Early last month, Snapchat founders Evan Spiegel and Bobby Murphy successfully made their third, alleged co-founder Reggie Brown disappear— with an undisclosed settlement after a prolonged legal battle. News of the decision rippled through the valley, recalling past disputes between Mark Zuckerberg and the Winklevoss twins, and Zuckerberg (again) with cut-out co-founder Eduardo Saverin. Tech lawsuits seem to have reached starpower status, but there’s surprisingly little advice out there on how startups should work with their lawyers on a regular basis, before crisis strikes.
This is Ken Callander’s wheelhouse. As the managing principal at Value Strategies, and a marketing veteran from leading business law firm Davis Wright Tremaine (and Agilent and HP before that), he now works closely with startups to help them not only find the right lawyers, but get the most value from those relationships at every stage. In this exclusive interview, he shares some of the tips and tricks he’s discovered over the years to help founders get smart about managing their legal spend.
The Needs
It goes without saying that there will be legal considerations with starting a company, but many entrepreneurs vastly underestimate how much help they’ll need from a lawyer. It starts at the very beginning and only escalates as their startup grows and moves towards an exit.
When should a startup start thinking about finding a lawyer? I say yesterday.
As soon as you have an idea, you may have intellectual property to protect. It could be software or a product design, but you should have a lawyer help identify and protect right upfront what makes your company special, either with patents or trademarks or copyrights. You’ll want protections in place before you start sharing the details with anyone, and that includes potential hires and investors.
Once you have your innovation protected, you want to figure out the ownership entity: Should it be a sole proprietorship? A limited partnership? A general partnership? A corporation? An LLC? “That determination is really important. The answer depends on what the business is, what tax issues are involved, how many partners or investors are involved, and the potential liability issues,” says Callander.
If you choose wrong, there can be major financial repercussions — the initial decision is high stakes, but surprisingly few people treat it that way. “A lot of people don’t want to set up an LLC or a corporation because it seems like a bigger hassle and there are more costs involved, but if you’re a sole proprietor and you infringe on someone’s trademark, patent or whatever and someone comes after you, they can come after your personal assets.”
If more than one founder is involved, you’ll want a lawyer’s help drawing up a founder's agreement to avoid situations like the Zuckerberg and Snapchat suits. You want to be absolutely clear upfront with the people you’re working with where things stand, how much of the company they own, and who can take credit for what.
Even picking a name and logo can be fraught with legal concerns. "You should have your attorneys do a search to make absolutely sure you’re not violating anyone’s trademark and that you truly own all the properties you need like your web domain." Increasingly, startup founders are needing to buy their domain (sometimes from squatters) and may need help resolving this and other issues.
“If you’re going to have employees, you’ll need employment documents like contracts, stock option offers, etc.,” he says. “There are going to be issues with IP and confidentiality all along the way. What if your senior engineer comes up with a new design? Does it belong to him or the company? It may belong to him unless you have the right documents and IP assignments in place.”
Non-disclosure agreements become critical when your startup starts working with other companies or partners. “NDAs are important to protect your interests,” says Callander. Every company will want its own clauses specific to its interests and technology. “Eventually, you will have more vendors, consultants, and other third-parties involved so operational agreements become a requirement, along with distribution, licensing, and franchising agreements.”
And, once you’ve grown to a certain size, the possibility of a sale or merger may be on the table — either you’re interested in acquiring another company or someone wants to buy you out. Having the right legal team is vital to getting the deal you want. “All of these things, raising funding, shooting for an IPO — you don’t just need a lawyer, but the right lawyer who really understands your company and your interests.” Ideally you will want to work with a person, a team or a firm throughout the life of your startup that knows your story and your goals. But making this happen comes with its share of challenges.
Where are founders’ blind spots?
