Someone had asked me what I meant by Google lawyering when I described the CEO of Chicago technical startup who informed me that his outside counsel had drafted his Private Placement Memorandum (“PPM”). When I inquired about his legal bills, he stated that he only spent $2,000 for the year. Then I surmised that the non-attorney senior executive had cut and pasted whatever investment documents he found on the Internet, and claimed that his outside lawyers had done the work. I knew from my professional experience that the legal costs for drafting a PPM should be closer to $15,000, not $2k. Upon close inspection of the document, I concluded that no decent securities attorney would have ever drafted that document. Indeed, the document had so many holes that it would face considerable difficulty finding its bridge financing. So nowadays I describe the practice by senior executives at startups who draft their own documents from various Internet sources as “Google lawyering.”
Although I have stated in my blogs that I always attempt to manage legal costs, it does not mean that I would not approve a substantial legal bill during a transaction or corporate documentation if one balances the cost/benefits. A critical benefit can mean an important IP filing that needs to be iron clad. The IP filing is core to the company’s survival. Another cost/benefit analysis is employing securities lawyers in order to close a round of investment. In one real life example, I had to approve a legal bill from a well-known International investor where the attorneys cost more than $1,000 an hour. In the case of this particular private investment and similar ones, the company has to pay the investor’s legal bills as part of the transaction. Just to receive millions of dollars, the company had to pay outside counsel about $50k-75k. Not an insignificant number. This cost is fairly common while seeking capital. Even during the IPO process, the company has to select from 10 New York law firms to represent it with the investment bank. Attorneys with financial expertise are few and far in between and generally work at expensive, major law firms. So one accepts that sizeable expense.
Let us revert to my terminology, “google lawyering” and when I began using that phrase. I worked with an East Coast company, whose principal business was selling partnership units in real estate. The wording looked OK, but I definitely asked the CEO whether a securities lawyer had reviewed the documents. He stated that an attorney had done the review. Unfortunately for the CEO, the clients for the partnership units filed a complaint with the state’s Blue Sky regulatory agency, which alleged that the partnership units were unregistered securities – hence illegal, subject to fines and, possibly, criminal sanctions. When I brought in a securities attorney from a major firm to defend the CEO, he confirmed the state’s Attorney General allegations. I then realized during the due diligence that he had pieced together the paperwork for this so-called “partnership units”, without having a securities attorney review the work. In other words, he became his own lawyer and to impress his clients, he presented documents that apparently been authored by various attorney websites found on the Internet. Again, “pennies wise, pounds foolish.” Yes, he did save some expense by not having his documents reviewed by qualified counsel. On the other hand, the CEO spent a fortune in attorneys’ fees in order to avoid severe sanctions including a prison term. Had he done the appropriate legal review, he could have avoided that legal and financial headache. Instead he became financially bankrupt, losing any gains from his business and more.
Recently I met a high tech CEO practicing “google lawyering”. In his case, I had asked whether he had filed a provisional patent for his technology. He said yes. But when I asked which law firm he used, he stated that he has the experience filing such documents and drafted the provisional patent himself. Now I know that he has a MBA, but not a J.D. I also know that his English is rough, having been a recent immigrant working in Silicon Valley, which led me to question some of his writing skills. He also stated that he was seeking bridge financing for about $500k.
Let us revisit the “no” rationale for a potential investor in this instance. There are many law and accounting firms. Only a fractional amount are considered to be the best in their class. Graduates from the top ten law schools represent the top 5% of that legal classification. When a potential investor inquires about the law firm, he is evaluating quickly whether the company has reduced its risks by employing a “quality” law firm. He assumes that a quality IP firm would review extensively the potential technology in the patent ecosystem. In other cases, I have seen companies employ a small accounting firm where the CEO’s cousin works, which raises a red flag about the impartiality of the accounting services and due diligence. In other words, the higher quality law or accounting firm suggests fewer risks for nepotism, greater quality professional work, due diligence ( for example, when once securing a top 4 accounting firm, the firm insisted to investigate the senior management team for criminal records) and across-the-board impartiality.
What could go wrong with the self-serving provisional patent filing? The CEO might not have done sufficient research on patent filings which would raise challenges to his provisional filing – until it is too late. Then there is no IP protection. I can understand that the google type filing would look impressive to any potential investor, but experienced investors will inquire as to whether outside counsel were involved in the filing. It is not only the paperwork that the investors want to see, but, most importantly, who was behind that paperwork. It is all about credibility.
In my ISO blog, I stated that purpose behind IRS Rule 409 (a) was to have a third party evaluate the FMV of the company. Again that is about credibility. The more reputable, the more impartial and better known is that third party, the more credible is the FMV assessment to the IRS. Potential investors do follow that 409 (a) best practice philosophy for every assessment of every business facet of a company as well. It is just not as obvious as the 409(a) rule. Now the tech oriented CEO is thinking that it is the provisional IP filing justifies its investment requirements – wrong assumption. What matters is the individual or firm that does the filing. What is the potential loss for doing the IP filing in-house? Well experienced institutional investors would be reluctant to invest in such a company for the reasons described earlier. They begin to question the business judgment of the CEO. And I doubt that any qualified investor would invest in such a company. That CEO will struggle finding his desperately needed $500k.
On the other hand, I see no problems in google lawyering documents that are short and have little or no long term impact on the Company. But key legal or accounting matters need to be reviewed by qualified experts. Or, as what happened to someone else I knew, it can cost more than money.