Every once in a while, I’m reminded just how harmful overlawyering can be.  I just finished preparing an operating agreement for 3 partners in a new venture.  They have a promising startup with a couple hundred thousand in seed capital, seeking to raise maybe a half million more to fund their initial operations.  I worked with them to prepare a detailed operating agreement, standard founder intellectual property (IP) assignments, and consulting agreements to govern their go forward work for the company.  That’s about all they need at this nascent stage.

All was good until one of the partners decided it would be a good idea to have their personal counsel look over the documents to protect their personal interest.  (After all, I’m company counsel, not founder counsel.)  Unfortunately for the company, founder’s counsel is what I’ll call an “Overlawyer”.  Next thing you know, I have a seven page memo of comments on the operating agreement.  And that’s not counting the four page tax memo that followed.   Or the three separate counsel phone calls I fielded on a completely standard founder IP assignment.

Mind you, most of the memo was written by a third year associate in his vast business experience (nice guy though, kind of sad to see him indoctrinated).  It was then reviewed by a senior corporate partner, and I’d estimate the combined hourly rate of these two lawyers at about $1,000 per hour.  Needless to say, many hours and thousands of dollars later, we are all “agreed”.  About 15 minutes’ worth of the input from Overlawfirm’s tax counsel was helpful.  Aside from that, what do I think was improved in partner’s “deal” as a result of their hiring Overlawyer to represent their interests?  Zero. Nada. Zilch.  The company will function exactly the same as it would have otherwise.

So everybody talks (complains) about the cost of Overlawyers in terms of dollars.  And the financial cost is ridiculous, no doubt.  But people rarely talk about the nonmonetary costs of an Overlawyer approach, which in my book are just as, or even more, detrimental to an entrepreneurial venture.  In the current founder situation, Overlawyer scared its founder client into worrying that certain benign document provisions were detrimental to founder (and somehow only to founder—odd, since they applied to all the founders equally).  That needlessly instilled in Overlawyer’s founder a certain degree of mistrust in both company counsel and in founder’s partners.  That’s a crying shame, because we all will be working together for years to come to build the business, and that’s not the right way to kick it off.

Worse, the business partners have just spent weeks negotiating with one another, rather than working together to advance the business.  The other partners who didn’t hire separate counsel were frustrated by the delay, and they aren’t happy that their partner sought out special protections for themselves rather than just doing what’s best for the company like everybody else.  These things take a toll on founder relations.

Finally, by incessantly prioritizing individual founder interest before the company’s operations, Overlawyer missed the forest for the trees.  Had I not put my foot down, founder would not have properly assigned their IP to the company, and the company’s decision making processes would have been held hostage to founder.  That would have made the company less investable, less functional, and quite likely, less successful.  Ultimately, what serves the founder’s financial interest in the startup context is a well functioning company, and that is a fundamental business truth that remarkably few Overlawyers grasp.

I’d like to say that this experience was unique, but it’s not.  While of course there are Overlawyers at firms of all sizes, I find almost an inverse relationship between the size of the law firm, and how prone they are to utter nonsense like the above.   There are structural reasons for this.  Many lawyers at big Overlawfirms have never done anything in their professional careers but practice law, and as a consequence have little ability to distinguish between salient business risks and theoretical legal issues.  Every business lawyer I’ve ever met likes to claim that he or she is a “practical lawyer,” and 90% of them are full of crap.  The inefficient approach is also inherent in the internal Overlawfirm financial model, which relies on leveraging young, inexperienced associates to enhance revenues at the top of the law firm pyramid.  Indeed, Overlawfirm’s business model depends on its lack of restraint; if every hour is billable, every issue, whether important or not, is revenue.

On a less cynical note, there are many honorable Overlawyers who are not trying to churn billable hours.  They truly (but falsely) believe that they best serve their clients’ interest by advocating for them in this way.  I would like to see law firms teach their corporate attorneys that their number one goal is to facilitate their clients’ businesses, while acting ethically and protecting against undue (not all) risk.  Instead, big Overlawfirms tend to drill into their attorneys that their number one priority is to avoid missing anything, always turn over every stone, never make a mistake.  Risk avoidance at all costs.  This leads Overlawfirms to the conclusion that overlawyering is good lawyering.  It’s not.  And it can be fatal to an entrepreneurial venture.  Whereas Overlawyers seek to avoid risk at all cost, the very essence of all business, and most certainly venture backed business, is calculated risk taking.   Shy away from too much risk, and you choke the opportunity.

