Jason Calacanis, Meet the Current State of the Legal Profession

December 7th, 2009

I don’t generally write about the business of lawyering, but a few things came together recently that I want to make note of to readers.

First, those who don’t follow legal news should be aware that 2008-09 has been brutal for the legal profession. The best summary I can find is this chart, showing well over 100,000 jobs lost at big law firms since the start of 2008.

(image courtesy lawshucks.com)

Most recently, the entire US economy lost 11,000 jobs in November, of which 2,900 were in the legal profession.  As a friend put it, the legal industry is “shrinking faster than any that I can think of“.

Into this environment steps Jason Calacanis, who last week announced plans for his Open Angel Forum.  The forum is a great idea and I certainly wish him well with it.  Here is the part that rubs me the wrong way, though:

The organization is charging a small group of service providers $1,500 each to attend.

I certainly understand the concept here.  My old firm used to run an event we called Angel Law Forum for entrepreneurs and service providers would routinely outnumber entrepreneurs and investors.

To say that lawyers can easily afford it, though, is comical for two reasons:

1)  Easily is the wrong word. Lawyers (and other service providers) are struggling along with everyone else this year;

2) Jason doesn’t seem to have worked through his own math.  The only way any service provider can afford a $1,500 seat at a networking dinner is by charging high rates to clients.

As I said in my comment on the OAF’s announcement (awaiting approval as of this writing), I hope the event goes superbly and I look forward to hearing great things about it. In the meantime, I will be attending cheapie networking events so that I can keep my rates low.

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Class A/B Stock Structures

November 25th, 2009

News came out yesterday that Facebook has created a dual-class stock structure where Class B Common Stock has 10 votes per share compared to the ordinary 1 vote for Class A shares.  I certainly don’t know what Facebook plans to do with this type of stock, but Google has a similar deal (Cypress Semiconductor does as well), which has caused a lot of entrepreneurs to ask me about this type of setup.  Here’s what I think.

The Good – Voting Control
This type of structure allows founders to retain a lot of control over a company even as it grows enormously.  To use a very simple example, as founder of a company I could issue 1,000,000 shares to myself.  If the company grows rapidly and takes on a lot of employees I might want to issue 3,000,000 shares to them.

When I do that, I incur economic dilution and voting dilution.  This blog won’t speak to the economic side at all and will just assume the money all works out.  On the voting side, though, you can see that I went from controlling 100% of the stock to a mere 25%.  I have lost most of my control over the company.

I could issue more shares to myself to bring my percentage ownership back up, but there are a bunch of tax and logistical issues that make that hard to do.

Instead, I could convert my shares into supervoting stock.  If my shares all vote 10:1 and the other 3M shares are 1:1, then I keep control of the company because my 1M shares have 10M votes compared to everyone else’s 3M.

Google has said it adopted this system before going public because it wanted to think long-term and the founders did not want to risk being outvoted on shareholder matters.  B corporations can use similar structures to ensure that their companies’ core social missions can not be easily stripped away.

The Bad -Investors Hate it
My experience with these structures is that investors have a hard time getting comfortable.  Professional investors want to know that they can influence major decisions by the company, so it takes a while to get folks comfortable with the idea that founders have super-special voting rights.

My advice to entrepreneurs is not to rock the boat.  There are lots of perfectly good, non-investor-threatening reasons to create supervoting stock, but if the setup makes it harder to raise money then it’s a big gamble for a startup.

These things work for Facebook and Google because those are well-established, already successful companies.  They have negotiating leverage on their side.  Most startups are not so fortunate.

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On Zero-Sum Deals

November 20th, 2009

Most of my work is building connections between two companies or people, which sometimes means negotiating a software license agreement and sometimes helping a group of founders start a new company together.  In most of these cases everyone benefits in some way.

A few times a year I help people unwind difficult situations as well.  These are much harder deals to do- emotions run high and frequently the two sides don’t trust each other at all.  There is a tendency to look at these disputes as zero-sum situations: one side needs to lose something for the other to benefit.

