GPSOLO January/February 2008
Start-Ups: Providing Value with Non-Legal Advice
Entrepreneurs are fantastic people to do business with as a lawyer—they keep a law practice vibrant and energetic. They are infectiously optimistic, ambitious, and full of enthusiasm about their professional endeavors. Entrepreneurs must have these traits if they’ve got any shot of succeeding. As a corporate and securities lawyer, I find working with entrepreneurs and their start-up companies to be the most rewarding part of my practice.
Start-up companies create opportunities for employees, investors, customers, and suppliers. When you counsel a start-up company, you inevitably become an integral part of this team. It’s a great feeling to know that you are helping to add value to the economy, and in my case, it’s a constant reminder of why I started my own practice five years ago.
For lawyers who represent early-stage companies, it is frequently difficult to communicate the value of your services to start-up entrepreneurs. When entrepreneurs get sued or need to commence a lawsuit, they know they must hire a lawyer. When entrepreneurs start a business, however, they often don’t know why they should bother getting legal representation immediately—even though a good corporate lawyer will save them tens of thousands of dollars (or more) in the future by avoiding costly legal mistakes.
Many entrepreneurs start their companies on a shoestring budget. The corporate work lawyers typically perform is often too intangible for entrepreneurs to understand and, therefore, justify the expense. For example, an entrepreneur with partners clearly should invest in drafting a good agreement among them. Although most entrepreneurs already know this, they have a choice as to where they can obtain the contract. They can either pay $3,500 for you to draft it, or they can buy one for $99 off “www.GreatestLegalFormsWebsite.com” or some other forms factory and hope for the best.
As lawyers, you and I know the value in paying the extra money to have a lawyer draft a high-quality agreement. In the eyes of the entrepreneur, however, that $3,500 could easily buy something more tangible, such as a good-looking website that could help them find paying clients. When you compare playing with a cool website to thumbing through a 45-page operating agreement that, to them, is about as fun to read as watching paint dry, it’s no wonder that legal services can be a tough sell.
A great way to convince entrepreneurs to work with you, as opposed to going to the form factory, is to create additional value by counseling them on non-legal issues related to their business. Many times, you can use your business expertise to create situations where clients can realize sufficient savings to pay off your fee. For example, if you have special knowledge about your clients’ industry, you may be able to help them make smarter business decisions, such as using a particular vendor or structuring their business model in a way that might be easier to manage.
As lawyers, not only are we permitted under our ethical guidelines to advise clients on non-legal issues, the practice of providing non-legal counseling relevant to the client’s situation is, in fact, encouraged. There are three key areas where I have consistently been able to help my start-up clients on non-legal issues: figuring out the interpersonal issues in a business partnership, helping clients determine the most effective way to raise investment capital, and helping clients find high-quality vendors and services providers.
As compared with other professionals or businesspeople, lawyers usually have significant experience in dealing with partners on some level or other. When counseling about legal terms in a business, you’re doing your client a disservice by not addressing the interpersonal issues involved as well. After all, it’s usually the interpersonal issues between business partners that cause problems down the road.
Some of the obvious issues relate to which partners will fill which employment roles in the business, but perhaps more importantly, don’t ignore the touchy-feely stuff. Pay careful attention to the way the parties interact with each other, especially during discussions about sensitive topics when negotiating the terms of the partnership agreement. If their interaction with each other causes you to cringe as if you were witnessing a former husband and wife duking out a divorce settlement, chances are these people are not going to be able to handle difficult problems in the business when they come up. It might be worth exploring this issue with your clients or pointing them in the direction of a good business coach who can help them work out their communication issues.
Another area where a lawyer can add value is by helping clients determine what is the most realistic way for them to raise capital to fund their business. Entrepreneurs read business publications and come away with the impressions that every start-up company finds funding through angel investor groups or venture capital (VC) funds. The reality is less than one-half of 1 percent of companies seeking investment capital finds it that way. You can save your clients a lot of time and effort by helping them choose an investment strategy that will work best for their business model. Additionally, if you have the experience, clients find it useful for you to help them with their business model, particularly if you can help them construct a model that will put them in the most favorable position when looking for investors.
Finally, because you are a trusted advisor, your opinion about which vendors and professionals to use will be taken seriously. My firm has gone to great lengths to amass a list of professionals who can handle the sophisticated needs of a complex start-up business at rates that the start-up entrepreneur can afford. When we meet with a client, we make sure they know that when they hire us, they get access to our contacts, which will save them valuable time and money.
Even if you are counseling a client on non-legal issues, you still may be subject to professional discipline and malpractice liability. The determining factor of whether non-legal counseling can be construed as part of a legal service and therefore subject to malpractice rests on the purpose of the retained services. If the lawyer’s services were retained in a non-legal capacity and the services rendered were of a non-legal capacity, malpractice is not applicable. If, on the other hand, the non-legal services were retained as part of, or incidental to, legal services, then malpractice is applicable.
For example, my colleague Ted is a lawyer, but he also owns a business where he writes business plans for start-ups. If clients retain Ted through his business plan writing company to perform business plan writing services only, then he would not likely be subject to professional malpractice as a lawyer. If, however, clients retain Ted through his law practice to perform corporate organization work, and they also hire Ted to write a business plan, Ted could be subject to malpractice liability for his business plan writing services because these services likely will be construed as being incidental to the legal work he performed.
