The idea is to give readers an informed opinion that, while not specific to their situation, highlights some of the major issues involved in various decisions, such as whether to form an LLC or corporation for your tech startup. (Hint: read this first.)

What is free advice all about?

To some, these posts look like free advice, which makes no sense for a lawyer who gets paid for giving advice. But that’s only half-right at most. From the lawyer’s perspective, only specific advice is worthwhile — after all, you can learn lots of general stuff about incorporation, venture financing documents, and even (although rarely) about venture math from lawyers, VCs, and entrepreneurs (who are now VCs).

What I tell prospective clients is this: you need advice that is competent, focused, reliable, and dedicated. These other writers all fall short on one or more of these factors, and even my own posts have the fault, necessary though it may be, of not being specific to *your* exact situation. Even something as otherwise “standard” as the Delaware C-corp will not apply to certain tech startups depending on the business model, the resources available to the founders, and even the actual nature of the underlying business. Could I lay out some examples here? Sure, but even then you wouldn’t necessarily be sure that your situation fell within the general guidelines. And you wouldn’t know whether there is some other fact in your situation that would change everything, like a substantial spendthrift trust for your living expenses. Trust me: no VC is worried about that issue from your perspective.

If I can’t ever get “real” advice, am I wasting my time?

So why do I write if I’m ultimately doomed to fail by my own standards? Well, first, I think there’s no harm in having high standards. Second, my real goal isn’t, and can’t be, to give you THE answer. Third, what I can do is tell you most of the questions, point you to many of the factors, and most importantly, show you how I approach the issues and structure my advice.

Because what you need, what you come to me for, is trusted advice. I show you that I’m trustworthy by showing (not telling) you that I know what I’m talking about and by giving you lots of evidence of my mindset so that you can see what sort of service, experience, and advice you’re getting.

And that makes a difference for different types of work: putting a typical venture deal together requires a classic Silicon Valley approach: focus on the high payoff terms, put everything else within the zone of reason, and get the parties moving forward; on the other hand, negotiating debt with strict operating covenants and a *gulp* personal guarantee requires a classic New York City approach: no stone unturned, every phrase — representation, covenant, and condition — examined and pushed in your direction.

Please share any examples of when you got the “wrong” type of lawyer for work you needed. What do you expect from a lawyer — what’s just the price of admission and what closes the deal?

The question was essentially whether the fellow with some IP to build a business on should form an LLC or a corporation. In typical LinkedIn fashion, off-the-cuff answers that are specific end up being wrong. In my mind, if someone is asking this question, they either want a quick answer without worrying too much about whether it’s the right answer, in which case they might as well just phone a friend, or they want to understand *how* to make the decision.

As my readers have probably learned by now, I’m happy to educate clients on how to make decisions, on what factors to balance, and point them in the right direction on perceived issues that are just red herrings. At the end of the day, we all have to make our own decisions. Even if you decide to defer to a lawyer to make this sort of call, even if that lawyer is me, then you’ve decided to adopt (if only by proxy) my view of the world and my evidence to you that I understand your goals and plans well enough to make a recommendation that is right for you, just you, in your exact situation at this exact time and place. That’s what I do and how I do it.

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Dan, the answer to that question isn’t usually determined by just how you’ll exit but also who you may need (or want) as Investors and their requirements, the amount of capital your business plan requires, the timeline between here and there, and what the company will look like as it’s operating (the activities it undertakes, the risks it creates, the nature of the competition, and the underlying business model).

The business model is basically how you take capital from Investors, convert it into revenue and gross margin, and do those things at an SG&A level that leads to the generation of free cash flow.

So, in a nutshell, that’s the start of the analysis that I and other startup lawyers do when advising entrepreneurs. Not everyone belongs in a Delaware C-corp even though almost all Silicon Valley-style tech startups do.

I’ve linked two articles that will round this out a bit for you.
Good luck!

Links:

• Incorporate a tech startup
• Compare ownership structures

What popped up quickly was that he was the source of the famous (to me, at least) quote:

The map is not the territory.

We all learned about this one in the Army, whether at IOBC (Infantry Officers’ Basic Course) or in Ranger School. The idea was that looking at a map for your leader’s reconnaissance was asking for trouble. While a map is “a representation of the Earth’s surface as seen from above,” it’s not as accurate as reality. There are things in reality that don’t show up in maps, such as heavy vegetation to slow your progress, or trees that hinder vehicles but provide cover for infantry. The lesson was that it is important to put “eyes on the objective,” and verify that the representations matched reality.

