In a 2013 article, Forbes identified 10 Big Legal Mistakes Made By Startups. These include breakdowns in documentation, ignorance of tax consequences, and choice-of-entity issues. Significantly, the article concludes by naming “not having the right legal counsel” as a serious problem for startup companies. Strapped for cash, startups often hire discounted and inexperienced legal counsel from among friends and relatives. Instead, Forbes advises conscientious startups to research and vet potential counsel, retaining attorneys or law firms that have experience in “some, if not many” of the following areas: contract law, employment law, IP law, real estate law, tax law, franchise law, and corporation, commercial and securities law. Perhaps not surprisingly, Forbes does not suggest that startups hire in-house legal counsel.
In his article How Do Startups Obtain Their Legal Services, Darian Ibrahim explores the reasons why many startups choose outside counsel – like the sophisticated full-service firms recommended by Forbes – instead of bringing legal services in-house. Ibrahim’s empirical survey identifies two reasons why startups favor outside counsel: a) early-stage startups cannot justify the expense of an in-house attorney, and b) outside counsel can offer “more coverage” (i.e. more relevant expertise) than in-house. However, Ibrahim’s study also reveals that a minority of startups do choose to hire in-house counsel, for two main reasons: (a) in-house counsel is perceived to have lower information asymmetries about their business, and (b) in-house counsel often demonstrates greater responsiveness and increased monitoring capabilities.
Beyond the Binary of In-house and Outside Counsel
Ibrahim’s study was one of the first to examine issues of in-house legal representation in the context of startups. However, framing a startup’s legal options as a binary choice between in-house counsel and outside representation ignores several other options for a startup’s legal support. As Ibrahim notes, most companies that use in-house counsel also retain outside counsel, including full-service firms. Furthermore, the choice between hiring in-house and retaining experienced representation may be inapplicable to the youngest and most vulnerable startups; Ibrahim’s study only examines startups that are backed by at least 5 million dollars in venture capital, a sensible limitation that nonetheless excludes alternatively funded companies and nonprofits. These other entitiesmay be financially unable to retain quality counsel, to say nothing of a salaried in-house attorney. (Although Ibrahim explores the possibility of compensating in-house attorneys with stock options, only 6.3 percent of participating startups used this method of compensation, a method that nonprofit startups lack entirely.)
Furthermore, the most socially conscious among for-profit startupsmay be hit hardest by this binary thinking; while not-for-profits are well positioned to obtain grants and pro bono legal services, social enterprises and other for-profits with social or charitable aims may have less access to these resources. For these reasons, the startup community may benefit greatly from the development of cheaper, more direct access to legal services in the early stages of their organizations.
Alternatives for Legal Service: the Form System
To this end, the startup community should further explore the use of a kind of legal self-help called the form system. In his article The Legal Spark, 78 UMKC L. Rev. 455 (2009), Jeff Thomas references the proprietary form systems used by Silicon valley law firms to counsel young startups and help them develop into sophisticated organizations. While these form systems are currently proprietary to law firms, Thomas proposes that a hypothetical Foundation acquire and develop one such form system and make it available online. The Foundation would also provide “starting point documents,” teach legal and economic strategies, and provide annotations with background and explanatory content to accompany both the documents other counseling content. Thomas emphasizes that this system would be tailored to a specific kind of organization undergoing a particular series of developments, rather than a “collection of random legal information and forms.” Although Thomas’s proposed system focuses on venture capital-backed startups, it is not difficult to imagine form systems developed for other kinds of startups, such as nonprofits, social enterprises, and sole proprietorships. These systems might be housed by the same hypothetical Foundation or perhaps by separate foundations.
A Web-Based Form System Business
The vehicle that Thomas proposes to make form systems accessible to startups is his Foundation – presumably a charitable foundation functioning as part of the not-for-profit community. However, it may be easier and more efficient to provide startups with a well-maintained form system through the use of a form system business. A business–perhaps charging a monthly access fee or a fee-per-service – may be particularly well positioned to efficiently compile, manage and distribute form systems. Since, as Thomas imagines, this information could be made available online, a form system business could provide access to legal advice with low overhead, passing its savings on to struggling startups.
Furthermore, as a web-based service provider, a form system business could be national in scope. This is particularly significant in light of concerns about startup attorneys engaging in rent-seeking. In his article Startup Lawyers at the Outskirts, Abraham J.B. Cable describes a growing perception of startup attorneys as engaged in a distinctive practice that combines legal services with civic engagement and support of local economic development. Although he sees the role of specialized startup lawyers as a positive one, Cable expresses concerns about such lawyers developing rent-seeking cottage industries by trying to recreate the conditions that made them successful in early startup communities like Boston and Sillicon Valley. A national, web-based, form system business could ameliorate this concern by shifting focus from communities of specialized lawyers and relocating it to startups, regardless of location. In addition to providing legal services at lower fees, such a company could employ lawyers for legal support and complex issues, but prevent the enterprise from creating a cottage industry for them.
In sum, a web-based form system business could fill a niche in the legal market for low-cost counseling to startups. Furthermore, it could provide this counseling without incentivizing rent-seeking by attorneys or creating a false dichotomy between in-house and outside counsel.