Thoughts on Howard Tullman’s terrific Inc. magazine piece
I loved the piece in Inc. entitled “5 Ways to Stop Legal-Fee Madness” by Howard Tullman, a legendary Chicago entrepreneur who recently became the CEO of 1871, one of the premiere startup incubators in the area. I agree with just about everything Howard says. Stop for a moment, go read it, and come back and click “more” below to see my thoughts.
Shameless plug alert: My practice, goodcounsel, is doing pretty much everything Howard says a startup should want a lawyer to do. If you want a lawyer who knows his stuff and will deliver a standardized set of investment documents, drafted more or less in plain English, for a reasonable fixed fee, call me. Operators are standing by.
As noted, I agree with the goals that Howard states in his piece. However, I would like to explore one of his assumptions. He seemingly has it in mind that the lawyer hired by the startup will be at a law firm of the size to have “partners,” “associates” and “administrative assistants” – that is, a larger law firm. Logically, his further premise must be that hiring a lawyer from such a place will lead to the outcomes that he advocates. This is where I would like to weigh in. (I have a lot of opinions here, so apologies for what will be a very long post.)
I’ve worked at big law firms – a couple that are regularly atop most lists. They are great places to bring the types of matters that larger businesses tend to have: IPO’s, high-stakes litigation, and the like. However, generally speaking, the larger the firm, the worse the fit will be for a startup, culturally and economically. (My caveat is key, because there are some lawyers at larger firms serving startups quite well.) An entrepreneurial company typically ought to partner with entrepreneurial organizations across the board – those that understand what running a startup is like, and that are organized to respond to a startup’s needs – and this includes the lawyer. Entrepreneurial lawyers are uncommon, but increasingly, they can be found.
It is no disrespect to larger firms to say this. Larger firms are better for certain matters and not good at all for others, just as some diners want a Michelin-starred restaurant experience, and others prefer the price and atmosphere of Chipotle. It’s rare for any business to be able to serve all segments of a market well. Law practices are no different in this regard, including mine. My focus is early-stage companies.
Some further thoughts with regard to Howard’s points:
The need for standard documents
Howard is not the first smart person to propose that there should be a unified set of documents agreed to within a community of companies and investors. He is reacting to the ridiculous fees that many law firms charge startups. (That issue is addressed below.) I think standardization is a laudable goal, and there has been progress toward it (e.g., “Series Seed” documents), but it will never be fully achieved. Just like voters who hate “pork barrel spending” in general but love pork barrel projects intheir districts, everyone agrees that documents are too long but each of the parties to a transaction typically has at least a couple of issues that they feel are absolutely essential. What should be “standard” is very much in the eye of the beholder.
Example 1: I represented a Company that had to amend its Certificate of Incorporation to add director indemnification because the VC investor did not feel that the indemnification terms set out in the bylaws were sufficient. Furthermore, the VC insisted on contractual indemnification too, using the NVCA model document that is 25 pages long. Whether necessary or not, issues like this are frequently raised.
Example 2: Nearly every VC seems to believe that anti-dilution provisions are reasonable protections for their investments and should. I strongly disagree. I believe that VC’s get plenty of protection, and that anti-dilution is unjustified and often just a bad idea. It’s standard in the sense that VC’s often insist on it and get it, because they are writing big checks. But whether it should be part of standard set of documents is debatable and probably not something that can be agreed upon as a general rule for all deals. It’s more a matter of the parties’ bargaining power.
In my view (and admittedly, I generally represent companies), it’s often the investors — the institutional ones — that complicate things with a variety of terms. In small angel rounds, it’s far less typical for issues to arise.
Regardless of whether platonically ideal documents will ever emerge, the fact is that all lawyers recycle documents. We call it, “precedent.” That’s a good thing, because it saves effort and should therefore result in lower fees – but it has to be the right precedent. When a lawyer uses a precedent from a large transaction for a smaller deal, that’s when you end up with a 50-page document where it should really be 10.
When a startup hires a lawyer that works with startups all the time, there is a better chance that the documents will be suited to the task.
Howard, I would love to work with you on a simple, standardized convertible note document set for 1871 startups. The price – how about $1,871?
Conventional law firms typically charge by the hour – $500 per hour and up. By contrast, entrepreneurial practices are comfortable with fixed fees. Delivering early-stage transactional documents on a fixed-fee basis is a no-brainer. Nearly every single early-stage funding transaction I’ve worked on with an early-stage client has been for a fixed fee of less than $5,000, and many have been less than $3,000. If a lawyer cannot confidently propose a fixed fee, that is a lawyer who does not have enough experience with that kind of transaction.
There is simply an order of magnitude (or two) of difference between what is “normal” to a larger firm as far as fees go. I can still remember the shock I felt when I learned that a client of mine had been forced to hire the preferred big law firm of its would-be investor (a wealthy and presumably sophisticated person) to document a relatively straightforward preferred equity investment. The legal bill came to $175,000. I would have handled that matter, on a fixed-fee basis, for about 10-15% of that price. (See my previous post, “Lawyers as deadweight loss.”)
Many of the more senior partners at larger firms are indeed experienced, but if a law firm of any size has reduced its rates to a level that a startup can afford, the odds are – as Howard acknowledges – that you will spend very little time interacting with those partners. Whether the junior associate you are dealing with is any good, or knows anything about early-stage investment transactions, is a crapshoot.
Generally speaking, startups are not a durable priority for larger law firms in the same way that they are for smaller ones. The larger law firms have clients paying them six and seven-figure fees annually. If a larger client’s matters heat up, there is no way the startup is going to get the same level of attention (even if the startup is paying a lot by its standards). You want to work with a lawyer to whom your business is really a priority.
My subjective observation is that larger-firm interest in startup work tends to follow high-profile IPO’s (LinkedIn, Facebook, Twitter). I believe interest also ebbs and flows in proportion to how busy these firms are. When larger firms have unused capacity (i.e., associates), they don’t mind discounting their rates or deferring fees. (Associates are to law firms what seats are to airlines – fixed capacity that needs to be filled.) Companies need to understand that if they do make it to the next stage, the deferred-fee day of reckoning will come, and it will be very expensive. (Interesting New York Times piece on this general subject, here.)
It is a point of pride with me to use the simplest language possible, and to avoid bad lawyer drafting habits (such as writing as if you live in medieval England). I agree that, regardless of the language used, it’s imperative for clients to understand what their documents say. Clients, therefore, must hire lawyers who will take the time to explain things to them.
Closing thought: Howard recently became the CEO of 1871, one of the premiere startup incubators in Chicago. I hope that 1871, and other institutions that have emerged to incubate, coach, and invest in startups, come to recognize that the practice of law is undergoing profound changes.