When to Involve your Lawyer

One of the biggest challenges I’ve seen working with new entrepreneurs and startup companies is balancing the need for getting good legal advice with the cost of good legal service. In a prior post “When to Involve Your Lawyer: Part 1, I wrote about the types of agreements when a startup should nearly always have their lawyer review. In this post, we’ll examine how to ‘Pre-Review’ a contract or agreement before getting your attorney involved.

The Pre-Review

Truth is, lawyers usually bill by the hour. Therefore, whether your lawyer is negotiating your Series A financing terms or washing your car, it is costing you the same. (For the record, I usually give a discount for my car washing services.)

One of the issues that startups struggle with is when to involve their attorney in negotiating or entering into a contract. Your startup is like a paper-generation machine. You’ll be looking at more contracts than you ever thought possible. And the problem is, if you had your lawyer “review” or “negotiate” every one of them, you may hit the poorhouse.

That’s where the concept of a pre-review can help focus your lawyer on areas where you really need his or her assistance. The concept of a pre-review can help you to better understand the contract itself, identify the easy issues you can handle and address with the other party to the agreement, and then get the insight and experience from your lawyer to address items above your pay grade.

This saves you money and gets legal review where it is needed. That, in a nutshell, is the pre-review.

Being an Informed Consumer of Legal Services

So what should you do? Be an informed CONSUMER of legal services. Not every contract will rise to the level needing attorney review. But, and this is a big but, remember that you should ALWAYS have your attorney review certain types of contracts or agreements as noted in the previous post. Don’t scrimp on those contracts as you’ll probably wind up paying for it sometime down the road (having your attorney FIX the problem you didn’t see playing part-time lawyer).

So, don’t blindly send a contract to your attorney. Pre-review it and handle what you can with the other side. Then, get your attorney focused like a laser on areas you aren’t equipped to handle. Anyways, before you send any contract to your attorney, here’s a suggested approach:

1. When you get any contract, read through it before you do anything. Print it out, and write notes where you disagree, have questions or don’t get it.

2. In those places where you have questions or you don’t understand, ‘Google’ it and look it up on Wikipedia. Hopefully that will help you understand better.

3. After you’ve read through it and used the Internet to educate yourself, have someone else in your company also read through it (if you are the only one in the company, then get your spouse, significant other, mother/father, neighbor, etc. to read it).

4. Talk through your comments, questions and concerns and come up with a list of issues.

5. Then, get on the phone with the other side and talk about those issues, questions and concerns. Don’t agree to something that you aren’t sure of, but try and get a rationale as to why the other side put something in the contract.

6. NOW, you can finally involve your attorney. You’ve focused the issues down and can get the lawyer to provide the value-add service (rather than car washing services).

When to Involve Your Lawyer

Lawyers are expensive and we bill by the hour.  Which means one thing: using less legal services saves you money. Unfortunately, it just ain’t that simple.

The real problem is, failing to use legal services when you really need it, can cost you down the road.   So, the purpose of this article is to help you identify the types of contracts where you should have your attorney review.  What can happen if an attorney doesn’t review these?  Well, I’ve seen venture financings get helps up, huge tax bills created, M&A deals die and companies spend tens of thousands of dollars to fix a problem that could have easily been fixed in a few minutes, just because the client didn’t have their attorney review certain agreements up front.

I’m not an advocate of having your attorney review every contract (the expense isn’t feasible), but I do think for certain types of agreements or very important agreements, those dollars spent can keep you out of trouble down the road.

So, without further ado, is a list of a few times and types of agreements that I think a startup should ALWAYS involve their attorney (at least in some level of review):

• License Agreements. License agreements oftentimes involve complicated scenarios over ownership. Be careful in cases where you are licensing technology from a third-party or are licensing your technology to a third-party.

• Non-Standard Employment or Consultant Agreements. Many startups will work with their attorneys to create standard form agreements for employees and consultants. In the event the employee or consultant has proposed changes to legal terms (ownership of intellectual property, non-disclosure, non-solicitation, or non-competition, just to name a few), you may want to involve your attorney.

• Investment Agreements. Compliance with securities law exemptions is very important for any privately-held business. You should involve your attorney when you negotiate any non-standard investment contracts.

• Joint Development Agreements. Be careful of intellectual property issues that may arise when you negotiate a contract that involves two parties making contributions.

• A “Material Contract”. Any time you are entering into a contract that you would consider to be material to your business you should get your attorney to review it. A material contract is any contract that is not entered into in the ordinary course of business. If it isn’t a contract you’ll enter into with regularity in your business or involves a major amount of expense or revenues in your business, you should consider outside review as well.

• When the other party involves their attorney. In the event the other party has elected to have their attorney participate in the negotiations and the contract preparation, you may consider involving your attorney.