When it comes to finding a good legal team and mapping the right strategy, early-stage companies face three major hurdles:
Awareness
“Startups tend to be pretty naïve about what’s involved, what the pitfalls are, and what the processes are. The legal part of their business becomes sort of an afterthought because they’re so focused on their product, getting financing and hiring,” says Callander. “Legal is an area where you have to take serious care.” Too many entrepreneurs don’t know what to do and they end up using attorneys that are a poor fit, or end up paying more than they should.
Costs
“Legal costs can be all over the map and can be very hard to track,” Callander says. “Legal services can be very expensive. A lot of startups go in with a whole checklist of things they need to do before they can get funded, but they don’t have the money that’s needed to really do it right. So they cut corners, or they don’t do it at all. They skip important legal steps because of the cost and that can come back to bite them.” (More on how to reduce these costs later.)
The Right Fit
You want to find the right attorney at the right firm to do exactly what you want to do. “That’s really about finding someone who has good knowledge of the industry you’re working in, and who appreciates that you’ve got to keep costs in check. The right attorney should understand you’re just a fledgling business, and ideally be excited about the opportunity to work with you at that stage.”
You don’t want an attorney who's just going to fill out forms and make filings on time. If someone really understands your business and your industry, they can help guide you through some of the major obstacles you could be facing, because they’ve been there and they’ve done it before, Callander says.
There are relatively few resources to help inexperienced founders navigate the legal services process. The usual options include the retention of a large firm with multiple practice groups, attorneys from boutique firms or solo practitioners. Most people reply on referrals by going to a lawyer they know and simply asking: “Who should I use?”
“This is often not the best idea,” says Callander. A lawyer who worked well for someone in one industry is not necessarily the best fit for your business.
Instead, Callander advises that entrepreneurs ask for referrals from other people in their own industry. “Ask them who they're using or have worked with in the past, who is good and why. He also recommends ignoring almost all attorney rankings and lists that are publicly published. “Many of these lists are based on peer ranking — which translates into, ‘I’ll recommend you for a list if you recommend me for this other list.’”
Chambers, he says, is the most reliable ranking service to consult because it bases ratings on interviews with actual clients. Chambers can be found online and ranks attorneys across various areas of law and industry.
Finding the Right Lawyer
When it comes to deciding who to work with among a host of candidates, you want to make sure you find someone with solid knowledge of corporate law, contracts, IP, tax and employment law to start. But there are several other criteria Callander recommends prioritizing.
First, he says, you want an attorney who will be responsive, especially in a pinch.
Before joining Value Strategies, Ken Callander served as CMO for Davis Wright Tremaine. Prior to that, he spent 26 years at Hewlett Packard/Agilent Technologies as an executive in operations and marketing, where he was responsible for the pricing of professional services worldwide.
If you send a note to an attorney saying you're interested in working with them and you don't hear back the same day, I would hesitate hiring them.
“That’s a bellwether for the future — you want someone who will be right there when you need them. It’s that kind of role.”
Second, consider what kind of resources the attorney or the firm have at their disposal. What important contacts might they have? If they’re working in your industry, they could and should know a lot of people who can help you in different areas as you grow the company. “This could include everything from design to technical consulting. Good attorneys know a lot of people and can open doors for you.”
Personality fit is important as well. “You’re going to work with whomever you choose very closely, so it’s important to feel comfortable with them on a personal level.”
Startups should also think about their approach to risk and find someone with a similar world view. “A shared risk profile is really important,” Callander says. “What’s your risk tolerance and does your attorney have the same idea? If you tend to push the limits (of course within legal bounds), you want a lawyer who can spell out all the risks so that you can make an informed business decision. If you have a high risk tolerance and you have an attorney who’s too cautious, that may not be a good fit.”
When you’re looking for a lawyer who will understand you and your business, you may choose to take recommendations from the VCs who backed you. This can be great becaue you can benefit from the experience of others, but you should be sure that the recommended attorney is not only an experienced lawyer, but also a good match for you and your company.
