Category Archives: Tech

Integrated Startup Law — Specialists Matter

Without getting bogged down on details, you can largely categorize physicians as general practitioners and specialists. Generalists are the every-day doctors that provide primary care for more routine matters, and also (hopefully) coordinate care with specialists (cardiologists, neurologists, etc.) when appropriate. Unfortunately, the U.S. healthcare system does a terrible job on that second part, but this is a blog about startup law, not healthcare. End of digression.

The practice of transactional law, including startup law, can also be categorized in this way.  A “corporate lawyer” serves the role of the general practitioner. Her job is to handle the more common matters that a client is likely to encounter, and to coordinate with specialists (tax, labor, IP, etc.) when their input is needed.

Biology is Integrated

Anyone who’s studied health policy knows that, by far, the most effective and efficient healthcare delivery models in our country — Kaiser Permanente, Mayo Clinic, etc. — are what many call “integrated.” Specialists and generalists work under the same system, and share information with one another in as frictionless of a manner as possible. The reason for this is that the human body itself is an integrated system. The heart doesn’t operate in complete isolation from the brain any more than my macbook’s hard drive operates in complete isolation from the CPU.  So it makes little sense that medical practitioners who specialize in different systems of the body work alone, as if the knowledge of other specialists is irrelevant to their own work.

Startup Law is Integrated

What I try to ensure that our clients appreciate is that the law itself, including the law that affects startups on a daily basis, is also integrated.  Even at the most standardized of startup legal events — formation — there are at least half a dozen specialties of law that play a role in the steps a client needs to take.  Securities Law, Labor Law, Intellectual Property Law, Commercial Litigation, State Corporate Governance Law, Tax Law, etc.

A view commonly heard about early-stage startup law is that it’s all become so “standardized” that large, sophisticated institutions with specialists (not just generalists) are no longer needed to properly serve clients; the end-result being a retreat to a “cottage industry” mentality where small practices of generalists have set up shops pitching themselves as delivering the same service, but without all that unnecessary “overhead.”  Some have gone so far as to call this trend a “disruption” of law practice.

My response to this perspective is three-fold:

1. “Standardized” and “Simple” are not the same thing. Not even close.

Production of the iPhone is standardized; otherwise no one would be able to afford it. But that doesn’t mean the design and building of the iPhone is “simple” in a sense that it could be produced by a fragmented cottage industry lacking the resources of Apple.  In the same sense, the set of twenty or so documents that we produce for our startup formations has become standardized to the point that we can produce it quickly at scale, but the expertise of at least half a dozen specialties went in to producing it, and is required to constantly update it and ensure it fits the current state of the law.  A set of lone generalists, even brilliant ones, simply wouldn’t cut it.

2. The exact same process, delivered from a smaller office, while wearing denim, does not a disrupter make.

Disruption of an established industry comes from delivering what consumers want, but in a radically different, often cheaper way.  Productizing the expertise of highly educated and specialized individuals and delivering it at scale so that far more people can afford it: that is disruptive – and it’s happening in startup law.  Cutting off the relevant expertise of a large portion of the profession, moving into a smaller office space, and continuing to deliver the product in the exact same way: t’is not disruptive.

Because smaller legal practices often do have salary structures that lower their labor costs, they do tend to have lower hourly rates.  But many (that I’ve encountered) use this lower labor cost as an excuse to avoid adopting the kinds of technology and practices that actually make the delivery of startup law efficient.  In other words, “our hourly rates are lower, so it’s OK if we take longer to do something.”  People operating in Big StartupLaw, particularly techies like myself, are often floored to see how backward some (not all) smaller practices are. This is not a space for “cottage” practitioners, though not all smaller practices fit that definition.

3. Specialists will need to be consulted.

Forming your startup or raising a simple seed financing might be thought of as the legal equivalent of getting a cold (simple service is fine), but actions taken at the not-that-much-later stages of the startup, like drafting executive employment agreements, developing and protecting intellectual property, issuing securities, negotiating commercial contracts to be enforced in multiple jurisdictions; these can touch on legal nuances that are a whole lot more like brain or heart surgery. Leaving everything in the hands of a generalist can end up ugly.  We’ve seen this happen many times.