When in doubt, you should check with your attorney on provisions that raise issues. You may find that your attorney can quickly review select provisions of a contract even if they do not review the entire contract, or may be able to provide a final review prior to signing to flag any potential issues.

Startup vs. Small Business: What type of business are you forming?

“I’m the CEO of a new startup.”

As a conversation starter, this tends to be a pretty good statement to get someone’s interest peaked.  For some reason, being in the startup business tends to be pretty sexy, as far as business-building goes (wow, never thought I’d use the words startup and sexy in the same sentence, but there you have it).

On the other hand, forming a small business seems to have less of a ring to it.  I’m not sure why, but perhaps it has to do with what I saw on television — the general store owned by Mr. So-and-So or the Repair Shop down the street or insert your own random thought on a small business.

But the truth of the matter is, why does the phrase “startup” conjur up something different than a “small business?”  A startup tends to be a small business, by its very definition.  But oddly enough, they don’t have the same cache.

To Startup or Small Business… that is the question.

So what’s the difference?  In their book Engineering Your Startup, James Swanson and Michael Baird separate the businesses into two categories: (i) Income Substitution Businesses and (ii) Wealth Building Businesses. Generally, a small business will fall in the category of income substitution, while wealth building entities are more likely to be startups.

According to Swanson and Baird,

“people who simply do not want to work for someone else can easily startup a small income-substitution business such as a one-man computer repair service shop.”

This would qualify as an Income Substitution Business.  On the other hand, if you wanted to build a business that would be a national franchise or desired to create software allowing for repairs to be made remotely, then this model would be a wealth building business.

The terms “startup” and “small business” are sometimes used interchangeably, but in practice there is a difference between the two.  According to the Career Action Center,

“a start-up is a small company, most often with a high-tech focus, that is in the early stages of development, creating a product or service, or having a product or service needing manufacturing and/or marketing.  They are looking to grow through possible venture capital funding, initial public offerings (IPOs) or acquisition by larger companies.”

On the other hand, a small business tends to have a more narrow focus and is not limited to high-tech applications.  A small business may not have growth goals similar to a startup and may have no plans to grow larger than its small business size.

Does it matter?

That’s probably the better question here… does it matter if you say you are the forming a startup or a small business?  Perhaps smarter minds would differ, but I happen to think it does matter.  It may not be the difference between success or failure, but it matters.

Here’s why?  The use of the right description of your business and your goals sets the tone for your interactions with outsiders.  It is like knowing the secret handshake or the proper lingo.  Having the handshake and lingo will get you in the door (but don’t plan on staying long if that’s all you’ve got).  Why do most startups incorporate in Delaware?  Sure, there are the practical reasons (cutting edge law, most lawyers know it, ease of filing), but I think one of the other main reasons is it signals to outsiders such as investors, potential employees, executives, partners, etc. that you know what you are doing.

Same goes with the difference between calling your business a small business and a startup.  In all honesty, if you intend to build a business that, in all reality, will employ less than 20 people, most likely your concerns will be different than a technology company intending to build its product or service into the market leader for a market or sub-market.  One isn’t necessarily better (in fact, forming a small business probably is less risky and someone who has run the numbers may tell you that the odds of a successful outcome are higher), but you should probably know what you are planning to do and signal that to outsiders.  This prevents you from hiring the wrong types of folks (i.e. a programmer looking for a long term payout from some booming options) or spending time rubbing elbows with investor-types that aren’t in your wheelhouse.

In addition, small businesses tend to have different financing needs (which can be a good thing) and usually will have a more narrow market, either geographically or in scope.  Below are some of the basic differences between the two types of businesses:

Conclusion: Know thyself.

I’ve seen a number of people who have a business plan for a startup that would be much better off as a small business.  That isn’t to say that I bat 1000% on good ideas… but there are ideas that fit the ‘startup’ mold and those that just probably don’t.  For example, a consulting organization (even one that will consult on high tech issues or use high tech people) probably isn’t a startup in the traditional sense of the word.  The consulting business can prove very successful, create tons of cash flow and may even spin of an interesting technology for a startup.  But, few VCs will fund a pure consulting company.  So spending all the time, energy and resources making a VC-ready business plan for a small business isn’t a good use of time.

So, the long and the short of it is to figure out what type of business you should form based on your experience and idea, not the type of business that is sexier, hipper or sounds better at those elbow-rubbing parties.  A well-run small business may pay off multiple times over from a hot new biotech startup or innovative software startup.  And that’s just the way it goes.

Truth is, each of us probably wants to get into the restaurant on Hollywood Boulevard where all the celebs are hanging out, let’s call it Club Startup.  Yup, Club Startup is the sexy, hot hangout.  Tip the bouncer, give him the handshake and maybe you’ll get in.  Or maybe not.  But don’t go sittin’ in line if you really don’t want to go there.  People like me may be better off not waiting in that line if I’m not going to get in anyways.  Me, maybe I’ll just have Miller Lite…