Recently I’ve written about potential conflicts of interest between you and your startup lawyer. Now for the main event: Stock for Fees.
This situation arises when a startup company offers stock to a lawyer in exchange for legal services. I’ve derived the following 2 postulates to explain why startups and lawyers agree to this setup:
1. Startups are broke.
2. Lawyers are expensive.
For the same reasons that your startup lawyer should not be on your board directors, stock for fees may affect your startup lawyer’s ability to give unbiased legal advice. Furthermore, Rule 1-8(a) of the ABA Model Rules of Professional Conduct provides that a lawyer may not enter into a transaction with a client unless:
(1) The transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client;
(2) The client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and
(3) The client consents in writing thereto.
Thus, if your startup agrees to a stock for fees representation, you will likely sign a conflict of interest waiver from the firm stating that you were advised and had the opportunity to seek another lawyer about the stock for fees deal (along with other stock for fees conflict language boilerplate).
The most common stock for fees legal work is (a) incorporation & other related “getting launched” issues, and (b) financings. Incorporation stock for fees deals are usually set up as an agreed to amount of legal work (e.g. “$10,000 of legal fees billed at $400 hourly”) in exchange for an equity percentage of the startup. Startups that are about to go after funding or maybe even have a term sheet in front of them may offer a small percentage of stock in exchange for the law firm deferring legal fees until the financing closes.
In my practice, I have yet to do a stock for fees deal. The main reason I haven’t thus far is that I don’t want to add “GP of Early-Stage Fund” to my job description. That is, before agreeing to a stock for fees deal I would have to conduct a due diligence evaluation just like a VC would. (Of course, having a couple term sheets from VCs might preclude such a due diligence investigation.)
I may not be contributing cold hard cash to the startup, but my time is worth something. Instead of working for equity, I could be working on another paying client’s deal, blogging, or riding Tony Hawk’s Big Spin with my son. Plus, malpractice liability doesn’t go away if I don’t receive cash consideration for legal services.
In any event, both startup and lawyer should be prudent before agreeing to a stock for fees deal. And a startup should never take it personal if a lawyer or firm won’t do a stock for fees deal.