The high growth nature of tech startups means they can go from playing legal tee-ball to the major leagues very quickly, unlike most kinds of businesses that utilize small firms.  Legal representation that can scale with the startup at all of its stages, rather than max out once the startup becomes successful, is extremely valuable; particularly because the costs of switching law firms are not insignificant. The key is to find a firm that packages and prices its services appropriately for each stage of a startup.

Fragmentation v. Integration

Many smaller practices are well aware of these limitations in their model and have developed informal networks of specialists from other firms to call upon in situations when their expertise is needed.  I’ve touched on this topic here.  While this is definitely a good thing, thus far I’ve been unimpressed with the mechanisms (i.e. none) that smaller practices have put in place for actually drawing upon their “network” in an effective and efficient manner.

Having to formally engage a new law firm (including running a conflicts-check) to ask a question that someone under an integrated system could get answered by walking down the hall doesn’t exactly smell like progress to me.  Even if it works for lengthy, project-based engagements, the kind of quick, 15-minute consults that are commonplace (and necessary) in an integrated firm will inevitably go under-utilized in a system with that much friction.

Some “multi-specialty” firms have done a little better and brought in-house the handful of types of specialists that are most likely to be needed by a startup: employment, tax, and IP seeming to be the most common.  But that’s a tough model to sustain because those specialists almost invariably need to also work for large non-startup clients (the kinds that don’t work with small firms) to keep their practice profitable.

Of course, as in other industries, at some point the right platform for allowing a fragmented system of specialists to coordinate ad-hoc may emerge in a way that can match the quality and breadth of the integrated system. But for now, this “PC” of startup law is nowhere to be found.  For matters beyond the absolute most basic, Apple-like integration wins.  Note, however, that a smaller footprint can actually be the optimal model for attorneys/firms with enough brand recognition (gravity) to dominate a particular niche specialty (not generalist) of the market.

Conclusion: Process efficiency and technology innovation will disrupt legal practice. A “cottage mentality” will not.

Progress and innovation in the startup law space will not come from doing things the same old way, while wearing jeans in a less fancy office space.  It will come from sophisticated parties that, instead of retreating from the web of specialties that make up the field, find smart ways to affordably package and productize their knowledge.  This process is well underway, and it’s incredibly exciting to operate in.

Advertisements

The Economic Deflation of Startup Law

News.  Two big issues have been floating around the startup law space lately. First, Yokum Taku introduced “convertible equity” in an attempt to address the potential downsides (for entrepreneurs) of convertible debt, which set off a debate that Antone Johnson spectacularly Storified. More interesting to me, however, was AngelList’s announcement that seed rounds can now be closed, soup-to-nuts, on their platform.  The real news there, for lawyers at least, is that Wilson Sonsini will close those rounds for free.  Yes, as in nothing.

Startup Law – Deflation Accelerating

Much has been written about the “deflationary economics” concerning startups and the web, with Mark Suster’s post probably being one of the best articulations that come to mind.  Not as much has been written about the indirect effects that industries experiencing economic deflation can have on other sectors they interact with.  Wilson Sonsini’s AngelList pronouncement is, in my opinion, the clearest sign that the portion of the legal sector working with technology startups is itself experiencing rapid deflation — and not because lawyers have suddenly shed their luddite tendencies and read ‘The Innovator’s Dilemma’ (though they should).

What’s happened, essentially, is that with literally every other service used by their clients becoming radically cheaper, and the resulting downsizing of investment rounds, startup lawyers simply couldn’t maintain their usual fees and keep a straight face.  This deflation started out with what you might call Stage 1 deflation, with standardized docs emerging, fixed fee packages, etc.  Startup Law was just efficient at this stage, especially compared to other areas of the law.  But with free, dynamically generated documents from high-end firms available online, and now with one of the best firms in the country saying they will close seed rounds for free, I’d say its reached Stage 2, where commoditized is the more appropriate adjective.  And I’d argue that this has some serious implications going forward.

