Ask the Wizard

You are one lucky dude. You have a simple vanilla Series A term sheet from a venture fund that's done a bunch of A round deals. You and your investor get along and are looking forward to working together. The company is brand new. You have an attorney who does divorce deals normally but has done a few incorporations in his day to negotiate the term sheet and handle all the follow-on negotiations on the Articles, which should be no big deal, right? After all, how many Articles of Incorporation variations can there be especially when you're working with a very vanilla straightforward term sheet. You're raising a million bucks, the legal fees on this financing will net out at, what, 5 to 10k at the most, right? You can probably get anybody to represent you because this should be pretty cookie-cutter, right? You poor deluded fool.

There are a bunch of things to think about regarding legal representation and legal fees.

Rule #1: Making mistakes on your legal agreements now will cost you in spades down the road, both financially and otherwise. Do not skimp on representation. Do not focus on hourly rates (more on that below).

Get attorneys who have worked in your general area before (eg. internet consumer software or enterprise IT software) and who have done all kinds of work across this area (eg, financings, corporate creation, contracts - especially contracts, patent/IP work, M&A work, options plans, etc.). Geographic proximity to you is entirely unimportant, so don't worry if you're in an area that doesn't have lots of this expertise. FeedBurner's current counsel is Cooley Godward's office in Broomfield Colorado. We are in Chicago. I'm not sure I could point to Broomfield on a map other than to wave my finger generally over the denver area and say "it's thereabouts".

My cofounders and I were extremely fortunate that one of our spouses worked at the first firm that represented us in a previous company, but not everybody's in the position to have immediate access to a trusted and capable firm. So, what are some of the ways you can go about finding great attorneys? Simple: call or email a bunch of other startups in your general market and ask these people how they like their representation. I'll save you the hassle of emailng or calling me and tell you that we love our representation. Startupping, Mark Fletcher's excellent new resource for entrepreneurs, also has a bunch of helpful suggestions in this area in the forums, and you can always ask questions of a lot of people at once over there.

Rule #2: Financings will cost you a lot more in legal fees than you think they should.

Back to the opening paragraph. You're doing a straight A round financing on a blank slate company with a venture fund that's done loads of these. I would expect to pay up to $30k on all the legal fees associated with an A round financing. Why so much? Because you are paying the legal fees for both your attorney and the VC's attorney when these two attorneys negotiate against each other. "Did I read that correctly?", you say, rubbing your eyes. Yes, you read that correctly. You pay your attorney to negotiate all the docs and you pay the VC's attorney to negotiate against your attorney. Some percentage of the money you are raising will go to pay the attorney of the firm who is negotiating against you on the money you are raising. This is chapter 1 in the "Life's not Fair" manual that comes with running a startup.

Unfortunately, this puts you in a position of thinking "well, i don't want to really negotiate this point, because I'm paying twice to negotiate this point". That's no way to live, so here's how you (try) to deal with this. First of all, up front, get the venture firm's attorney to cap their fees. They will respond to this request with "we will if your guy will", and your guy will respond to this request with something like "we will if they will but our cap will be higher because we also have to do all the paperwork and file the articles and blah blah blah" or they might say "no." or they might say "ok, we'll cap ours at 30, which is fine since we only anticipate spending 20". Take a deep breath and keep at it, you want both sides to cap their fees before you get started here. Helpful investors that are really going to be your partner can put the squeeze on their counsel to cap their fees. Of course, you might reasonably say that a super helpful investor would pay their own legal fees, and I'd agree with you. This is one of the areas that I shake my head at and say "this don't seem right", but I've never been in a situation where the venture firm paid their own fees. In a financing where you have multiple investors, however, you should definitely make sure you're only paying one firm on the other side.

You may be thinking right now that I'm stupid to pay both sides' legal fees in any negotiation. If you can negotiate that you're not paying the other side's fees on the deal, good for you. Go for it. While I have never not paid the other side's fees, I'm sure some companies in huge demand have the leverage to negotiate for this prior to signing term sheets. As always, never take "it's standard, all our deals are like this" as a reason you should just accept the point.

The last point I would make on financing legal fees is that you can use the Wizard's very own patent-pending-financing-legal-fees-negotiation-tactic. Here's how it works. Before the two sides start negotiating, I call both sides and start swearing about how upset I'm going to be if this costs more than some reasonable amount. I'm generally informed that it's going to cost a lot more than that reasonable amount, upon which I call and email both sides again and the investors and swear a lot more about how capital inefficient this is and what a waste it is, and since I actually feel this way and am by now swearing in the office about the cost, it has the added effect of not sounding disingenuous.

Rule #3: Expensive attorneys can be less expensive

Referencing the Wizard's first rule of legal representation, one of the reasons you want people who've worked in this area before is that they can end up costing you a lot less money, even at a much higher hourly rate than other attorneys, to get pieces of business done. In the past, we've seen very expensive attorneys get financings, patent filings, contracts, and other work done for companies at 1/4 the total cost of similar work by another legal team and the resulting work is likely a lot more thorough if the firm's had lots of experience in this area. Our previous company (spyonit) setup costs were a lot less than my first company's setup costs in which I'd used a "cheap" non-researched attorney, even though the spyonit attorneys were lots more expensive and spyonit was a more complex company. Don't skimp on seemingly pricey attorneys as a means of saving money. It can easily backfire. This is to say nothing of the trouble and costs you could incur down the road if you sign a contract with troubling indemnification clauses or the options plan is messed up in some obscure but critical way, etc.

If you can find attorneys who also believe in what you're doing to the extent they feel like this will be a beneficial long-term relationship, that can also help a ton with short term fees. If your counsel feels like building this relationship is more important than getting another 1500 bucks out of you this month, that's obviously a good thing. This is easier said than done, however, and probably even more difficult in the valley at the top firms.

My opinion about legal representation does not cross over to audit representation, in which I think going with one of the cornerstone firms is a good way to ensure you will get raked over the coals on audit fees a few years down the road. Lots of auditors will mark down their fees in the first year or two while you're just getting started, but the really big firms will come back and bonk you on the head with ridiculous fees a couple years down the road, while some of the smaller, hungrier, and no less competent firms will keep their rates aggressive AND will give you more general attention.