Small Businesses – Deciding Between External and In-House Legal Counsel
An entrepreneurial company has multiple options to access legal counsel. The most appropriate option for a given company depends on its needs and circumstances, including the company’s industry, business plan and operations, anticipated growth timetable, regulatory obligations, and overall complexity. These options are:
- Issue and Project Basis – consulting one or more law firms on an issue or project basis,
- Outsourced Part-Time GC – engage a part-time outsourced General Counsel, and
- Full-time GC – hire full-time General Counsel working exclusively for the company.
Each option has its advantages and drawbacks, including different costs and varying levels of involvement with and attention to the business. Some of these choices reflect an increased cost and level of involvement with the company’s business, operations, and development. Below, this article discusses each option.
Issue and Project Basis
This is the traditional model for obtaining a law firm’s counsel and services. The company consults outside counsel as needed on discreet and related legal projects, which may include ongoing and recurring issues. The client either pays counsel based on time spent on the project (generally in six-minute increments), as a fixed fee, or a combination of the two options.
For hourly fees, lawyers charge different rates based on their years of practice or another experience-based metric set by the firm. Fees can vary greatly by geographic region and specific practice area (e.g., corporate law, intellectual property, real estate), as well as the complexity of the project. Small to mid-sized firms charge an average $325 for an hour of attorney time on a blended rate, with the rate increasing for law firm partners.[1] Large firms, colloquially referred to as “Biglaw firms,” can charge $1,000 an hour for a first-year attorney’s time with an extreme high of $3,000 per hour for partners in specific practice areas.[2] Fixed fees are set at the beginning of a project and can provide for adjustment under certain conditions if the project expands or proves especially complex or time-consuming. A law firm may offer hybrid options. For example, a project may proceed on a time basis and, once the bill reaches the fixed fee, no additional fee is charged for an agreed upon number of additional hours; if the project requires time beyond those additional hours, the hourly fee begins again at such time.
Hourly fees can be cost-effective, but a fixed fee can benefit a company if unforeseen issues arise; in addition, a fixed fee provides for planning and managing costs. A pure time-basis arrangement leaves the ultimate fee uncertain; even if a fixed fee may prove a bit higher in some instances than would be the case if billed by the time spent, but, conversely, it could prove far lower if a project requires more work than originally anticipated. Savvy prediction of legal and regulatory work burden and negotiation of a fixed fee can save the company a significant amount. The hybrid model attempts to give the company the benefit of a fixed fee while also protecting the law firm’s downside by providing for compensation if a project proves unforeseeably time-consuming or complex.
A company should review the billing records sent by the law firm in connection with time-based fees, which will describe the work done for each time entry made in connection with a project. Through this review, the company can determine, to some extent, whether the firm is working efficiently and the bill reflects the value-added. Also, in a time-based arrangement, a firm may require a company to provide a retainer before work begins on a legal issue; the firm draws on this escrowed fund as it earns fees. A firm may require a one-time or an “evergreen” retainer; in an evergreen retainer, the firm requires the client to maintain a certain amount in the retainer account and make additional deposits as needed to maintain it. If the project ends with funds remaining in the project’s retainer, the firm returns the funds to the company. The firm only claims funds it has earned. A lawyer taking unearned funds from a retainer account is a serious violation of legal ethics, which usually leads to disbarment from the practice of law as well as civil and potentially criminal consequences.
In a project-based arrangement, particularly for start-ups on a tight budget, counsel is not integrated into the operational side of the business. This is in contrast to the outsourced part-time general counsel and hiring general counsel options, discussed below, where counsel, to varying extents, is more integrated with the business and operations of the company. Counsel in this option can provide specific output, such as required regulatory policies and procedures or documents used in raising capital through loans or the offer and sale of securities (stock in a corporation or membership interests in an LLC), but implementation is the company’s responsibility, subject to questions and guidance from counsel. This arrangement suffices for relatively small companies not anticipating high growth or companies not operating in heavily-regulated industries.
Outsourced Part-Time GC
In this arrangement, a company retains an outside general counsel part-time as in-house counsel. The part-time GC services multiple clients on such a basis. The hours worked can be allotted weekly or monthly, and allow the GC to learn and understand the business, workings, and operations of a company on a deeper level than truly outside counsel working on a project basis. The company can get the full-time benefits of a general counsel at a fraction of the cost based on its need relative to a full-time schedule.
However, in heavily regulated industries like financial services, for example, greater day-to-day integration with counsel may be needed. For companies operating in such industries, virtually all aspects of the business activities and internal operations could be subject to federal, state, and/or local law and regulation, as well as non-US regulation. For example, founders starting a new local plumbing business would not need the type of hands-on, day-to-day integration with counsel that a consumer lending business or investment advisory firm would need. Day-to-day issues will arise that require a higher-touch and more integrated level of service. Counsel must not only be able to address the relevant law, but may be required to assist in granular implementation on a regular basis.