How We Got Here

First, it’s worth reflecting on the different steps that startup law firms have been (or should be) taking in order to compete in this deflationary environment.  I’d break those steps into 3 categories: contractual, technological, and operational.  These steps could also serve as a model for other parts of the legal field that, while not as aggressively deflationary as startup law, will likely eventually follow a similar path.

Contractual. 

  • Standard Firm Docs – In order to make contract drafting more efficient, firms started modularizing the language of their own documents.  If an investor gets a 1x participating liquidation preference with a 3x cap as opposed to the 1x non-participating currently in the document, ‘drafting’ involves mostly cutting and pasting bracketed language, with minimal tinkering.  While this cut down on internal drafting, it still left room for bickering about language with the other side of the deal.
  • Universal Standard Docs – Going one step further, standardized investor docs like the Series AA and the NVCA Model docs emerged, allowing for parties on both sides to have a common language framework to work from.

Technological.

The contractual efficiencies developed in startup law still required the usual process of opening a word document, filling in blanks, moving around language in a very straight-line fashion, and then proofing to make sure everything is coherent.  Closing required creating signature packets, then tracking signatures and assembling them back into fully executed copies.  But then technology emerged to streamline a lot of this process.

  • Proofing Software – A significant amount of time on a transaction used to be spent by junior attorneys flipping through pages to make sure names are properly spelled, commas are in the right place, and defined terms are properly in place.  Software like Deal Proof emerged that can scan a document and generate a proofing list for an attorney, cutting down on that proofing time by anywhere from (my estimate) 50-75%.
  • Document Automation – Companies like Brightleaf have emerged to turn the cut-paste-and-proof process of working with form docs into one of simply clicking certain options in a form.  Want that 1x participating LP w/ 3X Cap? Just click the right box in your template, and the language will get filled-in automatically, and every other area of the document that is impacted will also be modified. No need to proof.
  • Electronic Closing.  –  With multiple parties often signing dozens of documents, the usual closing process involved creating “signature packets” where you PDF’ed the signature pages of each contract, and created single files containing all the pages that each individual party had to sign.  Without doing this, mistakes would be inevitable.  With electronic signature software like Docusign, this process is largely removed.  Put the ‘Sign Here’ tabs for each person in the appropriate places, and Docusign will (1) guide them to where they need to sign, and (2) generate fully executed documents.

Operational.

One obvious end-result of the contractual and technological developments has been that drafting simply takes a lot less time, which naturally means less money billed.  But what they’ve also done is made the drafting and closing process a lot simpler.  To modify a vesting schedule or a liquidation preference, you don’t really need to understand the actual mechanics of the language. Just click the box.  And to get a deal signed up, you don’t need to create complicated signature packets and coordinate signatures.  Just drop the Docusign tags in the right place, and it’ll do the rest.

Firms have taken advantage of this simplicity by pushing work down to junior attorneys and even paralegals, who bill a lot less per hour.  Where it might have previously required an experienced attorney to draft and close a seed financing, an innovative firm might have a paralegal do 95% of the work, with zero drop in quality.  A partner or senior attorney might spend a few minutes discussing very high-level issues with the client, but that’s it.

The Next Step: Deal Platforms

I have zero doubt that Wilson Sonsini is taking advantage of all three of the above categories.  But the key to really get the kind of deflation reflected in the free AngelList closings is the next step of legal technology: Deal Platforms.  Rather than just the initial drafting of docs being automated, with negotiation over terms and language to follow, the automation becomes bilateral.  If the investor wants a better liquidation preference, he simply fills in a field or checks a different box, and if the Company disagrees, they uncheck that box.

Contract language becomes completely secondary – commoditized – on a deal platform.  One can easily envision a time in which the negotiation of a full venture deal, not just a convertible note financing, involves nothing more than checking boxes and filling in a few fields, with full documents automatically generated and then electronically signed.  The chances of closing such a deal for free are practically zero, but all that automation could make a ~$10K legal bill for a full institutional venture capital financing a reality, which would be about a 50-80% cut on current rates.

