Archive for September, 2009

Use a Low-Cost Filing Service Instead of Me? Sure, Why Not?

September 30th, 2009

I talk to a lot of people about forming new corporations.  Some of them ask me “why do you charge $2,500 – $3,000 to form a new corporation when I can have it done by ABC filing service for $375?  The answer is that you get different things when you use a filing service versus me and there may be good reasons to use both.  Here is my rundown of what you get from a filing service, what you get from me and how to think about using your time and money most wisely.

Filing Service.  The service should provide you with the following:

* Articles/Certificate of Incorporation, plain vanilla version, signed and filed with the Secretary of State of your choice
* Statement of Incorporator naming the initial Board of Directors.  Be sure to get this!  It is a one-pager that causes big problems if inadvertently missed
* Bylaws, probably not the best form ever, but probably good enough 99% of the time
* Initial consent of Board of Directors, plain vanilla form finalizing incorporation and issuing shares to founder(s)
* Form of stock certificate to issue founder shares

Me.  Here is what I provide:

* Discussion of which state is the best in which to incorporate.  Delaware? California? Other?
* Plan for capitalization of the company, including founder equity, possible stock option plan, roadmap to potential equity financing, vesting terms for founder & early contributor shares
* Complete documentation of founder contributions to the company via founder stock purchase agreements so that there is no question that the company acquired ___ assets or that $XYZ were paid for founder stock
* Detailed Board action that reflects all the same information so that future generations of lawyers can check off all the right boxes in due diligence review
* Securities filings to document that stock was sold legally

You can see that the filing service focuses on a bare set of very generic documents, while I spend time working with clients to make sure the documents fit the plan we develop together.

I know a lot of people (of whom one was a partial inspiration for this post) who believe that services like corporate formation are going to become totally free in the future and that the model forms provided by Orrick, Cooley and probably every other firm as soon as they can get the documents published are the vanguard of this movement.  I am not totally convinced on that- lawyers have a duty of care to clients that seems hard to meet if we don’t put some effort into working through the planning items I mentioned above- but I see the point.  The forms are out there and the services are straightforward.  Costs will probably trend downward, so it is really just a question of how close to $0 they get.

While we wait for that discussion to evolve, here is how I recommend you think about how to best spend their time and money.

1)  Talk to me.  I will give anyone a (free) hour of my time to discuss plans, figure out what will work and what is going to take you down the wrong path.  I don’t try to hold back the “key steps” so that people are forced to hire me.  You should walk away thinking you could incorporate on your own if you so choose.

2) Research the costs.  Once we develop the roadmap, figure out how much it will cost to have the filing service handle your documents.  Some clients do this and decide to have a service file for them (I have sent people to getincnow.com); for others it is easier to have me handle everything.  I am fine with it either way.

3) If you decide to use the service, tell me.  I won’t be upset or offended.  I will give you the summary of information you need to do it properly the first time: how many shares to authorize, what state to file in, etc.

My job to help clients incorporate their businesses efficiently and properly.  It honestly is not a big money-making part of my law practice, but I enjoy it and get a lot of satisfaction seeing clients launch their businesses.  The important thing for me is getting it all right the first time, not whether clients use my forms or someone else’s.

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Equity Grants for Company Advisors

September 24th, 2009

Clients frequently ask me how much equity they should give out to advisors.  It’s a multi-layered question and worth pulling apart a little bit.  Here is how I think about it, following by my basic rule on how to allocate equity in an early-stage startup.

Low Value Proposition – to the Company and to the Advisor
Most startups are cash-constrained; many get enormous benefit from informal advisors on business models, finance, sales strategy, etc.  The companies want to reward these people for giving their time; they also want to reward the behavior so that the advisors will be more likely to continue helping.

At the same time, most advisors have only limited capacity to donate their time so most advisory stints are short term.  On top of that,brand-new startups are about as risky as any investment gets and the return on equity for most advisory-level stock grants is incredibly low.  If I start out with 1% of a startup and I hold on to as much as 0.1% by the time of a sale, the sale price needs to be $100M in order for me to get $10,000 out.