This lesson wasn’t just about map reading and planning and executing operations, though; it was also about things like reports from subordinates that something was done, like the completion of a layout and inventory of equipment to turned in. We learned, as young lieutenants, that failure to inspect is a failure of leadership: a report of all done is not the same as the thing actually being done.

(This notion seems self-evident, and I have no desire to wander off into the pyscho-babble extensions of some authors.) But my next thought was that this idea, of recognizing the disconnection between real reality and perceptions or descriptions of reality, have always been interesting to me and maybe even explain why I’m good at being a lawyer and maybe why I’m happily married to a scientist.

Ex.: I remember a very fun lecture in high school physics (HT to Claude Meyers, the droopy-mustachioed teacher: this one has stuck in my head a long time). He was explaining the dual-slit experiments that revealed the wave-particle duality of light. He noted that the typical question was fundamentally wrong: is light *really* a wave? or is it *really* a particle? The answer he said, was that it was neither: it was what it was, and that “thing” exhibited these characteristics under these conditions. That was all there was.

So now, as a lawyer, I see this principle at work in two different ways. First, in the litigation context, we’re always trying to find and present evidence of “what really happened,” and the hurdle is that we’ve generally decided, via the rules of evidence, to only believe certain types of evidence as connecting the evidence with the reality. A good example of this is a recent case that involves a forged letter authorizing a wire transfer. The bank’s receipt of the letter is not actual authorization: it’s just the receipt of a letter that is some kind of evidence, reliable or unreliable, correct or wrong, of actual authorization.

In the corporate or transactional context, we use similar ideas to zero in on potential problems, whether to avoid or diagnose: we create restrictions on certain behavior, which might be innocent, to prevent mischief; we ask for certain documents to provide signposts to problems but that might themselves not be reliable (see forgery, above).

Recognizing the distinctions between these types of problems and their similarity, understanding the practical world well enough to identify more vs. less reliable indicators, and helping frame the relationship between two parties is the essence, to me, of being a good corporate lawyer. If contracts are, as I’ve said for years, fundamentally mechanisms for allocating risk between the parties, then this function of understanding map v. territory and being able to handicap the outcome is critical to coming out of negotiations with a set of transaction documents that can assist the parties in making the real world look like their vision (turning a territory into a map!).

As a final thought, I had a mini-epiphany on this quote either during pre-OCS map reading classes taught by LTC Daimler, Ret., or perhaps during IOBC or even at Ranger School:

The earth is a 1:1 map of itself.

Maybe even Korzybski would agree with that.

As I think about it now, I suppose I should edit to make that point clearer. But it’s there even without the keywords. I’ll explore this framework further on Simplifying Complexity if there’s interest: are you interested?

Non-lawyers, and lawyers new to transactional practice, have probably never really heard of a legal opinion or what it does. Briefly, the legal opinion letter is a carefully prepared document that is designed to allow a third party, i.e., not the client, to “rely” on what is stated in the opinion letter.

Why does someone in a deal want a legal opinion from the other party’s lawyer? There is the stated reason and the deeply true reason. The stated reason is that the lawyer/law firm writing the opinion letter is liable to the third party for what is said in the opinion letter. That might be simple or difficult to prove, and you can imagine that when lawyers draft contracts about their own liability, they are even more stereotypical in terms of drafting convoluted long sentences that exclude all the important things and attempt to remove the liability and responsibility that you were looking for in the first place.

What’s the deep reason? Someone I worked for framed it this way: the purpose of the legal opinion is to put enough fear in the lawyer that it triggers a frank conversation with the client, protected by the other party’s attorney-client privilege, that might reveal important facts unknown to the lawyer that will affect the transaction. In other words, if I’m on the hook, I’m going to be extra sure to ask you for all the documents related to earlier sales of stock, convertible debt, or other money raised. By creating a process for this outside of the inter-party negotiations, the legal opinion balances the tendency for a party not to talk about “bad” news. [As an aside, this is the smartest thing I ever heard that guy say. HT to you know who.]

As for how this affect’s Ted’s proposal: Ted suggested that opinions drive up costs because of firms’ concerns about risk. While good lawyers are going to do the necessary work to track down the operative facts so that their clients do not make false representations and warranties, there are always (a) those who cut corners, for whom the opinion may bring some back on course and (b) those who make mistakes, for whom the opinion process is unlikely to correct anything since I doubt that opinion reviewers are interested in re-doing the work to test a capitalization opinion, for example.

