Working with lawyers is a huge pain in the ass. They’re expensive, you never know exactly what they’re doing with all that time they’re billing you for and you never know exactly when they’re going to get back to you. In some ways working with lawyers is like outsourcing your work to a foreign country - you don’t know the language or the customs, yet you are trusting them with a core part of your company. Hopefully this and future posts on the subject will help. (Note: I’ve titled this “Part 1” for ease of reference if I do choose to write another post on this. Hopefully I will, but maybe I won’t… we’ll see.)
Tip 1: Ask for recommendations in the startup world.
Trust me when I tell you that you don’t want to be a law firm’s first / only startup client. That’s not to say you don’t want to work with a junior associate at a firm with a partner reviewing the work, in fact you might have the most fulfilling experience that way, but you want to make sure SOMEONE knows what they’re doing there! One horror story I can tell you about is a company that came to me only after another firm had spent a long time working on their documents, documents that looked like nothing any modern-day NYC startup lawyer would produce. This firm had wracked up a huge legal bill for a deal that should have cost a few thousand dollars. Documents from the first tech bubble deserve to go the way of Webvan.
Tip 2: Fixed fees are usually your friend (in the early stages).
Law firms offer fixed fees because they may make you more comfortable hiring the firm, since you know exactly how much they cost. When a firm offers a fixed fee to a startup the firm is frequently “losing” money on the deal (ie. billing by the hour would make the firm more money). Most very early stage legal work is not complicated enough that a law firm will not be able to judge the complexity well enough to offer a fixed fee. If the firm you are talking to suggests a high fixed fee or will only work hourly you might want to talk to another firm (Note: There are occasions firms will have a harder time giving a fixed fee, like if you are trying to do a complicated LLC structure. You can probably forgive the firm at that point.)
Tip 3: Deferral Deferral Deferral.
This is perhaps the most important tip of looking for a law firm to do your startup company’s work. EVERY firm that focuses on venture-backed startups will defer its legal fees until you raise funding (ie. you do not owe anything if your company goes out of business). Many will also defer between rounds of financing. Deferral works like this. Say your incorporation (including restricted stock agreements, stock incentive plan, etc) costs $4,000, you incur ~$2,000 in hourly fees for your terms of service and a couple other minor things, and then you raise money using a convertible note, which costs $5,000. After you close the convertible note financing you will get a bill for $11,000. Then you will frequently not get a bill again until you close your next round of financing (but do not be afraid to ask for monthly updates so you know how much you are incurring).
The reason firms that focus on startups do this is that they are “investing” in you, not by taking equity, but by deferring your fees. The economics work out like this. If you are paying the firm a lot of money when you don’t have a lot you are less likely to succeed. This means that you may go bankrupt or may just go to a smaller firm that will charge less, which means the big firm will lose your business. The big firm does not really care about having to write-off $5,000 if your company goes under (and will frequently welcome you back as a client for your second startup). The big firm really cares about the fact that if you stick with them through a sale your legal costs may be $200,000, and if you stay with them through an IPO your legal costs will likely be well over $1,000,000. Yes, 1 million.
Do you want a firm that is incentivized to see you sell / IPO or would you prefer one that is really concerned about getting $5,000 from you as soon as they file your incorporation papers?