Standardization v. Flexibility in Startup Law
TL;DR: Standardization reduces time and fees, but at the cost of increased inflexibility. And sometimes, flexibility matters more.
Imagine you’re about to have a baby. You start asking your OBGYN about the facilities, preparations, etc., and the response you get is: “don’t worry about it, it’s all standard.”
Ok…, but your family has a history of certain unique hereditary conditions. Things can go wrong. You try to prod further. “Don’t worry, everything is going to be standard procedure.”
Are all people “standard”? Well, are all companies?
Standardization has its place, and certainly has its benefits. Those benefits include:
- Lower Costs (at least upfront);
- Faster execution, often enabled by technology;
- Easier review.
In short, standardization makes things cheaper and faster. As great as that is, for any high stakes situation, a half-intelligent person will step back and ask: are speed and low cost really my top priorities here?
The purpose of this post is to discuss why the general push toward standardizing all financing documentation for startups, while clearly lowering up-front legal fees, is not always as “founder friendly” as the automation companies, investors, and other parties who also benefit from standardization, would have you believe. Nothing is free.
As I’ve written before a few times: “don’t ask your lawyers about this” sounds sketchy, and potentially raises red flags. If you want a novice team to simply move on and not ask questions, a real chess player will say “let’s save some legal fees.”
We’re negotiating over millions of dollars with potentially tens or hundreds of millions in long-term implications, but great, let’s save a few thousand in legal fees now by “streamlining” things. Right.
Who chooses the “standard”?
By far one of the most over-used phrases I hear in financing negotiations is “this is standard.” Says who? Do you have data? When you personally close dozens of financings a year across state lines, and have visibility into hundreds, like our lawyers do, it is very amusing when someone who makes maybe a handful of investments a year starts trying to lecture you on what’s “standard.”
The other day I heard a VC say that not having an independent director on the Board post-Series A is “standard,” and virtually everyone else in the room could smell the manure.
If you are looking to adopt market “standards,” make sure they are actually standards. Work with advisors with broad market experience to verify claims, and triangulate advice from multiple, independent advisors. Don’t let anyone simply dictate to you what the “standard” is.
Serial players benefit from standardization. It’s not about saving companies legal fees.
Investors have portfolio incentives; meaning that they have their bets spread around a dozen or two dozen companies, sometimes much more if they’re a “spray and pray” kind of fund. For investors who look for unicorns, they expect most of their investments to fail, and just need 1 or 2 grand slams to make their returns. Unicorn investors demand very high growth, because even if such an approach can increase the number of failures, it will also maximize overall returns across the portfolio by turning up the juice on the 1 or 2 unicorns.
Entrepreneurs and their employees, on the other hand, have “one shot” incentives. Their net worth is concentrated in one company, and therefore the specific details, and risks, applied to their specific company matter a lot more to them.
The emphasis on very fast, very cheap financings benefits, above all else, large investors with broad portfolios who are looking to minimize their costs on any particular bet. It is not something developed out of beneficence toward companies; who stand to gain more from adopting structures better suited to their specific circumstances.
Standardization necessitates inflexibility, and when you’re fully invested for the long-haul in one specific company, flexibility may matter much more to you than simply moving as fast and cheaply as possible.
Lies about fixed legal fees.
One of the worst lies spread throughout some startup law circles is that fixed fees somehow “align” incentives between clients (companies) and lawyers. The argument is that, if lawyers bill by the hour, they will simply bill endlessly without reason. Thus, fixing their fees “solves the problem.”
Except it doesn’t.
Assuming all lawyers are principle-less economic actors who will do whatever maximizes their profits (cynical, but the general argument here is cynical), fixing legal fees does not align incentives between a client and the lawyer; it reverses them.
If Mr. Jerk Lawyer will run up the bill unjustifiably when the economics are hourly, he will, once you fix his fees, reverse course and do the absolute bare minimum necessary to complete the work; pocketing the difference. Why put in that extra hour or two to discuss a few nuances with potentially very material implications to the team, if it just hurts my fixed fee ROI? “This is fine and standard” is a much easier answer. Trust me, the minimum professional standards to avoid malpractice are very low. Close the deal, and move on to the next one.
Oh, but wait, the fixed fee proponent would retort: the fixed fee lawyer will still do a great job because he’s concerned about reputation. Response: (i) isn’t the hourly billing lawyer also concerned about reputation? (ii) you often don’t find out whether the lawyering you got was “good” or “bad” until years later. A-players and C-players can both close deals. I’ll let you guess which ones more often agree to fixed fees.
There is a place for fixing legal fees when the work being done really is commoditized, and not of high strategic significance to a company in the long-term. But anyone who thinks that fixed fees are some kind of magical solution to long-term lawyer-client relationships is, to put it bluntly, full of sh**. In attempting to solve one problem, they create other ones.
Our view is that clients definitely deserve some level of predictability in their fees, and we provide that by crunching data across our broad client base, and providing clients budget ranges based on that hard data. We also keep clients regularly updated on accrued billings, to avoid surprises. I promise to deliver transparency and data-driven predictability within reason, but I need, and smart clients want me to have, the flexibility to address issues that, in my judgment, are material enough to fix, even if I could get away with ignoring them without anyone noticing for years.
Reputation plays a huge role in keeping legal fees reasonable. You’ll go much further diligencing a set of lawyers, asking their clients whether they feel they keep their bills honest, instead of adopting some nonsense idea that fixing/capping fees will magically produce the outcome you really want.
Standardization and Flexibility need to be balanced.
All good startup lawyers adopt some level of standardization, as they should. There is a lot of room for creating uniform practices that save time and money, without damaging quality. But any attempts to pretend that complex, high-stakes law can be “productized” should raise serious skepticism, at least from entrepreneurs who view their company as something more than just another cookie-cutter number in someone else’s portfolio.
If I refuse to fix all of my legal fees, it’s because the reality of serious startup law does not fall along some neat bell curve. There is far more qualitative nuance to strategic lawyering than there is even in healthcare, where the goals are much cleaner, and the base structure of each “client” (biology) is more uniform. Business goals are subjective, and the right outcome for one client may look totally different for another, requiring totally divergent, and unpredictable, levels of work. That requires flexibility, both in process and pricing.
Where the final outcome really matters, speed and low cost are not the top priorities. Leave room for flexibility and real strategic guidance, or you’ll pay for it in the long run.
Originally published at Silicon Hills Lawyer.