But as an investor, I do want the other party to have the benefit of getting all the legal advice I’m paying for. As a company, it’s almost always better to adjust a deal to work around a few changed facts than try to fix things afterwards when you’re already in the wrong. And, although investors are paying, in effect, for the pre-deal legal advice if the funding goes through, it’s odd that the cases where it matters most are those where the process reveals a dealbreaker.

Where do I come out on this? As a company-side lawyer, I think that the opinion could be dropped without huge problems, but I fall into the class that thinks we should have correct reps and not tread down the “hopefully true” path without some deliberation and frank discussion with the other side. As investor’s counsel, I could see myself legitimately advising clients to forgo opinions to save money when I knew the company lawyer personally. I could not see extending the reputation of one well-known lawyer to an entire firm, but maybe to a small group or team that practices together.

What do you think about not asking for legal opinions? Are there other purposes they serve for you?

Caveat: Ted and I worked on a deal several years ago where he represented the investors and I the company. So, my opinions of Ted’s proposal are definitely colored by personal experiences (in this case, for the better).

Ted proposes that small series A rounds, like seed rounds have in the past, take on a more standard “short-form” approach to the structure and volume of the financing documents. He notes that costs for using longer documents might add $7,000-$10,000 in legal fees each for the investor and company, which is not insignificant for a small $1-1.5m financing.

On its face, the uninitiated might not realize that it’s not the documents themselves, in terms of pieces of paper that lawyers draft from a wide range of forms, that create the “excess” costs: it’s the promises on those pages that are the culprits. Promises about facts mostly: what we call due diligence.

Fundamentally, the purpose of contracts, in general and definitely venture financing agreements, is to allocate risks among the parties. These risks come in three flavors: present, operating, and potential problems.

• In the “present” category, investors are concerned about knowing what is actually going on today with the company: they want to know what’s behind door #1 as much as possible. So, for example, we ask founders and companies to promise that there are only so many shares of stock, or that the intellectual property has a clean trail, and that employees are allowed to work for the company.
• In the “operating” category, we create rights to information and ongoing reports so that the “present” concerns above are regularly addressed, and we provide a bundle of rights, some affirmative (the investors get power to do something) and some negative (the investors get power to vote on something). In this category are information rights, board seats, protective charter provisions, and operating covenants.
• In the “potential problem” category, we include provisions that protect the value of the investment under different scenarios, such as future financings or sales, changes in the risk exposure of founders or other investors, and registration rights.

Before analyzing what changes should or could be made to the usual course of business, it is important to make explicit what every VC knows but often forgets: the company’s legal fees come out of investor money, the VC’s legal fees come out of investor money, and so the cost of these extra provisions is very much equivalent to insurance bought by investors with their own money! (Yes, these expenses don’t get offset against the money raised and owed, so like points on a mortgage, companies either raise more or have less cash to work with. Same result.) Ted even calls these agreements an “insurance policy,” recognizing their function and, implicitly, their underlying economics.

To me, the revealed preference for the status quo by VCs indicates that these provisions are worthwhile expenses. This could be because they actually chose to spend money this way or, perhaps more likely, the information cost of determining that they are inefficient uses of resources is too high given the uncertain value. Ted’s put a stake in the ground for value, right or wrong. What’s the risk of choosing to go with Ted? Any VC making that choice in a given investment where it turns out wrong would be subject to having to “prove” that he wasn’t simply being reckless about disregarding “industry standard” terms. (It’s a West Coast version of “nobody ever got fired for hiring IBM). I don’t know many VCs that want to deal with that, regardless of whether they have the clout to survive no matter the outcome (e.g., John Doerr). In other words, there’s enough failure built-in to the VC model that few would be willing to invite more!

So where does this leave Ted and his idea? Here are some options:

1. The NVCA could/should adopt Ted’s trim set of documents to ease adoption in the wild. Having drafted sets of Brobeck-based forms for Stanford Law School classes, knowing that those forms dated from Gunderson-era drafting, we all know that forms can take on a life of their own.
2. VCs could share, anonymously or within the attorney-client privilege, outcome and history data on investments. Empirical research on the actual usage of different provisions would be extremely helpful to those trying to allocate costs all around. This research project could be big, but there is a wealth of resources available to undertake it and track the performance of these contracts.
3. It will be critical for VCs, the real constituency to be addressed, to recognize that they are not choosing Ted’s model in a vacuum, but against alternatives with different costs and risks.
4. Finally, there is a role for lawyers like Ted to put on the counseling hat and help VC clients understand when they are spending too much money on too little protection. My two favorite examples from Ted’s piece: environmental representations for a dotcom and financial statement reps (or, sometimes, an audit!) for a new corporation.