Occasionally that is right.  I worked on a transaction a while ago where there was only 1 substantive issue between the two sides- one guy thought he was owed a bunch of money and the other thought the amount was much lower.  In the end neither side got what they really wanted out of it, which was unfortunate.  The deal later fell apart and I believe it was mostly because neither side got enough value from the agreement.

Most disputes don’t work that way.  Usually each side has something it doesn’t really need but the other side wants, and vice versa.  My job as counsel is (i) to help my clients figure out what the other side really wants and how to give it to them (this was a great quote from Hiten Shah- if only I could find the tweet), and (ii) help my clients figure out what they can give in order to get the deal done, move on and stop talking to me as much.   Some of the “give” items are material; frequently there are intangible items as well like reputational benefit and helping someone exit a bad situation gracefully.

So how do I help clients figure these things out? This post has been stuck in draft form all week because this is the hardest thing to do.  I talk to my clients a lot about all the facts in the situation, we use legal arguments as a backstop to think about what the result would be in litigation, and we spend a bunch of time assessing the other side’s needs.

We then make a series of offers intended to reflect our needs, the value we place on the things we want from the other side and the items we think the other side wants.  If we are lucky, the other side has done the same thing and we can find a small patch of common ground in short order.  From there, the thoughtful back-and-forth process lets us feel each other out and eventually find the key terms to avoid a zero-sum equation.

In other words, the alternative to a zero sum equation is probably something like: 40% part pragmatics (esp. how much money everyone is willing to spend on lawyers), 30% legal knowledge, 25% psychology, 10% intuition.  The rest is luck.

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Licensing in Plain English; or How (and When) to Write Contracts People can Understand

October 22nd, 2009

Most of my work is with medium and large companies negotiating software licenses between one another.  The documents tend to be long and assume deep knowledge of license terms, indemnification, warranties, damages and other key concepts.  I recently had a very different assignment, though, that turned into a fascinating exercise in minimalist licensing terms.

A high profile company needed to obtain rights to use photographs of some extremely unsophisticated members of the general public (i.e. people who don’t read legal contracts very often, if ever).  We needed to obtain a license to use people’s likenesses in a way that made clear the people understood the rights they were providing, and of course we wanted the language to be legally defensible.  The assignment turned into a great opportunity to go back to the most basic licensing principles.  As a bonus I got to poke around at how other people handle the same problems.

Licensing Concepts
The first thing I did was to strip down a license into is most basic components.  At a minimum, a license needs to identify (i) the material being licensed, (ii) the fields in which the material may be used (or the areas from which material may be excluded), (iii) the geographic scope, if any, and (iv) the price being paid for the license.

A typical license agreement has loads of other terms that are important in various circumstances.  I certainly would not recommend that companies omit these provisions- they are important in those types of transactions.

At the same time, most people don’t do these types of transactions and don’t have the benefit of experience in looking at license terms.  Sometimes it can be appropriate to use a very basic set of provisions that focus more on clarity and covering the basics than on detail.  It is very possible to write plain English that covers items (i)-(iv) above simply and completely.

What Other People Do
Creative Commons
is my favorite example of complex license terms described simply.  CC helps laypeople people select license terms that are appropriate for specific situations and they have developed a friendly set of mix-and-match logos to indicate what rights are imparted by the various choices.  The logos are backed by human-readable descriptions of the terms as well as traditional legalese.

STADSchromosomen, Creative Commons license
Image by spinster via Flickr

This a nice approach since it offers multiple ways to understand the essential provisions.

When to Use What Language
The real question is- when is it appropriate to use full-blown legalese and when can we make do with less?  For me it comes down to three basic considerations:

1)  The people giving up rights need to understand what they are agreeing to.  This is Creative Commons’ basic principle, and also the one I follow with my clients.  In that case we came up with a very stripped-down, nonlegalistic license provision so that we could clearly communicate what we were asking of people and have a decent expectation that they understood it the same way we do.

2)  What is the downside of leaving things out?  In many cases companies expect to see license terms written in a certain way.  Sticking with the tried-and-true format can actually move the deal along faster.

