Law Firm with Equity,
Basic Guidelines for the Netpreneur*
By: Andrew Sherman, Esq.
McDermott, Will and Emery
- Will the Law Firm Accept Equity?
- How Can I Convince the Law Firm to Accept Equity?
- Should I Pay With Stock or Stock Options?
- Will the Law Firm Have a Conflict of Interest?
- Do I Want the Law Firm Exercising Control Over My Business?
- Is Transferring Equity a Good Business Decision?
The affordability of securing expert advice from professionals,
including law firms, has always presented challenges to early-stage
traditional cash-for-services model remains to this day the
predominant method of compensating law firms.
Recently, however, entrepreneurs have begun to pay for legal
services, either in whole or in part, by transferring equity interests
in the new companies to law firms.
What follows is a checklist of the key issues and questions
that an entrepreneur should consider before transferring equity to a
law firm as payment for legal services.
Will the Law Firm Accept Equity?
A logical question to ask a law firm before retaining its
services is whether the firm would consider accepting some equity in
the enterprise as compensation. Some
law firms will not accept stock as payment for services as a matter of
policy, while others may insist on traditional payment for their
services but be willing to make a direct investment in the company
either through individual partners or via an internal venture fund.
If you receive an affirmative answer, you might also want to
ask the law firm how it has structured fee arrangements in the past,
and how frequently it has agreed to such alternative fee arrangements.
Each client's arrangement will be structured differently, and
no current benchmark exists among the legal industry mandating that a
specific percentage of fees should be paid in the form of equity, or
How Can I Convince the Law Firm to Accept Equity?
Perhaps the most difficult challenge facing any entrepreneur
who wishes to pay either all or a portion of his fees in the form of
equity, lies in convincing the law firm that the equity transferred
has a cash value equivalent to the legal services performed.
Because enterprises at the earliest stages of development face
the realistic prospect of eventual failure, it is incumbent upon the
entrepreneur to arrive at a fair value for the equity which is being
exchanged for services, which is typically supported by the company's
business plan or performance to date.
Should I Pay With Stock or Stock Options?
The client must also decide whether to offer actual stock or
stock options as payment, a decision that will often have tax
implications for the law firm. As
a general matter, taxes are deferred on stock options until the
options are exercised, while the receipt of stock requires the
recipient to report income immediately. Additionally, if you offer stock options, the law firm may
demand certain terms, such as a required payout if various conditions
occur before the law firm exercises its options.
Will the Law Firm Have a Conflict of Interest?
Entrepreneur clients should also be aware of the potential
conflicts of interest that might arise when a law firm becomes an
owner of the enterprise. The
law firm's role as objective counselor and advisor to a company can
potentially conflict with the law firm's role as a financial
stakeholder in the enterprise. A
committee of the American Bar Association takes the position that
there is nothing illegal or unethical about law firms accepting equity
as payment for legal services rendered.
According to the committee, however, any such transaction
between the law firm and the client must be fair and reasonable to the
client, the terms of the transaction must be fully disclosed to the
client, the client must consent in writing to the arrangement, and the
client must be given a reasonable opportunity to seek a second legal
opinion on the matter. The
ethical guidelines on this issue are still a bit unclear and few cases
exist on this issue which are helpful in structuring the arrangement
to avoid conflicts.
5. Do I Want the Law Firm Exercising Control Over My Business?
Entrepreneurs must also evaluate the implications on management
before transferring an ownership interest in the enterprise to a law
firm. Although some entrepreneurs might welcome the prospect of
outsiders holding some decision-making power, others might not be
comfortable with such an arrangement.
Before agreeing on any fee structure with a law firm that
involves the transfer of equity, an entrepreneur should carefully
evaluate how the transfer might affect both day-to-day management and
the overall business philosophy of the enterprise.
Another difficult example is where a transaction may be
pending, such as a round of venture capital financing or an
acquisition, where the law firm will be performing legal services but
may also be influenced by their own pecuniary interests in the outcome
of the transaction. This
cloud on objectivity is not likely to be helpful to the company or its
Is Transferring Equity a Good Business Decision?
Avoiding the payment of cash for legal services might seem
quite tempting at first, because it helps preserve needed funds for
operations and other purposes. Entrepreneurs
must consider the long-term implications of such a decision, however.
If the transfer of equity to a law firm would mean compromising
core principles of the enterprise, or putting at risk the health and
potential growth of the company, soul-searching and self-assessment
may be in order. An
entrepreneur must look at both the short-term and the long-term
consequences before deciding to transfer equity to a law firm.
Benjamin L. Krein, an Associate with the law firm of McDermott, Will
& Emery, made significant contributions to this article.