5 Tips to Manage External Counsel and Halve Legal Costs for Early Stage Start-ups

[Disclosure: This is an extract of an advisory piece written for Poko in my capacity as advisor and investor, edited for confidentiality and content.]

I regularly meet with early stage start-up founders suffering from slow and expensive legal services. It’s particularly a struggle for those founders who take legal matters seriously and often happen to be in a heavily regulated industry - in other words, those founders that need legal services the most!

If you are one of these founders, you are not alone. Here are five ways that will help you manage external legal counsel more cost and time effectively:

1. Assign product/client critical and BAU legal matters to different types of counsel: A significant part of the top tier law firm price premium is market signalling from reputational staking. This is very valuable when it comes to a legal opinion that gives investors, clients and other key stakeholders confidence on how you are navigating grey areas within complex regulation, but not so valuable when it comes to transactional legal ‘grunt’ work or housekeeping. Hence, you can manage your costs by having different types of counsel handling legal matters that are:?

a. "Core": For regulatory questions your product or service is hinged upon and/or are often the subject of client concerns, which benefit from the backing of a big law brand; versus

b. "BAU": Day-to-day transactional legal work like service agreements, employment contracts and other internal organization docs, which can competently and more cost effectively be dealt with by smaller legal practices for a fixed monthly retainer.?

2. For Core matters, switch to reputable ‘start-up friendly’ firms:?Not all law firms cater for early-stage start-ups. Magic circles and white shoe law firms target almost exclusively large enterprises, scoping and pricing matters accordingly. Start-ups are a different segment and they have, arguably, a different ‘top tier’. For example, firms like Orrick and Cooley in the US are more used to dealing with start-ups and are highly reputable. These are firms that will be perceived by clients, investors, partners and others as reliable and authoritative, and signal that you take legal affairs seriously within your start-up. At the same time, these firms are more used to dealing with start-ups and can be a bit more pragmatic in the way they scope and bill, as well as a style of communication and engagement that is more tailored to founders.

3. Set clear engagement terms in writing prior to mandating a law firm on each and every matter.?The engagement letter/email should include:

a. Fee Estimate:?The default is paying for time not outcomes. If you don’t ask for a fixed or estimated fee, you will be billed for however long it took to hit the deliverables. An estimated range is reasonable, but expect to be billed the higher number for ‘burn’ purposes, and ensure that the range is reasonable (~20% max, slightly higher for small matters).

b. Fee type:?Usually fixed, capped or uncapped; aim for at least capped. Fixed is a utopia beyond BAU transactional matters; capped is uncommon in regulatory advice but not unheard of, and very achievable for common in transactional work even if complex or heavy.?

c. Explicit in/out-of-scope work:?List out separately and explicitly both work that will be performed, and work that won’t. E.g. Scope includes compliance with securities laws in connection with a primary fundraise; Scope excludes any tax implications. Listing the out-of-scope is often left out and things fall through the cracks. Though it might be obvious to you as the start-up founder that you might assume its implicit, your lawyers do not the same level of understanding of your business strategy and goals, or may assume you will be dealing with matters outside the explicit scope of work independently. Educate your lawyers about your business and objectives as much as possible, point out if you feel there is something missing, and ask the kitchen-sink question - ‘Am I missing something’ - to your lawyers.

d. Explicit underlying assumptions:?Have your counsel explicitly set out the assumptions they are making in providing you with the fee estimate in addition to the scope of work. E.g. securities will only be offered in a private placement to institutional investors. Ensure the assumptions are reasonable/make sense for your goals and make it clear ONLY IF one or more of these assumptions is negated should there be any discussions about fees exceeding the original estimate.

e. Require that they proactively keep you informed of legal costs:?No surprises allowed. You should be notified as soon as anything changes during the course of the engagement that could blow the estimate/cap (i.e. negate an estimate assumption) well in advance. E.g. if you ask them to do something that would increase the cost, if there is a change in regulation or context changes, or if as things happen, they may have underestimated the scope in some way, they need to tell you before they incur further costs. Make this very clear. And chase them about it anyway.

4. Prioritise legal engagements based on risk/return.?The guiding principle is that external counsel has a highly risk-averse attitude and almost exclusive focus on covering possible downside exhaustively. It is up to you to bring into account the potential upside, probabilities and gravity of downside and balance it against the legal cost. So:

a. De-prioritize questions with low liability and reputational risk if you get it wrong (or minimal upside if you get it right). E.g. if you are hiring an intern in India from the Singaporean subsidiary of a Delaware company for $1k/month, probably not worth engaging the labour law teams of three offices across a magic circle for 25k :)

b. Avoid open-ended, abstract questions.?You are trying to prevent the ‘it depends’ answer followed by either a list of dependencies that is hard for you to apply in practice, or an exhaustive memo analysing scenarios you don’t care about that costs you a bomb! Try to provide concrete examples with factual context they can apply their legal knowledge to an evaluate. You can also agree to caveats to their answer that are not as relevant to you. For example, rather than just asking ‘are governance tokens securities subject to registration requirements’, give them the factual scenarios that you are envisioning (T&Cs of the tokens, manner of distribution, jurisdictions involved/not involved…). However, always ask counsel if there is any other contextual information that might be critical to assess such scenarios (in case you miss something).