“VCs and law firms are pretty connected, and a lot of VC firms will say, ‘This is the firm we work with, so we want you to work with them also.’ But it might not be the best firm for you. You may or may not have some say in the initial decision, but you should have the option to switch in the future."
Set Good Ground Rules
Once you’ve selected a firm or attorney to work with, part of establishing a good working relationship is in setting clear operating guidelines.
“These guidelines should help set pricing and billing expectations between the company and the firm,” says Callander. “Many clients are beginning to appreciate that the incentives and objectives of the standard hourly billing model may be contrary to their own objectives. That model compensates attorneys based upon the amount of time they bill, while the client’s objective generally is to minimize the amount of time required and have legal cost predictability. Instead of the hourly fee-for-service approach, attorneys and clients should look for ways to align their incentives and objectives. One way to do this is through alternative fee models in place of hourly billing.”
Another part of your guidelines document should set expectations around acceptable costs billed by the firm. For example, some clients consider that costs such as long distance calls, faxes, small quantity copies, postage, word processing and the like should be considered part of the firm’s cost of doing business, and not be billed.
You should also set billing expectations around how your legal work will be staffed. You may not want to pay for very junior associates or multiple attorneys attending meetings. You will want to indicate what types of timekeepers (people paid by the hour) can bill time to your company. You should also discuss staffing continuity and expectations about the eventual changes to your attorney team as you may not want to pay for new attorneys “coming up to speed” with your business.
While a set of documented guidelines isn’t a binding document, it can be extremely useful both once you’ve chosen a firm and even when you’re shopping for one. Callander even suggests discussing these expectations with the attorneys you’re considering working with as part of your vetting process.
How to Save on Legal Costs
At some point as you review how much you’re paying for legal representation, you may consider whether it would make more sense to bring your lawyers in-house. To make this decision, consider the types of legal work you’re going to need done over the next several years. In some cases, hiring an attorney as part of your staff can save you a lot of money.
For example, if you know you’re going to be registering a lot of trademarks or copyrights, it might make more sense to bring someone on staff to handle the work. Similarly, you should consider the value of the legal work you are sending to outside counsel. For basic operational legal work (contract review, lease agreements, employment counseling, vendor agreements, NDAs, etc.) you don’t need an attorney charging $800 or $900 dollars an hour. There are many good attorneys that specialize in those types of work at a much lower hourly rate. On the other hand, if you're looking at a major M&A deal or a bet-the-company litigation matter, economics will not be the driving force.
If you decide to use outside counsel, there are still many ways to cut costs and increase value.
If your startup is negotiating with a lawyer for the first time, always ask for a discount.
“If you ask for discount, they’ll give it to you, a minimum of 5% off. But if you don’t ask for it, they won’t give it to you at all."
Discounts are becoming increasingly common, sometimes labeled as “courtesy discounts” to attract clients. In fact, competition for clients is so heated that discounts have practically become standard. The problem is, most startup founders don’t know to ask.
In addition to asking for a discount, consider the use of alternative fee structures.
“A firm will usually propose working and billing on an hourly basis first,” says Callander. “But to really get more value out of your firm, you should consider different fee models. The hourly billing model may not always be the best option for many types of matters.”
This might seem counterintuitive. Both lawyers and clients tend to like hourly billing because it seems familiar, there’s a degree of transparency (at least on the surface since bills are itemized), and it’s more quantitative and objective. “You don’t need to define what success is or what value is. It works across all types of services.”
But there are significant drawbacks for startups. For one, there’s no fee predictability, and you will often have very little sense of what your bill will be at the end of a term or project.
In addition, you carry all the risk. You will pay regardless of outcome. ” Hourly billing can also discourage law firm efficiency and can promote duplication of efforts. In some cases, the fees will clearly not match the benefit or value received by the client.
