Much of the excitement of working for a high-tech start-up company lies in the possibility of hitting the jackpot when cashing in those stock options. For lawyers churning out billable hours, the attraction of that pay-off is proving irresistible. As a result, many law firms which represent emerging companies run the risk of losing their valued attorneys to their clients’ in-house law departments. To combat that lure, both in recruiting and retaining attorneys, many Silicon Valley law firms have created venture funds whereby attorneys can invest in the success of their high-tech and start-up clients.
Wilson Sonsini Goodrich & Rosati, the dean of Silicon Valley law firms, instituted the first communal venture capital investment fund approximately 25 years ago. Now, these funds are fairly commonplace in Silicon Valley firms, and have begun to be adopted in other pockets of high-tech and emerging company law firms across the country. These funds are structured and administered differently at the various firms but, in general, they allow pooled funds to be invested in emerging companies being represented by the firm. The investments pay off when the company either goes public or is acquired. This process usually takes between two and five years. The first such investment funds were limited to partners only; recently, there is a trend to set up separate side-by-side funds to benefit associates. Some firms also are considering additional funds for paralegals and secretaries, as well.
These funds are useful for retention purposes as one condition is that if an associate leaves the firm before the investment pays off, he or she forfeits all rights to the dividends. Additionally, they serve as an attractive recruiting incentive in that lawyers joining such firms know that their income is not limited by the number of billable hours they and their colleagues generate. While joining a start-up’s law department may have a higher pay-off, it also has higher risks. Practicing with a law firm that has a venture capital investment fund can offer the best of both worlds: the security of the lawyer’s salary, plus a stake in the firm’s emerging growth clientele.
There are practical and ethical concerns regarding these investment funds, however. Some law firms are concerned that investing in clients can become a liability by creating a conflict of interest. If such a client is sued, the company might wonder whether the law firm was acting in the client’s best interest, or in its own interests as an investor in the business. Or, a law firm may believe that it has been defrauded as an investor, giving rise to the right to sue its own client on that basis. Some attorneys argue that holding equity in clients inherently creates a conflict such that the law firm can no longer provide legal advice without bias. ABA Model Rule 1.8 bars lawyers from doing business with clients unless the terms are “fair and reasonable to the client” and all potential conflicts are disclosed. Therefore, it is extremely important that clients and their lawyers understand how these investment funds can change the attorney-client relationship. The ABA has set up a task force to study these issues.
Proponents of client investment funds believe that, if properly set up and administered, these funds can strengthen the law firm’s relationship with the client. They believe that clients appreciate the role of the law firm as a long-term partner rather than merely as a professional service provider. Additionally, these funds can act as incentives for the attorneys to work harder and smarter on behalf of the client.
Despite the continuing debate, the investment fund trend continues to grow, especially among the highly competitive high-tech law firms. And, as the emerging growth company law practice expands beyond the Silicon Valley to areas such as Southern California, Seattle, Austin, Virginia, Boston, Denver, and elsewhere, the investment fund trend is spreading nationwide.