When should a startup hire a lawyer?

This post is a part of a series based on my Law for Startups workshop at MaGIC in September 2015. It’s a basic introduction to legalities for startup founders. You can access the slides here.

Read the earlier posts for context:

  1. Law for startups in Malaysia — building on the best foundations.
  2. The legal landscape in Malaysia for startups — a hybrid of traditional corporate practices and Silicon Valley models.
  3. Choosing the right business vehicle for your startup or small business in Malaysia.

As with any business venture, startups need to get good professional advice from experts. Typically these advisors will cover legal, financial, and tax advice.

Time to lawyer up!
Time to lawyer up!

Lawyers have a bad reputation

Most people would prefer if they could avoid dealing with lawyers. When there’s a negotiation or discussion and people say get the lawyers involved, suddenly everyone gets a bit more serious and defensive.

There’s this phrase which is sometimes used when things get ugly and a serious dispute is breaking out — “it’s time to lawyer up”. This was before Barney Stinson made the phrase “suit up” popular. Lawyering up is a sign that the parties have given up on coming to a friendly agreement, and bring in the evil lawyers to do their dirty work.

People act more cautious when lawyers are around — parties can be happy enough meeting numerous times over coffee to discuss a deal, but when someone asks “can my lawyer sit in for the next discussion?” the other party will tense up — “Oh, you’re bringing your lawyer? Why so serious? I thought this was a friendly deal…” or “Oh, okay… but I’ll ask my lawyer to come too then…”.

It’s as if people think lawyers are out there to trick them into agreeing to something which is bad for them.

Why and when a startup needs a lawyer

I would obviously advise engaging a lawyer as early as possible in your entrepreneurial journey — it can be invaluable to get things done properly right from the start (such as choosing the right business vehicle) — but I also understand that this will not be feasible or preferable for the majority of startups.

However, it is crucial that a startup engages a lawyer before signing anything — not just with investors, but also with co-founders. Ideally, legal advice should be obtained even before proper negotiations begin. Some early mistakes made at the negotiation stage (such as proposing terms which are not in your favour) can prove to be difficult or impossible to rectify.

My first point of contact with a startup client is when term sheets are being negotiated. This is a good time to get a lawyer involved, as it is the stage where things start being put down in writing. However, there have been times where a client approaches me to draft the full-blown agreement, and gives me a term sheet which has already been agreed.

There are two reasons why you should get a lawyer involved when you start negotiating a term sheet:

  1. You need advice on what to include or accept. It is quite common for clients to approach me with draft or signed term sheets which contain provisions which are not in their favour. Naturally, there is a lot of give and take in negotiations, and a party sometimes has to accept terms which are for the benefit of the other party. However, in some cases, a client says that they accepted a term because they thought it was “normal” based on what they read on the internet or heard from fellow business owners. Even worse, some founders actually propose terms which aren’t in their favour to investors (such as anti-dilution protection, which protects the investor) even when the investor didn’t ask for it.
  2. Term sheets can be legally-binding. One of the popular reasons for not engaging a lawyer until after the term sheet is signed (besides saving on legal fees) is that “term sheets are not binding anyway”. This assumption is flawed, as term sheets can be legally-binding based on the specific facts of each case — the wording of the term sheet is very important, as is the conduct of the parties. You may be committed to certain obligations, or exposed to liability, even if all you’ve signed is a term sheet. Even if the term sheet turns out to be non-binding, there is a real reputational risk in tearing up a term sheet after signing just because you’ve then received legal advice that the contents aren’t in your best interests.

Get a good lawyer

Besides lawyering up as early as possible, you also need to get a good lawyer. But what is a good lawyer?

Would you say that Harvey Specter (his image was on my presentation slide) is a good lawyer? I don’t think I would enjoy having him as my lawyer, as any case he handles usually takes the following route — he’s confident of winning, then is seemingly out-smarted and is on the verge of losing, then comes up with a clever move that surely will see him win the case, then his opponent discovers something which looks to be the killer blow, and finally Mike finds a loophole which enables Harvey to snatch victory from the jaws of defeat right at the end! Engaging a lawyer like Harvey Specter would definitely send your blood pressure through the roof.

Some lawyers will tell you that a good lawyer will ensure that you win your case in court — those who say that are litigation lawyers. To me, a good lawyer ensures that you never have to go to court. If you receive sound legal advice from the beginning, and only sign contracts which are comprehensive and clear, there should be minimal room for disputes to arise.

A good lawyer has the right experience. It’s not good enough to hire a lawyer who has years of experience, or is a senior lawyer in a big, reputable law firm. You need to get a lawyer who has the right experience for the advice that you need.

My friend Mei Chel, who is a former tax and corporate lawyer and regional counsel at a VC fund has written an article about some of the issues related to “startup lawyers” (and I’ve previously warned about being cautious with lawyers who claim to be specialist “startup lawyers”) in Malaysia, says she has “received first hand feedback from a regional investor that they were not convinced after meeting certain reputed law firms, that they had the right experience, culture and understanding of the industry”.

It is very important to engage a lawyer who understands your business and is very commercially-aware and sensible with the advice and assistance he provides. Speak to a few lawyers before choosing one, and find one who you can get along with and seems to be genuinely interested in the success of your business.

Having said all that, it’s not easy to find a good lawyer — there is very little information out there.

Do as much research as you can with whatever information is available, and also ask other startup founders or investors for some personal recommendations.

Get your own lawyer

An unfortunately common cost-saving method is to use the investor’s lawyer. Investors will often recommend that you use their lawyer to make the process smoother. I would advise strongly against agreeing to this arrangement. Doing so gives rise to a clear conflict of interest.

Lawyers want to get the deal done so they get paid.

The investor’s lawyer will want to convince the founder to accept the investor’s “standard terms” — making the process smoother means getting everything agreed and signed, pronto.

Engaging a lawyer is supposed to help you to spot issues which you wouldn’t spot yourself — having a lawyer with a conflict of interest means you have to pore over every clause yourself, so you essentially don’t have a lawyer at all.

The investor’s lawyer is in a difficult situation, as one of the reasons he is being repeatedly recommended and used by the investor is obviously his track record in getting deals done. His natural inclination will be to smooth things over and to convince you to sign as quickly as possible. Otherwise, the investor will simply find another lawyer who can get this done.

Clients should also be careful not to create a self-inflicted conflict of interest, by coming up with complicated models for compensating lawyers. For example, agreeing to pay lawyers only post-completion or with a success fee creates a conflict of interest — how hard will your lawyers fight for your rights if it’s in their personal interest to close the deal?

Lawyers aren’t as expensive as you think

Probably the most common reason startups don’t hire a lawyer is to save cost. They assume that legal fees are very high, and they don’t see value in what they are paying for.

I understand that startups want to keep costs low and not spend money unnecessarily. I started my law firm in January 2013 and I was reluctant to spend on things which I deemed as not part of my core business, or things I could do myself — many lawyers try to save money when it comes to branding (website and business card design), IT-related matters, office interior design and renovation costs.

What I would advise startups is to consider the cost and balance it against the risk.

At the very least, get a fee quote (lawyers won’t charge you for this) and then decide whether or not to engage a lawyer — at least you’re making an informed decision, and taking a risk after a full assessment of the facts.

Deciding not to engage a lawyer — particularly at the stage where agreements are being negotiated and signed — means startups expose themselves to the risk of making mistakes which could be costly to rectify, or even impossible to fix, later on.

In the next post, I share some tips on how to approach the negotiation and drafting of contracts.

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