Takehome: Nobody should be myopic enough to expect AngelList-like automation to stop at the seed deal stage.  Again, The Innovator’s Dilemma, legal version.  See below from AngelList’s Q&A.

Does Docs support Series A rounds?

No. Docs only supports seed rounds right now. (emphasis added)

Implications: Freemium Startup Law

There are a number of ways that this rapid deflation has and likely will impact the structure of startup law practices.  One result of the already-occurring deflation has been the growth of boutique firms competing with BigLaw by offering similar, albeit more limited, services at lower billable rates.  I wrote about this previously: ‘In Startup Law, Big Can Be Beautiful.

The economic advantage of a boutique practice is that firms can avoid the high billable rates necessary to sustain the breadth and overhead of large law firms, while still offering their experienced attorneys comfortable salaries.  That works well in an environment where the demand is for cheaper seed financings and venture deals. But what happens when free or practically free becomes the dominant expectation?

Cross-subsidize.  As Wilson Sonsini’s move has made absolutely clear, large firms have their own economic advantage with respect to legal fees: cross-subsidizing low-end work with profits from larger deals.  Large firms don’t just handle formations, seed financings, and venture deals, they also handle cash cow M&A and IPO transactions that are not experiencing anywhere near the kind of deflation going on at the low end.  Those deep pockets make offering free startup work a lot easier, provided enough of the loss-leaders generate big deals down the pipeline.

This model of offering a lot of stuff for free and profiting off of the high-end users should look very familiar to techies: it’s the freemium model, applied to law.  And it distinctly favors large, brand-name firms.  Boutique firms lack the institutional capacity to handle the large transactions that a larger firm can use to cross-subsidize free work.  Without more radical change, their only hope is to make up for deflation with volume.  But [insert large number] * free doesn’t pay the bills.  Commoditized deal work favors the cross-subsidization of large firms over the lower labor costs of boutique practices.

Conclusion: Move Fast, Move Up, or Move Out

At this point (when deal platforms become ubiquitous), I see smaller startup law practices having to either (A) get used to operating at much lower margins, or (B) find a way to move up-market and take a piece of the larger deals.  I wrote previously about the possibility of boutiques using technology to scale for large transactions here: The Ad-hoc Law Firm? Granted, I don’t have much visibility into how boutique practices are doing, though I’d love to hear from other attorneys or knowledgeable people on how they see the future panning out.

As for large firms operating in this space, the choice is much more straight-forward: either become radically efficient with your commoditized startup work in order to keep the pipeline flowing, or get out.  I’ve seen firms here in Austin completely exit startup work for exactly this reason.  Thankfully, we’re going with the other option.

Legal Startups: All Chasm, No Revenue

Kenneth Adams over at Koncision wrote a blog post recently that caught my attention: The Perils of Innovation, about the challenges of true innovation in the corporate law field.  Take-home point:

Bringing innovation to the transactional world is like competing against a giant cartel. It’s like competing against faith. That’s what makes it so bracing, but it’s also why most people offering technology solutions to the transactional world will fail.

I started commenting on his post until I realized I was writing a mini-essay and that, given the relevance to other topics I cover, it made more sense to post here.  Ken talks about the recent shut-down of Ridacto, a little contract analysis tool that I came across – wait, now that I think about it, Ken was the one who introduced me to it, via Twitter – and found interesting, but a bit shy on execution. You uploaded a contract (more on that later), it ran an analysis, and then produced a proofing report that pointed out issues with defined terms, section references, etc. Much like a simpler version of Deal Proof, which my firm licenses but for some reason no-one used until I discovered it.  It’s highly imperfect, but has honestly saved my life as a junior associate, and has saved the clients I’ve worked with probably about 5-figures so far.