The Overlawfirm model is broken, period.  It works for few businesses at all, and almost never for entrepreneurial companies that must be nimble, practical and cost-efficient in their operations.  Entrepreneurs, if you find yourself with an Overlawyer, overfire.

Patents, trade secrets, know-how, copyrights, and trademarks can be crucial to your business. Managing this intellectual property can make the difference between fortune and failure. This brochure presents ten recommendations for protecting what belongs to you. In the spirit of David Letterman, here’s my Top 10 List.

#1

Obtain written assignments of all inventions and copyrights from employees and third-party vendors including consultants, advertising agencies, and photographers, and have these assignments reviewed by your attorney.

#2

When adopting anything new, such as technology, a trademark, or software, contact your attorney about conducting a right-to-use study to avoid infringement.

#3

Assume that any disclosure to a third party, including a customer, a vendor, a consultant, or a competitor, will not remain confidential. Confidentiality agreements offer some degree of protection, but they are not guarantees against improper disclosure.

#4

Discussing an idea in the presence of others, such as actual/prospective customers, vendors, or consultants, can result in a claim of co-ownership of your idea. Avoid this situation by listening to the challenge presented, and then by conducting your problem-solving in private.

#5

When negotiating an agreement, avoid terms that may limit your ability to compete. Terms that require careful scrutiny include:

- An agreement stating that ownership of an invention does not belong to you
- A software or website development agreement that does not explicitly provide for your ownership of the software
- Prohibitions against reverse engineering by you
- Confidentiality clauses
- Unreasonable restrictions on the use of deliverables
- Continuing obligations to use the vendor, e.g., for software modifications or hosting
- Limitations on the other party’s indemnification obligations, e.g., no indemnification for infringement of patents, copyrights, or trade secrets

#6

Protect your inventions by documenting all improvements and promptly disclosing potentially patentable inventions to your patent attorney. Do not offer to sell the improvements and do not publicly disclose them until your attorney has considered the feasibility of patent and trade secret protection.

#7

Protect your copyrights by using a proper notice on all copyrightable works, including software, advertisements, brochures, and artwork. Check with your attorney to determine if the copyrights should be registered.

#8

Before adopting a trademark or service mark, have a search conducted to make certain that the mark, and the corresponding domain name, are available. If the mark is available, register the mark and use it properly. Do not allow third parties to use your mark without a written license agreement.

#9

If you have a claim against another party, proceed promptly. If you delay, you could lose your rights.

#10

Contact your attorney promptly if you receive a cease and desist letter. Your attorney may lessen the possibility of a lawsuit being filed against you, and failure to consult with your attorney may expose you to increased damages for willful infringement. If actually sued, contact your attorney promptly. Failure to timely respond to a lawsuit can have serious, and costly, ramifications.

So you’ve just started your company, and as with most entrepreneurs, you have very limited money for service providers of any sort.  That said, you have heard in the past that it is always best to get a lawyer involved in the company sooner rather than later, especially if you’re looking to raise capital in the near future.  You’ve decided to bite the bullet and hire a lawyer, but you want to spend wisely. Lawyers can provide a large portfolio of services, but for the entrepreneur on a limited budget here are some suggestions for targeting your legal dollars:

1. STOCK OPTION PLAN.  In order to attract and retain the best executives and key employees, particularly in the technology industry, you will need to be able to offer attractive equity packages.  Potential hires respond to offers of cash for sure, but if that’s in limited supply, giving an equity stake in the future success of the company will make an offer more attractive.  However, if not done properly under an option plan, grants of equity are fraught with pitfalls for the unwary—unintended ambiguities in the grant language, failure to implement vesting, a lack of compliance with securities laws, unintended tax consequences to the company and its employees, and the list goes on and on.  These issues often lead to costly disputes.  At an extreme, they can make a company unfinanceable, for investors will rarely put money into situations where the capitalization of a company is unclear or in dispute. A properly drafted stock option plan is money well spent.

