Who you surround yourself with, you become. We’ve all heard that before. For an entrepreneur or executive of a fast-growing company, it’s no different.
The service providers a company chooses is a reflection on the founders/CEO. If you’re leading a company that may need to raise capital at some point in the future or may eventually be sold, the service providers you choose to work with in the company’s early days is an important decision.
Many founders choose providers based on price or personal connection/rapport. While those factors are important, there are other factors that are more important.
Here’s a hypothetical situation:
- Company X was founded 5 years ago. They are growing quickly and now need to raise money to fund their growth.
- In the early days, the founder bootstrapped the business and stayed scrappy to keep costs low. To form the company, the founder used a lawyer who was referred to him by a friend. The founder now has a friendship with the lawyer who has been very affordable. However, the lawyer has very limited experience with businesses like Company X or with businesses the size that Company X now is.
- As the founder starts talks with prospective investors, he’s asked which law firm he uses. None of the investors either know who the firm is or they know the firm to have specialties in other areas without much experience with fast-growing companies like Company X. It doesn’t reflect very favorably on the founder’s decision making because sophisticated investors want to know that the company is well represented by smart firms.
- The term sheet negotiations don’t go that smoothly because the lawyer recommends to the founder to ask for certain things that are “out of market.” This doesn’t reflect that favorably on the founder either. Nonetheless, a term sheet is signed.
- The investors begin diligence and begin reviewing the company’s legal docs. It becomes clear that the operating agreement and related docs need some cleaning up. As importantly, though, the founder and the firm didn’t work in partnership over the past several years on a proactive IP strategy, so Company X didn’t lock up some very important trademarks and other IP that would be valuable for the company and is expected by investors at this stage of a business. Similarly, there were some equity grants early on to a couple of key employees that weren’t done properly so further cleanup is needed with those.
- The investors manage to get comfortable with all of those issues and the negotiation of final docs begins. The company’s lawyer continues to recommend to the founder to ask for certain things in the final docs that are “out of market.”
- This further creates a contentious negotiation / diligence process which frustrates the investors and the founder while simultaneously jacking up legal bills.
- This situation will end in one of two potential scenarios, either (a) the investor walks and the company is left scrambling to find another investor, or (b) the investor and founder grit through the closing process and it starts the relationship off on bad footing.
It’s not worth saving a few bucks. Hire really good legal counsel early on. Here are some tips:
- Get referrals from serial entrepreneurs and founders of companies who are larger than yours.
- Look for firms who specialize in companies that are 2–5x as big as yours. If you’re planning on being a $20M company in the next 2–3 years, you want a lawyer and CPA firm who have deep experience working with companies who are $20M-$100M in size.
- Check references — talk with their other clients, not just about the law firm, but is the law firm taking on high quality companies?
- Ask other lawyers and entrepreneurs how a particular lawyer is to go up against. Good lawyers recognize other good lawyers and will tell you if they are technically sound.
- Does the lawyer attend board meetings for free? This is a great way for them to stay up to date on the business so they know all the business issues when a financing or M&A opportunity comes down the pike.
Those are some suggestions. It’s more of an art than a science, but it’s a very important art to think through early on.