Want More: In today's market, VCs rely on lawyers for everything
from sector expertise to deal flow"
March 1, 2005
By Tom Stein
The venture capital industry used to be such a noble profession.
Now, the gloves are off and players are getting down and dirty.
The headlines are increasingly filled with stories of hard-done-by
entrepreneurs filing lawsuits against their former investors, not
to mention VCs suing other VCs over down rounds, cram downs, and
washed out investments.
One result of all this nastiness is a greater appreciation for
the role attorneys play in the venture ecosystem. In the good times,
VCs were gleefully stamping out private financings. They cared less
about the actual legal documents and terms of the deal, quickly
signing on the dotted line so as not to miss out on a seemingly
great investment opportunity.
But in the wake of a protracted market downturn colored by hurt
feelings and growing tension, many of these documents are being
tested like never before. "These were documents we had used
for many years without ever putting the provisions to the test,"
says Matt Sonsini, a partner at Silicon Valley law firm Wilson Sonsini
Goodrich & Rosati headquartered in Palo Alto. "We suddenly
entered into an environment where the attorney became more prominent
in the boardroom and the value of having strong documents and engaging
the right counsel grew tremendously."
Even though the market is starting to correct itself and the venture
industry is returning to a relative state of normalcy, the role
played by lawyers continues to grow in importance. For one thing,
VCs and startups are now more aware of potential risks and conflicts.
As a result, they are paying greater attention to the details and
are demanding that their attorneys do the same. They are also requiring
a greater level of sophistication and expertise from their attorneys.
Just as venture investors are becoming specialized around certain
categories, whether it's nanotech or medical devices or telecom
or security, lawyers too must become experts in increasingly niche
fields if they want to provide the very best service. Finally, VCs
and startups are not just looking for lawyers who can provide top-notch
legal advice they also want attorneys who act as business partners.
That means they must be able to provide meaningful deal flow and
play the role of trusted advisor. Sure, it's a lot to ask, but the
best attorneys are clearly up to the task.
"The first thing we look for in an attorney is not just legal
competency but business acumen," says Vincent Occhipinti, managing
director of Woodside Fund in Redwood Shores, Calif. "We want
our attorneys to think like a general partner. Of course, you want
their legal judgment, but you also want to hear their business judgment
and what they think of any given deal. In this sense, a good lawyer
becomes an extension of your own firm." (Woodside, for its
part, tends to split its legal work among a handful of law firms
including Cooley Godward, Nixon Peabody, Wilson Sonsini, and Heller
Ehrman's Venture Law Group.)
Multiple Representation = Multiple Deals
VCs interviewed for this article all said they like to take a hybrid
approach to their legal representation by mixing and matching firms.
That is a significant change from the early days of venture capital,
when VCs tended to pick just one or two firms to represent them
and the majority of their portfolio companies.
One major reason for taking a hybrid approach is deal flow. Occhipiniti,
for instance, says he won't work exclusively with one firm because
that would only serve to cut off quality deal flow from other firms.
Over the years, law firms have been known to pass interesting deals
over to VC firms. That's because lawyers are often the first ones
to meet with a management team and help with the company formation
documents. Indeed, a company no less prominent than Cisco was first
introduced to venture backer Sequoia Capital through a law firm.
Today, especially, there is a greater premium on deal flow. "Right
now we are in a period where the management teams at startups are
so sophisticated, they will fund the company out of their own pockets
and not look for VC money until later in the process," says
Mark Medearis, a partner with Heller Erhman's Venture Law Group.
"As lawyers, we are in a position to develop relationships
and get to know these entrepreneurs long before the VCs do."
Moreover, the competitive environment for good deals is perhaps
greater than ever before, so any edge VCs can get in terms of access
is greatly appreciated.
"We really value deal flow," concurs Occhipiniti. "We
enjoy working with law firms who can make the right introductions."
In particular, Warren Lazarow, a partner in the Silicon Valley office
of O'Melveny & Myers, referred Woodside Fund to Athena Design
Systems, an electronics design automation company, and is currently
lobbying Woodside for another deal.
In the old days, it was also easier for VCs to pick one law firm
and stick with it, because one lawyer could represent a computer
hardware startup one day, a biotech startup the next, and a semiconductor
startup the day after that . Simply put, there wasn't the same kind
of need for industry-specific expertise that exists today. "I
remember when I first started, there were lots of lawyers like myself
who did everything from software to networking to chips," says
Medearis. "Those days are gone. Both startups and VCs don't
want generalists anymore. They want lawyers specialized along particular
Sector & Geographic Expertise
Indeed, firms like Wilson Sonsini and Fenwick & West now group
their lawyers under industry specializations ranging from energy
technology to communications to life sciences. Just as there are
now industry-focused venture funds that deal exclusively with health
care or semiconductors, law practices may soon be heading in the
same direction, say observers.
"Sector expertise is happening more and more," says Stephen
Meredith, leader of the private equity and venture capital practice
of Boston-based Edwards & Angell. "Startups are increasingly
seeking law firms that know something about their business."
That makes perfect sense. After all, a biotech firm faces fundamentally
different issues than a software company. Even when it comes to
something like intellectual property, a patent lawyer may know the
ins and outs of the semiconductor world but be clueless when it
comes to biotech, which requires knowledge of the FDA approval process,
among other things.
Bart Schachter, managing partner at BluePrint Ventures in South
San Francisco, Calif., says he not only bases his legal selections
on sector expertise, but also on geography and funding stage. For
instance, he recently funded a startup in Sacramento and was able
to find respectable legal talent located close by. He adds that
a different kind of lawyer is sometimes needed for different stages
of growth. "An older firm entering into a C round with 10 new
investors will need a different legal team than an early stage firm
that just needs some nuts-and-bolts work like stock option agreements,"
Still, more startups are requiring sophisticated legal representation
right from the get-go. "There is no doubt the legal needs of
startups have become more complex," says Matt Sonsini. For
example, he is increasingly dealing with startups that are coming
out of university labs. This presents a challenge in terms of how
you extract the intellectual property from the school and draw up
contracts that are fair to both parties.
Similarly, many new startups are embracing the outsourcing model
whereby they set up subsidiaries in China and India at the same
time they open their first office at home. This results in a whole
new set of tax and employment issues that the lawyer must be prepared
to navigate. These new complexities, say industry observers, favor
full-service law firms that can satisfy a wide gamut of requirements
for their clients.
"I believe the nature of the work has changed, and that diversified
firms are in a better position," says Richard Dixon, a partner
with Fenwick & West. He observes that, during the downturn,
firms that concentrated on corporate transactional work really felt
the pain as the number of deals diminished and liquidity events
screeched to a halt. By contrast, firms that were able to handle
litigation issues found that business was booming.
Over the past few years, firms like Edwards & Angell realized
they were spending more time on private equity litigation fueled
by down rounds and squeeze outs. The firm now tracks all lawsuits
in the industry in a coordinated way and has even established a
semi-formal practice around venture litigation.
Overall, the relationship between VCs/startups and law firms has
matured greatly. For one thing, there is more awareness of what
can go wrong and the legal steps needed to protect one's investments.
The lawyers will tell you that VCs are taking a lot more notes in
the deal documentation stage and are asking many pertinent questions.
"A few years ago, most VCs were totally unfamiliar with litigation
and thought it could never happen to them and were thoroughly insulted
if it did," says Meredith of Edwards & Angell. "Now
they view litigation as another tool that they can use or that can
be used against them."
For better or worse, learning the finer points of the law has become
yet another feature of a VC's busy life. And that makes lawyers
even more indispensable to the venture industry.