much infrastructure? Our answer, as a high-end boutique firm with lawyers in NYC, Seattle, Austin, Boston, etc., is not nearly as much as some people let on. There are a lot of serious startups for whom pre-IPO exiting below $300M is a “win.”  Those founders simply don’t need the same law firm that Facebook uses, and never will. High-end, leaner boutique firms close low 9-figure private tech deals (acquisitions, financings, etc.) all the time without a problem, and you’ll find them full of Harvard, Yale, Columbia, etc. and BigLaw alumni.  They’re also hundreds of dollars less per hour than BigLaw; not because they aren’t paying their lawyers well, but because they’ve been far more thoughtful about the infrastructure they’ve layered on top of their compensation. The kind of law firm you should engage depends on the kind of startup you are (realistically) building. Hiring a firm that is “overkill” will not only shorten your runway, but you might also be so “small potatoes” that getting your e-mails answered promptly is impossible. High-end, leaner boutique firms close low 9-figure private tech deals (acquisitions, financings, etc.) all the time without a problem, and you’ll find them full of Harvard, Yale, Columbia, etc. and BigLaw alumni.  They’re also hundreds of dollars less per hour than BigLaw; not because they aren’t paying their lawyers well, but because they’ve been far more thoughtful about the infrastructure they’ve layered on top of their compensation. The kind of law firm you should engage depends on the kind of startup you are (realistically) building. Hiring a firm that is “overkill” will not only shorten your runway, but you might also be so “small potatoes” that getting your e-mails answered promptly is impossible. Lie #3: Fixed fees “align” incentives between you and your lawyers. The fact that corporate lawyers generally bill by time, instead of with fixed fees, is always a fun fact for armchair commentators to complain about. Let’s cut through the nonsense on this topic with a quick bullet-point list. Name me another industry that, like corporate law for startups, checks all of the following boxes:Significant, unpredictable variability of each client’s needs depending on industry, location, investors involved, growth and financing model, market conditions, etc.Significant subjectivity in valuing work product not just from the client themselves, but from third-parties with whom you are negotiating and their lawyers as well. Different priorities. Different values. Different incentives.Extremely high-cost, often irreversible errors, given the nature of contracts and legal liability on high-stakes issues, that are very hard to quickly detect by the client.Significant unpredictable variability, subjectivity, and irreversible high-cost errors that are difficult for the client to catch. Can you think of another industry? Not healthcare. Far more uniformity and predictability (biology, science), and far less subjectivity (just fix it). I can’t think of one either. Did I mention that software developers often bill by time as well, and software bugs are *way* easier to fix than contract bugs? Fact: serious law firms don’t regularly bill by time because they’re lazy or overly mercenary. They do it because it’s the most flexible and appropriate for the unique context.The idea that there’s some kind of smooth bell curve enabling an optimal broad fixed fee for all startup legal work is total ghostbusters fiction unless you dramatically narrow the kinds of companies involved, and limit their options for legal work (inflexibility). The preference on the part of many clients for diversity and flexibility in their legal strategies is what usually makes fixed fees non-viable; or at best, a terrible idea.Also, how exactly do fixed fees “align” incentives anyway? They don’t. Fixed fees in startup law actually reverse incentives, often making them more dangerous. It’s often said (cynically) that hourly billing incentivizes lawyers to over-work. The logical corollary is that fixed fees incentivize lawyers to under-work, by making it more profitable to cut out as much work (and quality) as possible right up to the point before it’s detectable by the client. When a VC makes an ask and a startup’s lawyer chooses to not push back on it, how does a founder know if it’s OK, or if it’s actually corner-cutting incentivized by a fixed fee? They don’t, because they often have no idea what’s normal/market.This is precisely why, in the broader legal market (outside of startups), work that clients consider high-stakes is almost never done on a fixed fee, whereas work considered lower-stakes more often is.The consequences of over-working in startup law are very visible and verifiable to founders, and therefore correctable: you can balk at an excessive invoice, and verify in the market whether it actually is excessive. The idea that hourly billing in itself leads to inflated costs is therefore overblown.  The market, which is quite competitive, can easily correct for it.  Get a better lawyer.The consequences of under-working, however – like failing to push back on terms, not telling a client about certain options (because they cost time), and over-delegating work to inexperienced (cheaper) people instead of doing real analysis or negotiation – are far less visible, and therefore harder to catch before the damage is done.  It can be years later, in a tense moment of disagreement causing everyone to review their contractual rights, just as an example, before the company feels the full effects.The consequences of under-working, however – like failing to push back on terms, not telling a client about certain options (because they cost time), and over-delegating work to inexperienced (cheaper) people instead of doing real analysis or negotiation – are far less visible, and therefore harder to catch before the damage is done.  It can be years later, in a tense moment of disagreement causing everyone to review their contractual rights, just as an example, before the company feels the full effects.This is why we use fixed fees very selectively.  They can work if the right conditions are in place, but we never pretend that they’re some magical panacea for all legal work. Instead, we focus on transparency and open dialogue to minimize surprises.  It’s worked quite well for us.What kind of law firm would even tell founders that speed and price should be their top priorities on high-stakes work, when they’re negotiating permanent power/economic terms across from people 10x as experienced as they are? Maybe a law firm that flouts conflicts of interest and is “owned” by VCs?  Using lawyers with deep conflicts of interest with investors, and on a fixed fee, is a perfect recipe for ensuring that those lawyers rush their work and just give your investors what they most want.  Minimizing their “time spend” maximizes their ROI on the fixed fee, and caving on material issues ensures the loyal VCs refer them more work. That fixed fee may be making your VCs more money than it’s saving you.Be smart about diligencing your startup’s lawyers, and you’ll get trustworthy, efficient, right-sized advisory. But be careful with the lies floating around town from misaligned or inexperienced players. If you hire the wrong firm, they won’t be the ones holding the bag. You will.Jose Ancer (@ancerj) and Jeremy Raphael (@jraphs) are Emerging Companies Partners at Egan Nelson LLP (E/N), a Lean, World Class Law Firm delivering top-tier, scalable legal counsel to leading startups, without the unnecessary overhead costs associated with traditional firms.  Filed Under: Advice, LegalWatch, Management, Resources, Strategiccenter_img PREVIOUS POSTNEXT POSTlast_img

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