So- potentially big short-term help for the company; low return to the advisor in most situations.  Everyone needs advisors and fortunately there are plenty of people will to help others along, but be aware that the principal reward is not economic.  Every once in a while someone does a good deed and gets a big windfall for it, but that is not and should not be the norm.

Where Does the Advisor Equity Grant Fit In?
I am a rules-oriented guy, especially when it comes to equity.  My rule here is that an advisor’s equity should be proportional to his/her contribution to the company and should fit in the cap table scheme.  The typical early stage cap table should look something like:

* Founders at 60 – 80% ownership (depending on investment)
* Seed investors at 15 – 33% ownership (depending on investment amount)
* Equity pool for employees and advisors at 15%

Put the advisors in the equity pool, then compare their contributions to those of the employees.  Equity grants less than about 0.5% become meaningless really quickly and I don’t see companies going below that in most cases, but the amount of equity given to an advisor should be compared to employee grants.  If the lead engineer gets 2% and the person who made several introductions and advised on sales channel development also gets 2%, those introductions should be giving the company serious traction.

Advisor Equity is the Tip, Not the Full Payment
There is a balancing act here for sure: an advisor’s short-term help needs to be weighed against the long-term contributions of the full time team members.  In the end, it becomes unfair to the team to give out large advisor grants in most cases.  My favorite way to think about it is that advisor equity is like the tip paid at a restaurant- it is not the full meal ticket.  Sometimes the advisor gets her/his full bill paid in cash too, and sometimes the payment is in goodwill and the satisfaction of having helped out.  Equity grants that reflect this do the best job of treating everyone appropriately across the board.

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Compare/Contrast: Microsoft vs. Google vs. Yahoo Search API Terms of Service

September 14th, 2009

Pete Warden is an entrepreneur working on ways to find the value in one’s social networks through his company Mailana. We’ve only met online, though I hope one day we can connect in person because I like what he’s doing a lot.

Pete blogged last week about why he switched from Yahoo’s search API to Bing to Google. I wouldn’t know a REST interface from a stick in the ground, but he makes a point about terms of use where I can definitely weigh in.  For kicks, I looked up the terms of use for Yahoo BOSS, Bing and Google search APIs.  It is fascinating to me that the terms are substantially different.

I won’t go into all the differences in great detail and readers certainly should not take this listing as comprehensive in any way, but for example:

Delivery of Search Results.

Google cares a lot about this.  They say that developers can not reorder search results or intermix results from other sources. No surprise here; integrity of search results is key to public acceptance.
Bing is almost identical to Google. 
Yahoo
asks developers to acknowledge that reordering may affect “relevance or performance” and leaves it to the developer to decide what to do about it.

Yahoo really surprises me here.  I read the TOS 4 times to be sure I wasn’t missing something, but they seem to accept a laissez faire approach that would let me reorder search results or insert paid listings.  There is some language about the way queries and search results should be presented that might be read to limit this a little, but it is nowhere close to Google or Microsoft’s blanket proscription.  It is also possible that some other document adds this restriction, but I couldn’t find it on quick review.

Integration with other products.

Google says that search results can only be overlaid on Google maps and that Google retains the right to insert ads in search listing, which is a fairly narrow set of restrictions.
Yahoo puts a blanket prohibition of use of any Yahoo APIs “in a product or service that competes with products or services offered by Yahoo!”.  That seems incredibly broad and hard to understand to me.
Bing mentions MSFT’s Virtual Earth maps, but doesn’t make a big deal of other online products.

I am a little surprised that Google doesn’t mention any of its other products, but maybe there are technical reasons around use of the APIs that make it unnecessary.  Yahoo has so many properties doing so many different things (and Microsoft so few) that the language on this item doesn’t surprise me at all, though I wonder how a developer could possibly know its product doesn’t compete with some Yahoo product somewhere.

