How Well-Intentioned Lawyers from a Blue Chip Firm Almost Ruined My Startup

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People who say that lawyers are a commodity good don’t know what the hell they’re talking about. Lawyers are not a commodity. There’s no need to overpay, but do not skimp. Lawyers are expensive, and it’s tempting to go cheap when you’re small and broke. I get it. I’ve been there. But your legal docs are the hardest things to change, and sometimes, they’re unchangeable.

If you’re outside of Silicon Valley, make absofuckinglutely sure that you’re using a startup law firm with a Silicon Valley presence. Your cousin Andy’s friend who went to Harvard Law will not do the trick. The really smart lawyer your bud Jim knew at Goldman Sachs will not do the trick.

If you’re in tech, you need a startup lawyer. Period. And not’s because it’s rocket science, but because it involves nuance and long term issues that don’t apply to the rest of the normal business world, which is to say: there’s a chance you’ll raise venture capital and/or sell your company.

True Story…

I started the company that became SpeakerText in October 2008, just a couple weeks after the apocalypse Lehman collapse. I was still working on an ambulance at the time, paying the bills by being a paramedic in NYC. In December, I got my first lucky* break.

It was 4am. I was working 10w, tour 1 –– the Upper East Side overnight. Around 0300, we got the call for a cardiac arrest. Old lady. Cancer patient. When we got there, the family spoke with an aura of acceptance. “She’s dead,” said her son. But they didn’t have the Do Not Resuscitate order on hand. Fuck, I thought. We have to work her up.

I hate working up dead people.

I tried to get the medical control doc to let us pronounce on the spot. He got pissed, said ‘no dice.’ And so we did the whole CPR rigamarole. I felt bad for the family. Let the woman rest in peace, I thought. What a shame.

And so we performed the obligatory medical theater. Sometime around 345am, I pronounced death.

Of course, it was my job to do the paperwork, and so I started talking to the son. He was a nice guy, in his 50s or so. Amidst checking the boxes and transcribing her medical history, I asked him my favorite question: “So, what do you do?”

Turns out he’s a lawyer. A corporate lawyer. I didn’t know it at the time, but he was actually a very powerful senior partner at one of the top firms in the US.

“Do you work with startups at all?” I inquired.

“Startups?” He responded, a bit exasperated. “Who’s doing that?”

Lehman had just melted down. The end of the world, it was.

“Well, I am” I said, and proceeded to pitch him what became SpeakerText.

He was intrigued and gave me his number, said: “Call me. I might be able to help you out.”

A few days later, I called. And emailed.

I didn’t want to push, so I left it at that. The man was in mourning, after all, and while I was & am a determined motherfucker, I wasn’t going to be that guy.

A month later, he called me back. “Sorry I didn’t respond earlier,” he said. “I just wanted to say that I was really impressed by you and that would be happy to take you on as a pro bono client.”

Woot! Free lawyers! And good ones to boot Hot damn!!!

Over the course of 12 months, they helped me form an LLC and then converted that into a C-corporation called SpeakerText Inc.

Our engagement ended in December 2009. And boy was a I proud.

In March, I went hunting for a new lawyer: the kind you pay for.

“If you had paid for these docs, I’d tell you to sue for legal malpractice.” This is what the pros at Wilson Sonsini told me.

Fuuuuuuuuuuck.

In our incorporation docs, there were two fatal mistakes, the combination of which was our saving grace.

#1 I failed to file a 83(b) election with the IRS.

The 83(b) election is something you have to file so that when you have equity vesting in place, you don’t have to pay an increasing amount of taxes with each month your shares vest. If you don’t file an 83(b), the IRS will classify all the shares that vest each month as income…at their current market value. Thus, if your stock price goes up, then you owe the IRS more money each month. But the shares are illiquid, so if the share price goes up a lot, you become increasingly fucked.

I was setup to be increasingly fucked. That is, if SpeakerText went anywhere.

#2 We failed to implement founder stock vesting.

Even worse, we split ownership in the company 50/50. If my original co-founder hadn’t been amenable, the company would have been dead in the water when we split up a few months later, with one departed founder owning half of the company and no legal remedy for changing the cap table.

#3 The company issued more shares than the board had authorized.

We had issued 25,000 shares but only authorized 2,500. Whoops.

The upside of this is that it was such an egregious, astoundingly sloppy move that it nullified everything else, including the 83(b) election screw up. Thank gawd.

Our new lawyer, Heather Miles, cleaned it all up back in April. We were lucky, she explained. My ass was saved by the sheer grossness of our previous lawyers’ incompetence.

Heather reached out to our previous counsel to ask about the 83(b). “What’s an 83(b)?” was the response.

Oy vey.

It’s not that our previous lawyers were bad people. Sloppy, yes. Incompetent, yes. Well pedigreed, also yes. Part of the problem is that, as pro bono clients, we had gotten kicked to a very amicable first year associate that handled our work.

Regardless, the real point is this: they weren’t specialists. They had never done incorporation work before. They didn’t grock the nuances. And as a result, they fucked up.

It’s like in medicine. Pediatrics have a fundamentally different anatomy and different problems than adults. Same with lawyers. You can’t just scale down the tactics you’d use in a big company. You need a specialist. Spend the money. It’ll save you in the end.

The other good thing about a really good lawyer is that they can help you negotiate terms with investors and customers. They can be the bad cop to your good cop. They can provide you with normative leverage, which is awesome. “I can’t do that because my lawyer says it will fuck me when we raise a series A,” is a wonderful thing to be able to say.

***

ATTENTION: SpeakerText is hiring web developers and ML hackers. If scaling a semi-automated, virtual assembly line that combines AI with crowdsourced labor sounds like your idea of a good time, click here.

 

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4 Comments

  1. Sue Wang December 19, 2010 at 7:37 pm #

    If only we could harness the power of bad legal advice and turn it into fuel. For example, an attorney at @thelegaloracle will tweet you a legal answer in 140 char or less. For FREE!!! Who says lawyers are expensive. ;)

  2. Matt Bartus December 18, 2010 at 6:53 am #

    Great story Matt. The 83(b) is a great example because it’s something that no real startup lawyer would ever miss — not because we have superior tax knowledge, but because through sheer repetition of setting up hundreds of new companies it would stick our like a sore thumb if you didn’t do one. I also think one of the best “soft” services we can provide from our experiences is pointing out landmines in the things a company wants to do that will hurt you in financings or acquisitions and stop you from running over them. Glad Heather got you fixed up. -Matt

  3. kevin debias December 18, 2010 at 6:32 am #

    thank you matt. nice read.

  4. Anonymous December 18, 2010 at 7:03 am #

    matt makes a very important point. the legal biz, like many others, has a lot of areas of expertise and specialization. if a lawyer has not done work with startups, it is very possible that this lawyer cannot support you even if they are famous for what they have done in their respective legal field. so don’t just go naively thinking that any lawyer can help you; if you have a BMW, would you bring your car to a mechanic who specializes in Japanese cars? find a lawyer who specializes in not only supporting businesses, but specifically startups. and also make sure they specialize in the stage of startup that you are in; many lawyers have worked with startups, but rarely work with early stage startups. that also makes a big difference.

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