The same could be true for companies anticipating fast growth, such as tech firms, which plan to rapidly pursue multiple rounds of angel and/or venture capital. The need to raise capital quickly while scaling a high-growth business may require a closer relationship than outside counsel can feasibly provide. Offering such securities is highly regulated and can be fraught with liability. Further, given the complexity of such investments and their long-term importance in the company’s future viability and ownership, the nature (debt, equity, or convertible debt) and the terms of such securities are important in such capital raises. Complex licensing and IP issues in such companies also often require greater integration of legal advice as well.
As discussed above, the outsourced general counsel role has a number of benefits when appropriate:
- Predictable cost – the part-time general counsel avoids the variable costs that can come with time and project-based legal counsel, allowing a start-up to budget more accurately
- Tailored work and aid in implementation – an outsourced general counsel will be able to devote the time and energy to better understand the workings of the company, and can provide tailored solutions and assist in the implementation of those solutions, leading to better results
- Free up employees to focus – a part-time general counsel allows company employees to focus on their role and work, rather than attempting to address legal issues based on guidance from outside counsel
- Better regulatory outcome – the greater time and attention spent on the company’s legal needs can lead to better, more tailored outcomes, and help avoid potential issues in the future that can derail a company’s progress or require significant remedial efforts, taking time and attention
- Specialization – a general counsel can serve a broad range of needs, but often is specialized to address the company’s needs to an extent, such as intellectual property, securities regulation, or other specific areas of focus
- Prepping for a formal legal function – a part-time, outsourced general counsel can organize a legal function within the company in an efficient way to allow for a full time general counsel and legal staff when the company’s development requires it; otherwise, legal responsibilities and tasks are often split among various personnel and functions in inefficient ways which require restructuring when in house legal staff are later hired.
When looking for an in-house attorney, whether on a full-time or outsourced basis, a company should look for prior in-house experience and a broad-based skill set in various aspects of corporate, business, securities, regulation, and other areas of law. A company may seek a specialist in certain areas, but a broad-based foundation of experience is prudent. Prior business or in-house experience is desirable to ensure the counsel understands the needs and considerations of business and can prove a value-add beyond just purely legal considerations; such experience improves a counsel’s ability to implement legal solutions, rather than consider them academically. The role and perspective of an in-house attorney is far different from attorneys in a law firm, as in-house counsel faces practical issues far more acutely than as an outside service provider, including operational considerations, resource constraints, and business pressures.
Full-Time GC
Some entrepreneurial companies benefit exponentially by bringing on a full-time general counsel at formation or in the early stages thereafter. This is the most expensive option, but a part of the compensation could (and generally would) come in the form of equity compensation, such as options or restricted stock. In terms of motivation, this aligns the general counsel with the founders and investors. Given the cost of this option, whether in cash or in equity, however, it will likely appeal to companies that face not only heavy regulation but overlapping regulatory regimes or particularly complex operations that regularly implicate complex law and regulation. Just make sure you get the right guy.
For example, pharmaceutical startups or cryptocurrency-related businesses may use a full-time GC from the outset. In the case of the pharmaceutical startup, for instance, its success or failure will depend upon obtaining appropriate regulatory approvals from federal agencies, a process that requires the intimate involvement of counsel at every step. Further, such a business will likely need to address complex manufacturing, sourcing, import/export, and patent/licensing issues, often on a cross-border basis, with regularity. Similarly, cryptocurrency companies are subject to ambiguous registration requirements and regulation under the securities and commodities laws, including both federal and state frameworks. Such a company must consider various regulatory issues from varying regulatory frameworks in virtually all aspects of its business operations, structure, policies, procedures, and practices.
The full-time GC builds upon the benefits of the outsourced GC, described above. In choosing in-house counsel for a small company, a candidate has to present a business value-add and have sufficient experience and perspective to understand the role and limits of in-house counsel.
Conclusion
A small or early-stage company should carefully consider its relationship with legal counsel and whether its current or anticipated arrangement best fits the company’s needs. Such companies’ use of outsourced, part-time general counsel is growing as providers become more sophisticated in their offering of such services, given time and experience.
GOOD ADVICE:
Start-up businesses are well-advised to consult legal counsel early in formation and launch. Legal counsel can advise the founders on fundamental topics including, among others (1) the most advantageous business form (e.g., corporation, LLC, limited partnership); (2) the terms, features, and filing of the business’s formation, governing, and related documents; (3) the nature, terms, and documentation of early securities offerings; (4) the rights and obligations among the founders; (5) the terms of initial contracts (e.g., office or premises lease, supplier and customer agreements, employment agreements, etc.); (6) intellectual property licenses and protective filings; and (7) regulatory and licensing issues. Even with the budget of a start-up, investing early in legal guidance can prevent errors that can later cause significant expenses or even derail an otherwise-promising business. Often, the company discovers these errors only later and at inopportune times, such as during an investor or contract counterparty’s due diligence, creating potentially dire issues for an otherwise-flourishing young company.
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