How can a startup manage its legal costs — the abc’s of legal management


In another Blog from another site, I made some quick comments regarding how to manage legal costs when your company is a startup and/or has limited capital.  Because of time limitations, I failed to discuss the issues overall with legal billing management.   It is paramount to control these costs since a) these costs to not add to the production of a product, and b) when left uncontrolled, it can be a heavy, financial drain for the company. In this discussion, I am going to point out the most efficient legal management practices for small and medium sized companies.

The first recommendation I strongly urge any company to follow is avoid litigation whenever feasible.  Litigation, whether in the courtroom or administrative, can be a black hole of on-going monthly expenses. Depending on the opposing party, you can encounter many filings and court appearances that generate huge monthly bills.  Some corporations use litigation as means to drain financially or destroy their opponents. To quote, “Everything is fair in love and war.” Well, I have witnessed such viciousness from sizeable opposing companies.

In a startup telecom company, in which I was the corporate counsel, a major telecom carrier purposely filed a bogus objection to the licensing of my company.  Its filing stated that the actions of the small company were criminal and could not operate its services internationally – the bread and butter of the company.  That filed objection alone took over two years to litigate.  My company needed to win.  The win represented the ability for the company to file its IPO.  But I had to weigh the possible costs of this battle. Through smart litigation management, the company won without expending too much financial resources. I asked similarly situated companies to join in the defense and share legal fees.  I carefully monitored outside counsel every month, and worked closely to provide any documentation for their needs, while preparing that paperwork in-house.  This management reduced the costs substantially against a well-funded opponent and still achieved a victory.

Large companies use their legal department to weed out the competitors.  I once handled an administrative litigation that, for every two days, my computer inbox was full and my physical mail arrived in a large box every day, since the litigation covered filings in 38 states.  The company was represented by one of the best law firms in D.C.  (I always check to see who is the opponent’s counsel in order to determine how difficult will be litigation.  If I am not familiar with the firm, I would ask around. The better the law firm, the longer and more difficult the battle.) The opponent was one of the largest U.S. companies in telecommunications – 3 times the size of my company. Seeing that this particular litigation would overwhelm me and the department, I sought a way to settle the matter to the mutual benefit of both companies. The litigation would drain my company’s resources. I successfully reached a settlement, but not without some struggle: during the negotiations, I threatened a potential action in one state that would be a serious challenge.  I believe that, for one to negotiate, one has to do so from the position of strength.  The opposing counsel kept stalling and wanted to extend the deadline.  I resisted any changes in the deadline. (Later on, by coincidence, I found some correspondence between the opposing counsel and his superiors, where he tried to get that extension, knowing well that it would be to his advantage.  However, the other side, namely myself, did not buy into it.) This incident brings another strategy I always follow, try to close up a deal as quickly as possible, because if you don’t, many things can occur in the meantime that could stall the closing of the deal.

When I worked for a law firm, a partner chastised me for my billing for less than 6 minutes when I would receive a short phone call lasting less than 6 minutes from  the client.  The law firm charged for my time in 6 minute increments. He explained that minimal billing should be 18 minutes in those instances of short – less than 6 minutes – phone calls. The first 6 minutes represent the interruption in my work flow while working on other matters.  The third 6 minutes covered the time to gather my thoughts as I returned to work on the other matter.  In other words, any call of whatever duration, even less than a minute, had to be billed for an additional 12 minutes.  Therefore, if I were to receive short less than 6 minute duration calls throughout a 24 hour day, it was theoretically possible to bill in excess of 24 hours.

And this aspect of law billing seems to escape many non-lawyers – lawyers bill for their time besides authoring the legal paperwork  – phone calls, letters, emails, or travel.  Anytime the attorney leaves his/her office, that attorney begins to charge that client the minute he/she exits the front door.  Anytime the lawyer has to read a client’s email — however short, he has to bill for that time. Every second the lawyer is even put on hold while calling the client or in reference to the client, he must bill for that time.  That is the reality of legal billing and why virtually all legal firms charge by 6 minute increments.

So how do I minimize those legal costs?  I avoid calling attorneys for whatever reason unless it is extremely urgent.  I prepare whatever documentation needed for my meetings with outside counsel, and make sure that the papers are well-organized and complete. Every interaction with an attorney is direct and to the point, since time is of the essence.  I avoid travel considerations for counsel by suggesting my presence at his/her office.

I also have another rule: if you give a lawyer 2 months to do something, it will take 2 months.  If you give him 2 weeks, it can be done in 2 weeks for the same results.  The nature of law is such that one can keep looking for additional rules and regulations that may indirectly be pertinent to what you are trying to achieve, but are not critical. And they will look for additional issues to run up the tab.

