Should You Swap Legal Services for Interest in Client's Business?

It's a business trend that's once again on the rise. According to The Wall Street Journal, equity swaps for services were big during the dot-com boom-and-bust of the late 90s, but after many professional service providers were stiffed in the collapse, the arrangements fell out of favor.

The trend has reversed once again, however, with the new dot-com boom happening now.

Should your small firm join the trend? Here are a few considerations:

Playing Poker

Yoichiro Taku describes the typical business arrangement to the Journal. Wilson Sonsini LLP allows the startup to defer its fees (about $5,000 for the necessary paperwork for incorporation) until the company receives funding or goes public, in exchange for up to a 2 percent stake. Of course, "Yokum" is one of the foremost experts on start-up law, and Wilson Sonsini can handle the gamble.

You might be wary (correction, you should be wary) about swapping legal services for a stake in a small company. After all, many, if not most, fail. For your small firm, risking thousands of dollars in earned fees for the possibility of a business making it big is a risk compounded by the fact that you probably have no experience in evaluating these types of companies.

Evaluate the amount of time you'll have to dedicate to the company, the merits of the company's founders, and the probability of success, and weigh that against the ethical considerations, and you'll probably decide against such an arrangement.

Ethical Shades of Gray

The ethics issues are glaring, aren't they? Can you set aside your financial interest and represent the company impartially? Here is the New York City Bar's take on the matter:

"We see no ethical distinction between the transactional contingent fee and agreeing to take client securities instead of cash fees."

The biggest risk is the temptation to put "getting the deal done," or your financial payoff (such as an IPO) above the client's long-term interests. The ethics opinion compares this to the interest in a contingent fee in noting that while it certainly creates the risk of misconduct, it doesn't present an insurmountable bar.

In order to minimize risks for you, and the client, New York advises that you obtain full disclosure about:

(1) "the risks inherent in representation by a lawyer with a [stake] in the company, including the possible effects upon the lawyer's actions and recommendations to the client";

(2) "the possible conflicts that might arise between lawyer/shareholder and client or its management and the range of possible consequences stemming from them"; and

(3) "any potential impact on the attorney/client privilege and confidentiality rules, particularly in communications between the client and the attorney in his role as investor rather than as counsel."

Written informed consent and the opportunity to obtain outside counsel are probably the best ways to ensure that misconduct allegations don't arise down the road.

The biggest gray area is fairness of fees. You're taking a massive risk on the business, so a larger share of the company may seem fair, at least right now. But how fair will it seem when that company becomes Google and all you've done was file incorporation documents 10 years prior?

For reference, the equivalent ABA Model Rules implicated would be Rules 1.8a, 1.5 and 1.7.

Related Resources:

• Silicon Valley law firm exchanges legal services for equity (VentureBeat)
• How Paying Your Lawyer With Equity Works (The Neighborhood Entrepreneur)
• New Ideas for an Ultra-Modern Business Card (FindLaw's Strategist)