I have been giving some thought to Fred Wilson’s recent post, “A Challenge to Start Up Lawyers”.  His basic point is that he should be able to close an angel financing of under $1mm for legal cost of $5K.  Needless to say, this post brought out the sycophants (the Fred you are absolutely right crowd) and the deeply offended (the lawyers are worth every penny they charge crowd). 

I don’t think it is reasonable to be in either crowd.  Our firm enters into a wide variety of arrangements with start-up (and other) clients.  These arrangements are intended to reflect the needs of the client and the particulars of each situation.  We may agree with a client on fixed fees, deferrals, reduced hourly rates, premiums, blended rates – to describe just a few of the arrangements we have with various start-up clients and other clients.

But, I want to talk about the $5K for a $1mm seed preferred investment.  Let me start by separating the invoice amount from the time that needs to be put into the transaction.  In the world of hourly rates, these two things are inextricably intertwined, but they need not be.

Our firm knows, because we do many angel financings, that the result of hourly rates multiplied by the time spent is highly likely to exceed $5K.  (That does not mean that we charge more than $5K or less than the hourly rate times the hours – what we charge depends upon many factors, the most important one, of course, is any agreement we have with a client.  For example, it is not unusual for us to write off time that we feel is excessive for any reason.)

So, why are the time charges (remember not necessarily the invoiced amount) likely to exceed $5K when so many angel deals are done and the terms are so “standard?”

VCs and lawyers do tons of deals, entrepreneurs only a handful.  Investments, even (or perhaps especially) angel investments involve a lot of discussion.  By way of illustration, they may involve discussion of valuation, option pools, vesting for founders, structure (seed preferred versus convertible notes) and other items.  Note that I have not yet mentioned the actual terms of the seed preferred. 

I can just hear Fred and his army of outraged investors saying:  “But we posited that the deal would be a seed preferred on standard terms and we agreed (hypothetically) on readily available open source docs.” 

OK, but I know from experience that the entrepreneur is highly likely (near 100% of the time) to come to me and say, “Fred wants to do a priced deal, but my buddy Winston got funded with convertible notes, which is better?”  So, now we have a discussion on the merits vel non of priced deals and convertible deals.  (I know that Fred won’t do a convertible deal, but that does not mean the entrepreneur won’t ask the question.) 

So, Fred, does the time spent on the discussion of priced deals versus convertible deals count towards your $5K or not?  Well let’s tick off $500 for that discussion (in the hours times rate world) and move on.

OK, now there is some sort of email or other with the “terms”.  At this juncture, the entrepreneur wants to discuss whether the valuation is fair.  (Remember that the fact that I am a lawyer and (according to most investors) as likely to know about valuations as about paleo-anthropology will not stop the entrepreneur from asking what other clients are getting.)  The meter ticks on….

Eventually we get to the seed docs themselves.  I produce the docs at the speed of greased lightening.  Unfortunately, the entrepreneur reads them and, guess what, has intelligent questions. 

Here is a good question:  Ted Wang’s open source docs provide an MFN provision for new terms arrived at in the next equity round.  I have a client that asked at least these questions about that provision alone:  What does it mean?  Is it fair?  How might it impact my negotiations in the next round?  Does it give my angel investor a practical veto over the next round?  And the meter ticks on….

Anyway, you get my point.  It is not mere document production; it is time spent with the client.  No lawyer wants his client to sign something that the client is not comfortable with and does not understand.  It is just not good corporate hygiene.  (In fact, it might be malpractice.)

So here is one for you Fred:  Would you want your portfolio company to be using a lawyer who just says these are the standard open source docs, just sign them please?  Would you invest if you knew the entrepreneur signed on that basis?  Would you invest if the entrepreneur read the docs and did not have any questions?

Now back to the price.  Many high quality reputable firms would agree to a fixed price (perhaps $5K) – not because they believe they will be able to bring in the time at a profitable rate, but because they think of it as business development.  They may have other reasons as well.  The thing to do is to have a discussion and agree at the front end as to how the billing will be handled.  But don’t be under any illusion.  It is unlikely that rate times hours will yield $5K.

One more point is that law firms are likely to view fixed fee arrangements as loss leaders.  They are planning to get more work on which they can make a profit.  Fred’s example of the exit (where the law firm charged six figures) is an excellent case in point.  The risk, of course, is that the firm that did the early work at what is in effect a discount, does not get the more profitable back end work.  This can happen when VCs (and other advisors – most of whom know as much about legal work as they do about paleo-anthropology) come to the conclusion that the company needs a thousand lawyer national megafirm for the “important” work, and they push the client away from the start-up lawyer.  It can happen for other reasons as well, the ingrained preferences of a new CEO or CFO, the insistence of a new investor that the company use one of its “favorite” firms, or the insistence of a heavy hitting board member to the same effect.

This leads to a lose lose situation for the start-up lawyer, who will now think twice before doing the angel financing at a loss.