Here’s my comment to Ken’s post:

I’m pretty optimistic about the future of transactional legal tech, but I think that any startup trying to enter the space has to be incredibly strategic about how they build momentum.  I tried Ridacto – it seemed interesting, though the UI was a bit confusing.  But I think the real issue was that their approach to how they analyzed contracts would simply be a non-starter at a law firm of almost any size – hey, upload this contract for a private transaction that hasn’t occurred or been announced yet, we’ll analyze it for you, but we promise we’ll delete it afterwards!  Umm, yeah, good luck with that one.  I got my hand slapped by my IT overlords because Box, not Dropbox, but crazy-secure used by like the CIA Box, wasn’t secure enough for them.  Just suggesting Ridacto would get me laughed at.

Lesson: If you’re a legal startup, your customers, or at least those controlling their buying/use decisions, are pathologically paranoid about security and credibility.  You simply can’t be a $100K, bootstrapped, “lean startup” and expect to get any momentum in this space.  In some ways, you never get to truly enjoy the Early Adopter phases of most tech startups. You start out right in the middle of Geoff Moore’s famous “Chasm” – all the problems of a startup – burning cash, an un-proven business model or product + all the problems of a scaling tech co. that usually has revenue to rely on, like gaining credibility and convincing conservative customers.

The last sentence or two is a point I want to drive home.  The transactional legal field does have early adopters who love playing with new toys, myself included, but we’re (i) few and far between, (ii) usually at the junior level, and (iii) as a result, don’t control the purchasing decisions of our firms.  As a junior, I’ve recently been able to convince our firm of about 4-500 lawyers to trial two pieces of tech that can, and already are, transforming parts of our practice.   One of those is a true startup – BrightLeaf. But there are a number of factors that had to be in place before I could do that:
  • Price – low up-front cost, subscription based. If it doesn’t work out, we make a clean break, little money lost.
  • Trial Period/Demo – don’t expect any firm to consider your product unless you offer a trial, or at least a demo that they can play with.  Demos can be helpful where the firm would need to build in a bunch of of its own information to truly get a feel for the product.
  • Security – I’d have every single aspect of our firm in the cloud if I could, but I have to answer to IT people who get panic attacks at hearing the word “dropbox.”  If you’re handling anything with sensitive information, you need security credentials, and that isn’t cheap.
  • Credibility –  Hire ex-corporate lawyers that can sell – good luck finding them.  Network and get in contact with a single firm that (i) is an industry leader, (ii) has people who are willing to trial software – most likely tech-focused lawyers, and (iii) would allow you to mention their name in marketing materials.  Lavish them with attention.  Most law firms are sheep. Nothing perks the ears of a corporate partner better than “Well, X and X LLP are using it.”  That’s how legal language gets adopted. Same with legal tech.

Low up-front costs for customers and trial periods/demos, so not much revenue to rely on up-front – classic startup.  Security and credibility to convince conservative decision-makers that you’re legit, will make it past their IT people, and truly understand their problems – that’s the Chasm, and it costs money.  Usually a tech co. has some revenue from early adopters to rely on when its dealing with the Chasm, but not a legal startup.  You start out right in the middle of it.

Good luck being a true “lean startup” in this space.  Frankly, I think that an intrapraneur – operating with the brand and budget of a large Co., but with the freedom to innovate – has much better odds than a true entrepreneur running a legal startup. I know many VCs aren’t (yet?) pouring money into the legal space, but we’ll see.  We desperately need innovation, but it’ll take serious, well-funded risk-takers with a strong understanding of corporate law practice (not an easy combination to find) to make it happen.

The Cost of Customization

image by Domenico Nardone via Flickr

One way to tell whether you’ve found yourself a decent tech lawyer is to count how often he/she tells you to keep things simple.  That doesn’t mean that the overall structure of whatever you’re using your lawyer for (formation, a financing, etc.) is simple in a technical sense, but normally when startup attorneys say “keep it simple” they mean something like “keep it standard.”