It’s also worth noting that, if the non-legal field in which a lawyer is rendering services is closely related to the legal field, it may leave the door open to malpractice liability. Also, lawyers who have specialized knowledge or training in specific non-legal areas may be held to a higher standard than normal lawyers or specialists in that non-legal field based on the higher fees they can charge as a lawyer and the services they rendered in that field.
Will Work for Stock?
Anyone who has represented start-ups after the 1990s has very likely been asked this question, and any discussion about representing start-up companies should address this issue. Quite often, start-up companies are in the process of looking for investment capital and do not have cash to pay for many start-up services, including legal fees. In fact, in certain industries, there is still an expectation among entrepreneurs that the company’s professionals will work for stock, or at least discount their fees in exchange for paper. When deciding whether to work for stock, there are both ethical and business management issues to consider.
The act of investing in a client’s company, whether through a direct investment or by accepting equity in lieu of cash payments for legal fees, does not technically violate the ABA’s Model Rules. However, the ABA and most state bar ethics committees caution against the practice because it creates a conflict of interest between the client and lawyer.
According to ethical rules, the corporate lawyer’s client is the corporate entity. At first blush, it would seem that making the lawyer a shareholder would align the interest of the lawyer and the client. However, if the lawyer intends to sell his or her equity stake in the company at the earliest opportunity, his or her interest may be less aligned with the long-term goals of the company and more aligned with early-stage investors, VCs, or underwriters. In particular, ethics committees at state bar associations seem to be most concerned with lawyers making decisions that may help a client bring a liquidity transaction closer to a closing table, even if those decisions may not be in the best long-term interest of the client. Notwithstanding, lawyers’ ownership of equity in a client will pose less of a conflict of interest if they hold only a small percentage interest in a client, if they intend to hold that interest as a long-term investment, and if that interest is not significant in the lawyers’ entire portfolio.
In 2000 the ABA issued a formal ethics opinion advising lawyers that the Model Rules do not prohibit the practice of lawyers investing in the stock of clients. However, lawyers engaging in this practice must disclose the potential conflict of interest to the client, afford the client reasonable opportunity to seek independent legal advice, and obtain the client’s consent in writing. In addition, when stock is received in lieu of cash payments for legal fees, the fee must comply with the Model Rules’ requirement that the transaction be fair and reasonable to the client. Many other jurisdictions have construed their ethics rules to allow lawyers to take equity in their clients given the same safeguards. Be sure to check your state’s rules prior to engaging in this practice.
From a business perspective, be very cautious about accepting stock in lieu of cash fees. Of course, there’s the obvious risk that, given the high failure rate of start-up companies, you may never see a return on your investment. But also, paying for any service with equity is a very inexpensive way for management of start-up companies to obtain services. An early-stage company generally has very little value, so issuing stock to professionals in exchange for services is almost like getting those services for free. As you probably know already, people who get legal services (or anything for that matter) for free will not take you, or your legal services, very seriously. It sets a bad precedent with clients, and it can lead to a situation where, even when the company has funds to pay for your services with cash, the client will not have an expectation of doing so.
Sometimes it’s worth working out a special fee arrangement for a client as an investment in a long-term relationship. If you decide to take equity in a client, just go about it in a smart way. If that arrangement includes receiving equity in your client’s company, consider discounting a small portion of your fee in exchange for a small percentage of equity in your client’s business, but never take equity in lieu of your entire fee. Also, set limitations as to the length of time that you will proceed with this alternative billing arrangement. The limitation can be based on the passage of time or on the company’s achieving certain milestones. Be very clear with your client both verbally and in your engagement agreement as to these terms so there is no misunderstanding between you. Finally, if prospective clients don’t have enough money to pay cash for at least the majority of the fee for serious legal advice, let them come back when they do.
Even if you have to advise such prospective clients to return later, there’s still a way to provide them with exceptional value that comes at virtually no additional cost to you: Take your expertise, whether legal or non-legal, and put together an information product that you can give to your prospective clients, either for free or for a low cost.
By viewing your information product, your prospective clients become more familiar with you and your services, thus continuing to develop your relationship without your having to make an additional investment in time. By giving your prospective client something of value prior to the engagement, you are more likely to keep the door open to working together in the future.
In your information product you can educate your prospective clients about topics that are important to them, such as how to spot issues in their business before they become major problems. You can disseminate your information product either in paper format, via e-mail, through auto-responders, or by audio or video.
I have put together two information products for my clients and prospects. One is a seven-session “mini e-course” that helps entrepreneurs avoid “deadly legal mistakes.” The other is an audio mini-course that teaches the four most common ways entrepreneurs fund their businesses other than through angel groups and VCs. To see how I put these courses together, check out the “Resources You Can Use” page on my firm’s website, www.furnarilevine.com.
The great thing about creating a multi-session information product is that you can stay in front of your prospective clients over a long period of time, so when they have the budget to pay cash for your legal services, you will be fresh in their minds.
Stephen T. Furnari is a corporate and securities attorney with the New York-based law firm Furnari Levine LLP, where he represents entrepreneurs, high-growth businesses, and the investors who fund them. You may contact him at firstname.lastname@example.org.