You need to understand equity as soon as you are ready distribute stock. The decisions made here will affect your company for years to come.
For companies seeking venture financing, there is a familiar script to follow, regardless of industry. The process involves negotiating funding terms, closing the round, issuing stock, and plenty more steps that often require extensive amounts of paperwork. Founders can take comfort in this playbook—it’s predictable and getting more efficient every year. There is also an entire profession full of people ready to help you.
I’m talking, of course, about lawyers.
From raising financing to finding product-market fit, founders have a lot on their plate. Most founding teams will have to start thinking of their legal needs once they’re ready to accept a check from investors. Having the right lawyer to assist you through the process of forming and financing your company can make a big difference in your ownership and control of the company going forward.
Here are a few things to keep in mind when looking for the right startup lawyer or firm to partner with:
Recognize your company’s needs
For founders that feel like it’s too early to engage a lawyer, a lot can be achieved through self-serve platforms—like Stripe Atlas or Clerky—including formation and initial fundraising documents. These tools help automate some of the common legal needs at the pre-seed stage.
But as you begin to hire, develop intellectual property (IP), or take checks from more than just friends and family, you may want to get representation for the company. A big firm will usually have higher hourly billing rates, but they are built for efficiency and have experts in many of the areas that typically come up for early companies (like IP, compensation, terms of service, regulations, commercial contracts, and patents). A single lawyer or boutique firm might not be able to cover as much ground, but they may be more cost efficient.
Find the right legal and business fit
Cost should not be your only concern, though. Sara Mauskopf, CEO and co-founder of Winnie, says it’s important to view your law firm as a partner—one that can be beneficial to your business as it grows. “Don’t focus so much on the money” says Sara, “because it’s not going to be the legal fees that make or break your company.”
Some of the things to keep in mind when evaluating a firm include:
- Look for a firm that represents other companies in your space, whether that’s B2B SaaS, consumer products, e-commerce, social networking, or something else.
- Find a partner you connect to, who understands your goals as a business, and is someone you’re excited to work with. You don’t want to hold back if you have a question or concern that’s keeping you up at night.
- Ask to meet the broader team. You may work more closely on a day-to-day basis with associates and paralegals than with partners (and you’ll save a lot of money in doing so).
- If you are in a heavily regulated industry (like healthcare, education, finance, etc) find a specialized lawyer, a great referral, or even one on your team. Working in the child care space, Winnie got help from their legal team to navigate the regulations that exist and learn how to best inform and protect their users.
Remember, firms are interviewing founders, too. You may even have to provide references (investors, other founders, previous lawyers you’ve worked with) before they’ll agree to represent you. “We’re seeking people that have a good sense of how to get products out there in the market,” says Andy Bradley, partner at Gunderson Dettmer, who gets most of his clients through a wide referral network.
Know your first priorities
Peter Werner, a partner at Cooley, says there are hundreds of questions founders could have when starting a company (Cooley even has freely available answers to many of them), but during the pre-incorporation phase there are three critical things that most founders should be concerned with:
- IP ownership. Peter says legally documenting the “chain of title” of the company’s IP— documents that demonstrate the company’s ownership—at the outset is easier when the startup isn’t worth much because there’s less to fight over. This will also help you avoid potential lawsuits from people who were around early in more amorphous roles (aka, “the Winklevoss problem”).
- Equity. Waiting until you get a term sheet to set up your cap table gives founders and early hires time to rethink a verbally-agreed upon split. According to Peter, it’s a good idea to create your cap table and formally issue equity to the founders early on, and then have some time before raising your first round of financing. If founders buy their founder stock and then raise money at the same time, they might have to explain to the IRS why the common stock that was worth fractions of a penny was suddenly worth a lot more after the raise. Carta has a tool called Launch—only available through our partner law firms—that helps early-stage companies set up and manage their initial cap tables free of charge.
- Roles and the board. Before working with a set of founders, firms like Cooley and Gunderson Dettmer will often give them a questionnaire (here’s one from Orrick) to help them think through some crucial topics such as: who’s CEO, who’s on the board, how the cap table will be allocated, as well as founder vesting and acceleration. Founders should have these (sometimes difficult) conversations early on to identify any potential sources of friction relating to ownership, control, and decision-making.
Communicate clearly about fees and expectations
In the late 1990s, companies were going public at an aggressive rate and some law firms would ask for equity in the company as part of their fees. Sometimes they asked for stakes as high as 2.5%. While firms will occasionally ask for equity, they often don’t for such a high percentage anymore. Also, many law firms have small investment funds of their own for participating in clients’ financing events. If a firm brings up the topic of ownership, it’s up to you if you want the lawyers to have “skin in the game,” and you can treat them as you would any investor.
Here are some of the common fee scenarios for early-stage startups hiring law firms:
- A flat fee. This would cover basic formation services you need to get up and running.
- A deferral. This happens when a law firm agrees to delay payment until a certain amount of money is raised or achieved in revenue.
- A discount. Another approach firms might take involves providing a discount on a specific amount of services for the first year (example: a 10% discount on the first $100K of services). These discounts can include clauses that let a firm’s venture fund invest a small check in the first few rounds of financing. Having this shared benefit in your company’s success can be beneficial in creating a foundation of mutual trust.
Remember that most law firms bill by the hour, unless you have a flat fee arrangement. Be sure you have a clear understanding with your firm about how they’ll bill against one-off requests for help or “quick question” emails. Choose a firm that’s looking for more than just billable hours—that they’re interested in creating efficient workflows for their clients. Remember to communicate how you retain information as well, as many conversations with lawyers can get nuanced and complex, and you’ll likely need to consult the advice a few times before you make a decision.
Ask for help
Your law firm is one of the first major outside partnerships you will establish as a founder. And it’s not one you can source via an online list, Yelp, or even your friends. While it’s good to ask your network (especially any lawyers or founders you may know), it’s important to find an experienced team or individual that’s comfortable working with startups in all their ambiguity and growing pains, as well as the industry your company is entering.
If you’re getting ready to raise financing and need a referral to a law firm, let us know by writing to firstname.lastname@example.org and we’ll do our best to help.
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