For example, our fixed -fee Startup Formation Package has dozens, if not hundreds, of moving parts.  It takes dozens of hours, and multiple specialists to comb through the docs and make sure that (i) they all work together (no bugs), (ii) they are actually legally enforceable based on the current state of the law, and (iii) they fit with what future investors expect to find when they diligence potential investments. It’s an on-going process because the business and legal environment is constantly changing, which is one reason why it’s dangerous to just grab docs off the web or just go with the cheapest attorney/firm.

To draft these docs anew and build in, from scratch, the kind of legal analysis that has already gone into them would easily cost $100,000 or more, but we’re able to offer the whole thing for $5K because it’s standardized.  Of course, it also comes with several hours of consultation discussing the docs and other issues.    We’ve designed the package to only have a number of variables that founders can adjust (common things like vesting, share numbers, etc.), which ensures that our clients get a coherent, enforceable set of docs at an excellent value – it’s quite popular.

That being said, sometimes circumstances call for deviation, and we’re obviously happy to modify things accordingly.  But I’ve encountered situations in which deviation is driven more by founder preference than true circumstantial need.   In that context, founders need to understand the full cost of adding extra complexity into their deal structure.  Deviating from what’s “standard” usually ends up costing a lot more than just drafting time.

Costs of Deviating from Standard Terms

  • Drafting time – the obvious one
  • Risk of Conflicting Language – once you’ve built in bespoke language, you’ve added the risk that somewhere in the docs there is language that conflicts with what you’ve added.  At the end of the day, there’s no debugging program for contracts.  No beta testing either.  Usually when conflicts are found, maybe years later, it’s too late to fix.
  • Proofing Cost – After drafting your special language, your lawyer will try his/her best to go over the other docs and find, preemptively, any obvious conflicts in the language. This, of course, costs time and money.
  • Future Drafting Cost – Most law firms, at least properly run ones, have all of their docs for all stages of a company’s growth sync with one another: defined terms, cross-references, amendment provisions, etc.  To the extent that you’ve deviated from standard terms for earlier-stage docs, this increases the cost of drafting later stage docs, because they’ll have to be customized as well.  And there’s a 99.99% chance the attorney drafting those later-stage docs won’t remember (or it might be a completely different attorney) the customization made in the earlier ones, resulting in (i) conflict risk, and/or (ii) time ($) spent understanding the early stuff.
  • Diligence Cost – When investors come around and do diligence on your company, they (and their lawyers) will have to take extra time to understand the unique arrangement that you’ve built into your docs, which wouldn’t be required if it were standard.  Guess who ends up paying for that lawyer time?

Again, life is complicated, and things can’t always be standard.  But if you find yourself asking your attorney to customize docs because of some unique arrangement that you want, make sure you understand the full cost of that customization.  It’s likely a lot more than you think.

Startup Law Hack: Get to Know Your Associate

One common gripe that you’ll hear around the startup community is that a startup using a large law firm will simply be “thrown to a junior associate.”  If you’ve read my post “In Startup Law, Big Can Be Beautiful” you’ll understand my perspective on this.

Junior associate can mean someone who is truly clueless about what they are doing.  But with the right firm, it can also mean someone who:

  • has been assigned tasks appropriate for their skill level, with senior-level oversight
  • has access to other more experienced (read: expensive) attorneys when they’re actually needed
  • has access to institutional knowledge and resources within the firm to efficiently handle most of your basic needs, and
  • because they are early in their career, will be much easier to get ahold of than a senior attorney managing dozens of much larger clients.

Much like how properly-run hospitals efficiently distribute work, with the assistance of technology, between specialists, general practitioners, nurse practitioners, etc., you won’t find any problem with being assigned (not dumped) to a junior associate if the firm you’re working with knows what its doing.  You’ll get better service because of it.

The logical conclusion of this is, when you approach a firm, you should care just as much about the junior associate assigned to your company as you do about the partner/senior attorney.  Research their junior associates, and don’t be afraid to request one.  This will probably surprise the firm a bit, but there’s nothing wrong with making sure you are well served both at the senior and junior level.  Within any firm, there can be wide variance between associates who are there just trying to earn a paycheck and pay off debt, and those who love working with entrepreneurs and have the credentials to show it.