Content.

Yahoo offers a long list of content its APIs can’t be used to promote, including spyware, cigarettes, illegal drugs and paraphernalia,  pornography, prostitution, body parts and bodily fluids, and professional services regulated by state licensing regimes.
Google tells developers not to upload, post, email, transmit or make available inappropriate, defamatory, infringing, obscene or unlawful content.
Bing says only that developers may not “promote or provide instructional information about illegal activities or promote physical harm or injury against any group or individual”.

Bing is the clear winner here for porn sites in need a search API.  Google runs a close second with its local-standards-dependent “inappropriate” and “obscene” restrictions, and Yahoo is by far the most family-friendly search API.

On a serious note, it looks like Yahoo would not allow my law firm to use its search API on our web site.  I can’t see the rationale for this whatsoever, but the point is duly noted.

This was an interesting exercise.  Search products look awfully similar from the outside and it is easy to lump them all in a basket.  The companies behind them have different motives for making the APIs available and it is instructive to review the requirements.

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What is the Best Structure for Social Ventures?

September 4th, 2009

The SOCAP09 conference on social entrepreneurship has swamped my Twitter feed for most of this week and I had a chance to stop in Wednesday evening to check it out.  The conference is for people starting companies looking to do well by doing good.

Todd Johnson, a preeminent lawyer in this area, posed a question via Twitter last week about the best type of entity structure for social ventures.  It’s a good question and there are some very interesting developments in the staid realm of corporate law that can help these types of companies along.  At the same time, there is tremendous diversity in the types of businesses being created, so if I had to give a one-line answer it would be “whatever structure makes partner organizations yawn the most”.

That’s probably not tremendously helpful, so here is my quick survey of social venture entity structures.  I’ve posted on this topic before and will continue to revisit as the landscape changes.  If readers know of other entity structures, and especially if you have seen certain structures work well in specific environments, please leave a note in the comments.

Nonprofit.  With apologies to non-profits and their lawyers everywhere for collapsing an entire sector into a pithy sentence, what most differentiates a nonprofit from a for-profit company is that the nonprofit has no owners in the financial-return sense.  Benefits are potential tax deductions for donors to the business and pure focus on the mission without having to consider shareholder returns.  A major drawback is that if the mission changes and participants wish to take profits out of the business it can be difficult or impossible to do so.  I have worked with nonprofits only in passing, so I won’t go any further except to note that non-profits run the gamut from entirely donation-dependent organizations such as the General Assistance Advocacy Project I worked with in law school to significant revenue-generating businesses like Kiva.org.

L3C. This is a new flavor of for-profit entity intended to help charitable foundations make grants more easily.  I don’t do anything remotely like this kind of work, so I can’t speak much to it except to say that the L3C was designed to allow foundations to meet their Program Related Investment guidelines under federal tax law more easily.  The first L3C was adopted in Vermont in February 2008 and as of today (Sept 4, 2009) there are at least 6 states with similar statutes in effect or pending, so I will assume they fill a need and leave it to more knowledgeable people to advise further.

Plain Old Company.  In many cases this is a great option and all a social entrepreneur needs. A “regular” corporation or LLC is simple, well-understood and easy to form.  One drawback is that while the owner/managers can dedicate the business to social goals, there is nothing to prevent the mission from being overridden.  Many social venture experts look to Ben & Jerry’s acquisition by Unilever as an example of this shortcoming- the B&J Board had an offer that was financially rewarding, but there were apprehensions that Unilever would not retain B&J’s commitment to support communities around its stores.  In the end, the Board decided it did not have discretion to put social-welfare goals over shareholder returns and accepted the Unilever buyout.  Many of B&J’s social programs ended shortly thereafter.