We as lawyers should be analyzing these documents like the insurance agreements they actually are (transferring risk between parties); Ted even calls them insurance policies. The hallmark of well-crafted insurance policies is that they transfer each risk to the party best situated to bear it. One [thought-]exercise I would often run through, on either side of a financing transaction, would be to wonder what the other side would be willing to trade in terms of either pre-money valuation or amount invested in exchange for some term of vague or frankly unknowable value. Want two demand registrations? Up the valuation by $50,000? Want 90 day lockups instead of 180 days? Take $25,000 less money in. These sound like silly examples, don’t they? But they’re absolutely [un-]realistic in that my opinion is that no one at the table — company, investor, or either lawyer — has any estimate (as opposed to a guess within an order of magnitude) of what any of these terms is worth.

And that’s what makes Ted’s point sing. If all sides are spending time, money, and effort to trade worthless rights and privileges that no one really wants to keep or avoid, there just might be a better way.

I’m with you, Ted. Who’s with me? What techniques have you used to narrow down the range of operative reps and warranties or place a value on other terms?

(I’ll address the legal opinion question in a separate post as well as one alternative for implementing some of Ted’s ideas in a format I invented years ago that might also be useful for analyzing past deals to discover the economic benefit/cost of the suspect provisions.)

1. Learn something.
2. Earn a following and reputation.

We’ve added another option in our own business:

3. Help your clients, even if you have to get things rolling by kicking the ball downhill.

We’ve gone to our best contacts, our closest friends and colleagues, and offered to help them by helping their clients. We’ve created the ability to start some of our top-shelf analytical work easily without running up the usual fees and expenses, and so we have hoped that that would initiate a virtuous circle where we help those companies, they generate new work or transactions for our colleagues, and then maybe some additional work trickles up to us.

I’ve long held that a good part of the present malaise in the economy is primarily one of expectations (both past over-expectations aka delusions and current under-expectations aka fear). After all, houses aren’t actually falling down, unable to serve their primary purpose; factories aren’t closing because machinery is decrepit and no longer working. The economy will move when people decide that they need something enough to go out and buy it, whether it’s a nicer house in a better neighborhood or a new couch. The same holds true for companies, whether it’s buying assets that will create future cash flows or hiring better people to upgrade the talent pool.

Starting projects, adding value with your slack time, is not only a way to join arms with your clients and customers but also a great way to keep your own talent engaged. I saw the downside of slow times during the dotcom bust in Silicon Valley: I was at Brobeck’s Palo Alto office at that time. Returning from my honeymoon in August 2000, it turned out that I billed a grand total of 7 hours in September. Now, I didn’t spend the other 153+ hours at work that month doing nothing: I helped other lawyers on their matters and doing my best to train and develop younger lawyers as they worked on other matters.

I just met a recent law school graduate working at an AmLaw 100 firm in New York City. This grad and other new grads are apparently not very busy, which isn’t hard to imagine given the happenings at so many large law firms. However, the response described to me of both partners and associates was often to hunker down and hide work behind closed doors. My advice: partners should be sending these new associates out to client offices, with a no-fee guarantee if needed, to help their clients out. If these associates aren’t billing, it’s better that they be learning as part of an investment by the law firm in its clients than sitting and waiting for work to come to them. Will every client accept? No, but those that don’t are fools. Will every placement generate billable work? No, but those that don’t will generate good will and training. What firm wouldn’t do this?

What are you doing to turn the crankshaft on the engine of commerce? Please pass on your stories and ideas in the comments.

This boingboing post refers to two compounds as “powerful yet nontoxic” and “safe.” Luckily the commenters are smarter and note the fact that sodium hydroxide, conveniently labeled as NaOH for those who passed high school chemisty, is LYE. Ugh. Not recommended.

Knowledge is not a dangerous thing. Stupidity is dangerous. Thinking you have knowledge is more dangerous. Wisdom is knowing where your personal line between knowing and just thinking you know lies. (Yes, that’s a lawyerly skill — well-trained lawyers are typically very good at helping you discover that line during their questioning.)