3)  Leaving out big items like warranties, post-termination obligations and indemnification language can create risk for one side or the other, so I consider litigation risk as well before I start cutting things out of agreements.  Does the other side have the means to sue?  Would we cause undue exposure for ourselves by omitting certain terms?

In the end, I put all these items together and try to find the right spot on the plain English-legalese continuum for any given agreement.  I like this process because it means I don’t hew blindly to certain forms, but instead think about purpose and how to meet everyone’s needs as efficiently as possible.

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Reading a Negotiation: Who Wants to Do the Deal and Who Wants to Argue?

October 15th, 2009

My normal strategy in a negotiation is to be frank about my client’s needs and try to find a collaborative solution for both sides.  Here is an example of when that worked really well, another one where it didn’t and what I could have done to improve the outcome.

Negotiation as Collaboration
In one recent transaction my client and its business partner had reached agreement on about 90% of the issues in the deal.  The last few were somewhat sticky because they were less about business terms than allocation of risk.  I explained our situation to the other side, then listened carefully to the other side’s points.  When we started going through the draft agreement I realized that the first two points were much more important to them, while some later ones were bigger points for us.  After hearing them out we agreed we could concede the first two items. The mood on the call immediately improved, the other side agreed to concede the items we explained were important to us and we breezed through the rest of the call.

Negotiation as My Way or the Highway
This strategy worked so well that I tried it again in another deal and it blew up.  The difference was that the attorney in the second deal had no interest in collaborating- she simply wanted to “win” every point.  That call was so adversarial, in fact, that everyone started shouting and stopped listening.  My client ended up getting everything it needed, but only by going around the attorney after the call and convincing the business principal that his attorney was standing in the way of the deal.

How I Avoid Making the Same Mistake Twice
The lesson I took away from negotiation #2 is to read the tone of the discussion as quickly as possible.  The people on the first call started out wary, then quickly warmed up through a candid discussion of the issues.  The attorney on the second call was belligerent from the outset and had no interest in talking through the business points.

Fundamentally I believe in my approach- I know my clients’ products cold, have business reasons to justify almost every point and a strong sense of which purely legal items we can give up in order to do the deal.  In my second deal, I should have avoided letting emotion take over, stuck to the business points and gotten off the call as quickly as possible so that both sides could work through the facts without having the attorneys showing off for their clients. The call might still have been unsuccessful but we could have avoided polarizing everyone.

My clients and I work as a team.  My job is not to win every point in a negotiation but to put the business terms into language both sides can benefit from.  I love this job because even though I have spent 11 years practicing my approach I still learn new things every time.

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Sad, Sad Week; Saying Goodbye to Craig Johnson

October 5th, 2009

Last week Craig Johnson, co-founder of my law firm, Virtual Law Partners, suffered a massive stroke.  He died Saturday evening surrounded by his family members.

VLP was formed when co-founders RoseAnn Rotandaro and Andrea Chavez approached Craig for advice on how to grow their small firm practices.  Craig immediately saw an opportunity to do something larger and more interesting.  VLP launched in May 2008 with a mission to provide personalized, efficient legal services to clients with minimal overhead.

A mere 14 months later one can not read legal news outlets without finding a slew of articles on client demands for higher efficiency, closer contact with partner-level attorneys and predictable legal expenses.  I mention this in order to point out that Craig was ahead of the curve throughout his career- from his start at the brand-new Wilson Sonsini in the 1970s, to Venture Law Group in the 1990s where he rode the Internet boom, to VLP Craig’s vision was prescient and many of us in the legal community and elsewhere have been well served by his guidance.

I had not met Craig before I joined VLP. He was impressively smart, confident and creative. He was a role model for me in my legal career; like me, he was also an avid cyclist and I will miss talking to him about his cycling trips as well as his career advice.

All of us at VLP consider ourselves part of Craig’s extended family and will miss him greatly.

(image courtesy ABA Journal)

(image courtesy ABA Journal)

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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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