B Corporation.  The good folks at B Labs are setting standards to address this problem, along with many others.  A B corporation is a “regular” corporation (or LLC or other entity) that has made a commitment its charter documents to consider factors other than shareholder returns in determining corporate actions, esp. environmental, community, social and employee welfare.  The benefit of this is that the Board can, if necessary, choose paths that may lead to a lower shareholder return if circumstances require.  The problem is that only 32 US states allow this type of language in corporate charters, so businesses in California and elsewhere need to incorporate in B-corp friendly states to get the full benefit.

Social Venture Company.  You may be able to see where this is going.  There are groups in California, Minnesota (I think) and possibly other states working on legislation to create a new type of entity that permits the broad-constituency language promoted by B corp and others.  Like England’s Community Interest Company, these entities would be separate from “plain old” corporations or LLCs by their commitment to work toward positive outcomes for shareholders and non-financial stakeholders.  We don’t know much about these proposed entities yet and many of the draft ideas are subject to change so there isn’t much to say about them currently.

Going back to the start of this post, I strongly believe that the best entity structure for a given project is the one that investors, donors and business partners can gloss over without thinking about much.  We don’t quite have a standardized approach that allows this yet.  With luck in a few more years we will.

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Fixed Fee Billing and Other Legal Red Herrings

September 1st, 2009

There has been a great deal of talk this year about fixed fee billing as way to address problems in lawyer-client relationships, starting with major clients like Cisco and major firm leaders like Cravath Swain & Moore’s presiding partner Evan Chesler.  Richard Susskind also talk a lot about the idea that fixed fees align client and firm interests better by encouraging efficiency.

I have no doubt this may be true.  Flat fees can reduce double-billing, the multiple rounds of review that occur as documents are prepared by junior attorneys, then reviewed by mid-level ones and then senior partners.  Legal invoices generally don’t relate time spent to specific goals or deliverables either, so they can leave the reader/client confused about what has been accomplished in the time spent.  Flat fees could make that clearer.

Or, flat fees could simply be a way to throw a thicker blanket over firm billing practices.  I wish I could find again the cynical viewpoint I read recently about how large firms have gotten about as big as they can get and the lawyers physically can’t bill more hours in a year, so they have turned to fixed fees to continue to increase partner profitability.

I have never worked in a large firm, never mind managed one, so I won’t presume to know what drive’s any firm’s billing practices.  I will say, though, that there are not many clients sophisticated enough to know that XX transaction should cost $YY.  Most clients simply need to take the firm’s estimate at face value, or solicit multiple bids.  A firm that wished to could certainly estimate the likely cost of a matter, round up slightly, then streamline its internal resources in order to bill the fixed-fee equivalent of 10 hours for work that can be performed in 8.

The point here is not to accuse any person or firm of bilking clients, but merely to note that the discussion of billing practices *per se* is a red herring.  It is just as easy to obfuscate and pad a fixed-fee invoice as an hourly one.

So what, I was asked over the weekend, is my approach?

The Grand Scheme
The master plan includes initiatives like the ones Mark Chandler describes in the ILTA speech linked at the top of this post.  He talks about letting Cisco attorneys dive into outside-firm knowledge management systems directly, reverse auctioning patent prosecution matters and a service level agreement that requires Cisco to take back low value-add (but expensive at outside firm rates) matters from outside counsel.  My firm is developing technology that will let us collaborate more closely with our clients on many matters.

The Day to Day
In the meantime, there is the day-to-day process of meeting new clients, assessing their needs and getting the work done cost-effectively. Every client wants to know how much the work is going to cost so it can budget appropriately.  Here’s the simple, low-tech approach that works for me:

  • Listen carefully to what the client needs and ask a lot of questions
  • Be honest with the client and with myself about how much time a transaction will likely take
  • Communicate regularly about progress.  If something major happens that seems likely to increase the scope of a project, work through it as early as possible
  • Strive to show that each invoice shows value provided, whether the bill is broken down hourly or on a fixed-fee basis

In the end, it’s developing relationships of trust and mutual advantage with clients.  Billing practices are a means to the end, not the end itself.

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