So what are your options? Callander says there are a few different types of fee structures that could benefit your company:
Fixed Fees
With the fixed fee model, you define a specific project and agree on a set price. For example, an early-stage startup can ask a lawyer to take care of all of their initial documents of incorporation or operating agreements for a single fee. The firm will come back with a price for that work, and you will be able to budget accordingly.
“The big challenge with startups is that they’re usually fiscally restrained. They don’t have an open checkbook. They need to be able to budget their expenses now in order to manage cash flow,” Callander says.
With fixed fees, there’s an incentive for the law firm to manage their workflow well, use technology to better manage the project and pay close attention to staffing. The client still accepts the risk of a bad outcome or even the risk of an early settlement if the engagement details are not documented correctly, but the firm takes on the risk of cost overruns. On the positive side, there are no complex bills to generate or to review, so the administrative costs on both sides are less.
Fixed fees require some extra groundwork on the part of both sides. The law firm needs to consider most contingencies when they quote a price, and a clear definition of success needs to be documented.
That said, for most basic legal matters with more predictable time-frames, fixed fees can work well and save money.
Variable Fees
Under a variable fee, the client pays based on the results achieved. Often this is a contingency fee based upon a percentage of the recovery or settlement. Clients only pay if they win. If they lose, the firm covers the fees. “This can be very beneficial for a startup that’s struggling financially, and law firms can do well with this too if they know how to screen their cases,” Callander says.
That said, if clients do win, the fee for the law firm can often be significant. In litigation matters, the variable fee can be 30% or 40% of the recovery. But, if your company's on the line, that can be a small price to pay.
Success Fees
Success fees are designed to motivate a law firm to perform in accordance with a clients’ objectives. The client will pay the fee only when certain pre-defined goals are accomplished.
“Success fees are good way to share the risk between a startup and law firm because the client often pays fees up to a certain point, and then kicks in a premium if the work succeeds.”
One version of a success fee is allowing a law firm to take an equity position in your company. The firm will do well if the company does well, so the incentives are well aligned.
If, as an entrepreneur, you come armed with knowledge of these alternative fee structures, know how to choose the right counsel, and set expectations to build a good working relationship, you have a great shot at getting more value from your outside counsel while still getting the quality representation that you need to grow.
Create a Strategic Plan
Just as you build a roadmap for your product and your business model, you should think through when you’ll need legal support over the course of the foreseeable future and what it might cost in terms of both time and money.
“I tell the startups I work with that they should think about what the company will look like in three to five years based on where they are now — everything from their products to their competitors to their location and number of employees,” says Callander. “They should have some idea of where their market is going and where they’ll need to be from a growth standpoint to be competitive.”
Their legal plan should be laid on top of this framework to make sure needs line up chronologically and financially.
“Do you have plans for expansion? Acquisitions? Geographic moves or additional offices? Are you planning to develop new sales channels or maybe move into a franchising model? Is there any chance you’re going to get involved with regulatory issues?”
You want to have answers to all of these questions, and then develop a strategic plan that defines the types of legal needs you expect to have and how best to meet those needs using both in-house and outside counsel. Using this information, you will be able to develop preliminary budgets.
Measuring Value
Critical to this plan is developing metrics and reports in order to monitor the effectiveness of your legal team, and to recognize changes. Your top-line metric should be the ratio of legal spend to total budget. If legal fees have run over budget, you should know exactly where, why and how it happened, and how to prevent it in the future. If you’re consistently running over your budget, it needs to be addressed as fast as possible.
The other metric to pay attention to is spend by “matter type” — basically the type of legal work assigned. You want to make sure your expenses for each category of work are within expected margins, and what are the trends. For example, are you spending more than anticipated on employment documents? Does this mean you're expanding headcount too fast? This will not only help you control your budget, but will give you early indicators of where your business is headed.
Be aware of the legal needs of your company, find the right team to do the work, and focus on getting the best value from your lawyers. All three will go a long way toward managing your costs and getting quality service in an area that can make or break the success of your company.