Lawyers earn their income by billing their time — to  earn more revenue, they must bill more.  Even the young associates are measured by how billable time they bill on a monthly basis.  There are 2 groups that fall into exceptions: corporate lawyers because they are salaried, and contigency lawyers who are finally compensated by sucess.

Standard law firms still abide by the billable formula. For example, while working with a startup, I dealt with a major D.C. law firm to establish a Russian corporate entity.  Because of the local laws, the establishment legal costs vary tremendously whether it was a marketing office or a standard corporation.  Now, the entity would never generate revenues since it was only a R&D operation.  If the entity would never generate revenues, there should not be any deductions or international transfer pricing. The more we discussed the creation of this entity, the outside counsel suggested that it could generate revenue over time.  If that were to occur, then we needed to establish a standard company. To mitigate taxes, the new corporate entity would then be owned by a Cyprus corporation.  All of these new, legal points were bolstered by a tax memo of 100 pages, which I never requested.  The legal bill for this transaction was extraordinary, and the irony of all of this, the company merged with another company in the U.S. a few months later.  So the incorporation costs were a total loss.  In retrospect, I should have simply instructed the outside counsel to create a simple “marketing office” for the operating entity in Russia.  I let this attorney run the tab over several months by not setting a timeline.

This Russian experience generated another rule, manage outside counsel carefully. It helps to have a corporate counsel with experience in these matters, since many outside counsels tend to obfuscate laymen as to the services required or even needed.  Also it is useful to establish a budget.  Generally, I apply 3% of gross revenues as the potential maximum for legal costs.

I have worked on contracts or financing agreements consisting of over 100 pages in the commercial banking and corporate world, and I have drafted short contracts that cover less than a page.  Because I have encountered wide examples of agreements, I determine the extent of the length of contract by a simple rule – what is or how much is at risk?  In other words, my due diligence and legal documentation are directly proportional to what the deal costs or might cost the company.

In a simple guaranty agreement where the potential exposure is only a $1,000, I would draft a simple paragraph.  Or I could go online and find a standard legal form for less than $25. I would avoid sending the work to outside counsel, because I know if it were sent to an outside counsel, that document will be substantially longer, costing in excess of what is at risk — after the associate writes the guaranty and the partner approves the draft, and the partner calls or sends me some correspondence related to the agreement.  (I already anticipate 4 hours of work for a contract of one page with outside counsel — do the math.) Note that the outside counsel does not care what is at risk here, or establish a balancing act of whether it merits being done in-house.  It is up to the company to submit the task to the law firm and understand those risks. The law firm would attempt to squeeze as much billable time for that simple agreement, maybe point out some esoteric case law that in all likelihood would never occur. So by the end of the day, the transaction that merited a short guaranty agreement costs the company more in legal fees than it would gain from the transaction.

On the other hand, I have worked on deals valued over several hundred million dollars. As an attorney experienced in this area, I know that several lawyers work on putting such an agreement together.  I also know that the opposing side will draft whatever clauses or paragraphs that favor their client over my company’s interest.  By nature, lawyers only do advocacy – they must represent the interests of their clients and look to win with some esoteric clause.  And my company has to expend more resources for these larger deals to make sure that the transaction is favorable to itself.

This experience brings another rule – employ lawyers the way you use doctors.  Determine the expertise needed to match the work being done. Large firms should be used for very large transactions.  Employ smaller firms for smaller transactions.  And every law firm cannot handle every expertise, whether languages, litigation, corporate, SEC, banking, etc.  The fact that a lawyer has a law degree does not mean that the attorney knows every subject matter.  Since the hourly fees reflect the size of the firm, you reduce your costs by parceling the work to different law firms according to the size of the matter or deal,  and according to the subject matter.

And when your company is technology based, one uses IP lawyers.  Now recently, I noted that these IP lawyers can always find “extra work.” I know of one startup company that its IP attorney filed the patents for the technology.  This company is solely being funded by “Friends and Family”.  The product does not have a beta version and is not being manufactured outside of the U.S. I can understand the initial patent filing.  What I didn’t understand that the attorney filed the same patents in Europe, Asia and the rest of the World.  Now, I doubt anyone bothered to research whether anyone would buy or manufacture the product overseas, given that it has 1 full-time employee.  And it might be impressive that the business plan states the overall IP protective schemes. So why these additional filings and the expenditure of very limited capital needed to market or manufacture the product? A standard patent filing costs in the vicinity of $50,000.  Then add to that number the costs, time and efforts to file for the rest of the World. And the start-up’s latest round of funding is less than $50k. Now I can envision the attorney arguing for the additional filings, that it “is possible” that this product might be marketed or manufactured offshore.  But that is not the case, and the IP filings should have been narrowed down to its U.S. activity.  And, when the capital is raised and there are activities offshore, then file offshore.  Don’t go around filing throughout the rest of the world when the company has meager financial resources needed for marketing or manufacturing and there is no evidence that the company has begun that process.  In the long run, the attorney gets his fees, but the company closes its doors by continuing such strategy.  IP rights do not generate revenues per se.