5. When it comes to legal opinions, consider accepting reasoned / negative assurance opinions where appropriate.This is part of the balancing act. You can’t always get an unqualified opinion from counsel, or it might be very costly. Reasoned opinions set out the reasons why counsel believes it is more likely than not a court or regulator would take a certain position. Negative assurance is saying ‘Nothing leads me to believe that this is required’ rather than ‘This is not required…’ - it’s a lower standard of assurance that may under some circumstances be acceptable to you and require less risk/narrower scope for counsel => lower fees. (But don’t take this lightly - tread carefully and ask for advice)

As you have probably gathered by reading this far, making these decisions, prioritizations and trade-offs not only requires business judgement, but also a fair amount of legal knowledge. This begs the question – should an early stage start-up consider bringing inhouse legal talent on board??

For most early stage start-ups, in-house legal ranks pretty low in how they want to spend their runway. With respect, I’d argue that in heavily regulated industries where legal is core to your product or customer relationships and/or your constantly having to navigate complex licensing regimes, this is a?penny-wise, pound foolish strategy. Hiring legal talent early, like could allow you to put in place some of the above strategies generating legal cost savings well beyond the talent investment.?

Crucially,?you do not need to break the bank?hiring the most senior and expensive legal talent, provided that you carefully align your talent selection criteria with your specific goals in hiring inhouse lawyers early in the game.

This requires you to be purposeful about?hiring early legal talent to implement the above efficiency strategies. Some tips on how to judiciously looking for the following criteria within the pool of candidates:

1.?????Issue Spotting:?Quickly identifying all the relevant legal issues and factual context involved in a given scenario, even if they don’t know the answer (but know what needs to be researched).

2.?????Creative problem solving:?Breaking down complex issues into discrete, more answerable questions, and thinking creatively about interim, sometimes scrappier legal fixes as versions of the solution.

3.?????Practicality and Effectiveness:?Good judgement assessing the criticality of the legal matter in order to prioritise internal research and determine the need for counsel, as well as instructing and managing external counsel to efficiently and effectively maintain the highest degree of ‘legal integrity’ in each jurisdiction.

4.?????Customer-centricity:?Prioritise and solve legal questions with the customer in mind- understand the start-up’s customers, their challenges and how their legal work contributes to solving them.

5.?????Efficient legal research and analysis skills:?Conducting research and analysing findings with a problem-solving mindset to find a de-risked, legally compliant and efficient path to the company’s goals (versus an un-applied, academic interpretation / POV), and being resourceful in conducting thorough and reliable research within the limited legal resources of an early stage start-up.

Of course, these are not the only selection criteria - as a founder, you will be best placed to assess the candidates’ conviction and commitment to your vision, as well as them having the right motivations and cultural values that align to your business.?

This is particularly important when recruiting early-to-mid career legals to join tech firms. This is a non-traditional path for lawyers, making it all the more critical to be weary of adverse selection. In other words, in a space where most top performers join traditional law firms, you risk being left with lower-tier talent that couldn’t make it. This is where the founders’ recruitment gut is most important.

The best founders are able to narrow down a pool of top-tier legal candidates through a combination of (i) thorough evaluation of candidates’ beliefs and passion for their start-up’s vision in early interview rounds, backed by proactive engagement in tech and Web3 / tech law over traditional academics and legal practice (e.g. President of the Tech Law Journal instead of Law Review); and (ii) ‘pull’ recruitment style, inspiring candidates to join through widespread media evangelizing the company vision and culture. Generally, when you find candidates answering the traditional ‘Why this company?’ question with a specific interview or article by a company founder inspiring them to join the mission, you’re doing it right. Top talent will be inspired by your vision – get it out there!?

About the Author:

Jose Sampedro is a former VC-backed start-up founder and CEO in B2B SaaS space, currently helping to build and investing into deeptech ventures globally. He is an investor and advisor in multiple emerging companies and investment funds, including Poko.Fund and Pebblebed.com, as well as scouting and co-investing with Hustle Fund. He is also an entrepreneur-in-residence at Silicon Valley’s Mach49.

His prior experience includes Oracle Cloud Insight Director, Project Leader at BCG and finance lawyer for Magic Circle law firm Linklaters in London. He holds an MBA for INSEAD, a Juris Doctor from Columbia University in New York and a Bachelors from King’s College London.