Someone asked me a really good question last week – he asked me if it’s a good idea for a startup founder to use the same lawyer as the angel investor or venture capital firm that is about to invest in his company. It is an excellent question, and I want to share my answer with you.
IT IS A TERRIBLE IDEA!
Jump with me to find out why…
Here is the basic scenario: the startup is beginning negotiations with the investor, and the investor says “Just use my guy, he’ll take care of you.” Or in a variation on that theme, the investor says “I recommend the law firm of Dewey Cheatham & Howe, very respectable firm.” [Say the name of the firm out loud.]
Now, if you have read any of the installments of my series Anatomy of a Term Sheet, you will know that the terms of these financings are pretty complex, and typically the terms that favor the investor come at the expense of the startup. So ask yourself how the investor’s lawyer can represent the startup in trying to remove or alter a term that favors the investor to the detriment of the startup? He simply can’t. This is what you call a conflict of interest. Not just any old conflict of interest, it’s a whopping big conflict of interest.
In many states, lawyers can represent both sides in a transaction, as long as they explain the conflict of interest in detail and get a knowledgeable waiver of that conflict from each side. Here is how that waiver might read: “Lawyer has explained that he is also representing the other side of this transaction, and might routinely serve the other side’s interests at my expense. I’m OK with that.” Are you? You shouldn’t be.
What about that other situation, where the VC merely recommends using another firm, Dewey Cheatham & Howe? Even though Dewey Cheatham is representing you and not the investor, there is still a conflict of interest, although it is more subtle. You see, Dewey Cheatham relies on the VC firm to recommend it to startups. It wants this referral, and it wants more referrals in the future. So if really representing you might result in disappointing the VC firm, such that the referrals dry up, Dewey Cheatham is going to hold back. You aren’t going to get the most vigorous representation, as long as the VC firm and its referrals is more valuable than the $15,000 or $20,000 in fees you pay them on this one-off transaction.
So when your potential investor suggests using his attorney, or recommends and attorney to represent you, smile and thank them, tell them that you will take that under advisement. Then file the names and start working on finding your own attorney. You need an experienced and independent attorney that will be in your corner 100% of the way. Don’t worry about how the investor feels about you not using “their guy.” They will have more respect for your business savvy, in the long run.
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