2. FOUNDER ARRANGEMENTS.  Preparing the appropriate arrangements between the company and the founder is an important step and should be done before capital investment is made.  These arrangements typically include the purchase of founder’s equity, assigning intellectual property from the founder to the company, documenting founder loans to the company, and putting in place a founder employment agreement with the company.  Often, founder’s stock is subjected to vesting similar to stock options.  Investors like to see vesting for founder’s stock because this gives the investors comfort that the founders will be around for awhile or at least until their stock is fully vested.  It is also important to put in place legal arrangements amongst multiple founders.  Fact is, it is the rare management team that is 100% the same from inception to exit event.  How will you feel if your 50% partner leaves the company but keeps his stock while you continue to build the company’s success?  Co-founders need to put in place legal arrangements, most typically either through a simple vesting schedule or else through a more detailed buy-sell agreement, setting forth what will happen to the equity of the company in the event the co-founders’ participation in the business changes over time.

3. EMPLOYEE AND INDEPENDENT CONTRACTOR AGREEMENTS. Clarifying in writing the terms of employment and contractor relationships is one of the best ways to ensure your company is protected and avoids disputes and litigation down the road.  Ask your lawyer for a form employee offer letter and a form independent contractor agreement.  Particularly if you are a technology company, you also want a form employee proprietary information and inventions agreement (see intellectual property below).  The forms you use should be geared toward entrepreneurial companies and therefore include appropriate language for making stock option grants and covering other issues unique to emerging growth companies.

4. INTELLECTUAL PROPERTY ARRANGEMENTS.  Any intellectual property created by one or more of the founders should be properly transferred and assigned to the company such that the company now owns that intellectual property.  With respect to employees and contractors, it is important to document terms such as confidentiality and the assignment of intellectual property developed by the employee or contractor while working for the company, including those of any founders that are also employees.  Any future investors or potential buyers will want to have assurance that the intellectual property of the company is in fact owned by the company and not by one of the employees or contractors.  Accordingly, preparing the documents to evidence such terms is one of the most important steps in “getting your ducks in a row.”   Likewise, if you hire software developers or others to help you code, you need appropriate legal arrangements to ensure that the end product will be 100% owned by the company.

5. FINANCING TERM SHEET.  Experienced emerging growth attorneys have seen hundreds if not thousands of financing term sheets.  What likely looks like a foreign language to you is actually standard fare for your lawyer.  Your lawyer can walk you through an Angel or VC term sheet to help you understand where the risks and areas of opportunity for negotiation are.  This is time well invested.  It does take some time for new founders to come up to speed on this stuff, and you are best to begin your education regarding financing terms in advance of negotiations with potential investors.  With a solid foundation of the impact of various terms, and the knowledge of the range of what comprises market, you will be able to negotiate a financing deal that emphasizes the terms that are most important to you and also is reasonable and attractive to investors.

In my next post I’ll talk about the top five worst uses!

There are multiple types of applications for patent protection that are available.  Two of the more common are Utility (Provisional and Regular) and Design.  The difference between design patents and utility patents is that design patents only protect the non-functional appearance of a product, while utility patents cover how your invention works.  For some products both patent types may be available.  The main advantage of design patents is they are relatively inexpensive to obtain.  The main disadvantage of design patents is the scope of protection is generally narrow – they only cover the appearance of the product shown in the drawings, and not the product’s function.

If a utility patent is appropriate for your invention, then you need to decide whether to file a regular application or a provisional application. Because of their lower initial cost, provisional patents can be more attractive to start ups. Some of the more significant pros and cons of filing a provisional patent include:

ADVANTAGES OF A PROVISIONAL APPLICATION

1. Slightly Lower Initial Cost. The initial cost of preparing and filing a provisional patent application generally is lower than that of preparing and filing an actual patent application. This is because of the lower PTO filing fees and the more limited requirements of a provisional application.

2.  Delay of Examination Costs. Since a provisional application is not examined by the PTO, examination costs are delayed during the pendency of the provisional application.

3.  Shift of Patent Term. The end of the patent term can be shifted one year into the future, an important advantage for inventions, such as drugs, whose commercial value may be at the end of the patent term.

DISADVANTAGES OF A PROVISIONAL APPLICATION

1.  Delay in Issuance of a Patent. A provisional application cannot result in a patent— an actual application will eventually have to be filed.  Accordingly, the initial filing of a provisional application, instead of the immediate filing of a regular application, necessarily delays the issuance of any resulting patent.

2.  Higher Total Cost. The overall cost of initially filing a provisional application and then following up with the filing of an actual application will necessarily be more than the immediate filing of a regular application.

3.  Accelerated Foreign Filing Costs. Filing a provisional patent application starts the one-year period within which foreign patent protection must be applied for.

In next week’s post I’ll provide an entrepreneur’s checklist for determining if a patent application is required (or appropriate for your product or invention.