Some Wall Street law firms now offer a fixed price for services, rather than billing on a hourly basis.  I also began to call law partners to determine the approximate cost of a specific matter or filing.  Again, given the limited resources for startups, this approach works rather well for controlling costs and budgeting. Now when I fish around for the services, even with fixed costs, I approach those attorneys that already have the expertise.   Lawyers with experience on the specific subject matter tend to produce the work faster and at lesser cost than those with little or no experience.

I mentioned earlier that I treat lawyers as doctors in terms of expertise.  It makes sense to employ lawyers with considerable experience in the field; otherwise, they are learning at your dime. Not all law firms have attorneys who speak Mandarin, as an example.  Now I know that when a company is seeking some advice from the law firm on international matters, and that firm doesn’t have that resource in-house, the firm will seek to hire someone quickly to bolster its staff. Why?  Because the firm fears it will lose that client to another law firm that actually has that resource.  I know of an international telecommunications company from Brazil that employed a major law firm in the Eastern U.S. for its contracts and corporate matters.  Unfortunately, the law firm, although sizable, did not have one associate who spoke Portuguese.  I myself find it perplexing that a company hired this law firm without determining that the partner spoke Portuguese. Solution?  That same firm hired a consulting lawyer who spoke Portuguese.  Now, that solution, in itself, would double the legal bills for that company.  There is no difference between a lawyer who writes a contract in English vs. a Portuguese one.  But now the company pays for two layers of lawyers with the same law firm — one who writes the contract in Portuguese, and the other, the partner, who asks that it be translated into English and reviews that contract.  Then he bills the client for both efforts. Wow! Not a way to control your legal costs.  So I always make the inquiry of whether the attorneys satisfy my criteria — in this case, do you have a lawyer who speaks Portuguese? If so, let me meet him or her — my personal due diligence. This specific company’s CEO and President were from Latin America and spoke/wrote in Portuguese. They were well capable of communicating their language. There are hundreds of thousands of lawyers out there, and there are at least several hundred high quality law firms.  Given those numbers, a company should be able to find the right kind of attorney to handle its matters for Portuguese contracts.

I hope that these suggestions are useful to startups.  I have some more “rules” but I elaborated herein on my basic strategies on controlling and managing legal costs within this blog.

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About Juan Ramón Zarco, SVVGP 胡安•雷蒙•扎尔科

Juan Ramon Zarco, 胡安•雷蒙•扎尔科, Silicon Valley Ventures Growth Partners llp, Hygieia Healthcare Technologies Company, AllRest Technologies LLC, Crimson Growth Partners LLP, jrzarco2001@yahoo.com, is an experienced as CxO, General Counsel and Secretary to public and private companies with global operations. Established track record of producing practical, revenue-focused solutions. As Counselor and Secretary, demonstrating vision, integrity, and sound business judgment, to CxOs. Managed complex, strategic transactions, M&A, contracts support, PE Financing, IPO, SEC compliance, Corporate/HR governance, IP licensing, Budgeting, Staff, outside counsel management, International market access strategies, Domestic & foreign government relations and advocacy. Creative in designing and implementing market access strategies. Practices law beyond conventional model with low-overhead and project-based fees. Effective at managing departments, formulating marketing strategies, balancing budgets, and implementing cost-saving measures. Extensive in-house and private practice experience, advising clients on commercial, corporate, international business, and technology law and policy. http://www.docstoc.com/video/89135472/make-your-business-an-international-presence; http://www.youtube.com/watch?v=fx5gijf3yoc For Sprint, he managed iDen international development in Southeast Asia, Middle East, and Africa, and contractual issues with Verizon. In Private Equity, he worked with Pegasus in vetting international investment deals and interim President for portfolio companies, such as Data Foundation, a data storage company, handling marketing, strategy, fund raising, and accounting. Before Pegasus, Mr. Zarco, as CLO and V.P. of Corporate Development, played a principal role in the structuring, international expansions for 2 telecom companies, U.S. Cable Group and Viatel, Inc. in financing and M&A deals exceeding $200 million. Mr. Zarco earned a J.D. from NYU Law School, M.B.A. from Cornell, and B.A. from Williams College; is fluent in Spanish, Portuguese, French, and German, with working knowledge of Russian, Arabic and Japanese.
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One Response to How can a startup manage its legal costs — the abc’s of legal management

  1. Jim says:

    Juan,
    I found this blog page very telling of your capabilities.
    Thanks for pointing it out.
    Jim

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