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Startup Legalities, Avoiding Litigation & Legal Insights | David McCarville | WT3 005
25 Plays1 year ago
You don’t know how big of a problem these things are until they become a big problem.” In this episode of What The 3, the no-bs podcast for emerging tech startups, we sit down with David McCarville, Director at Fennemore Craig, to dive deep into the legal landscape that every founder must navigate.
David shares invaluable insights on common legal pitfalls startups face, from poor investor relations to IP protection missteps. He breaks down the key clauses to watch out for in term sheets, the importance of vesting periods and ownership of intellectual property rights, and how to set realistic expectations with investors.
Throughout the episode, David emphasizes the criticality of engaging a lawyer early on, budgeting appropriately for legal services based on your funding stage, and having clear communication and contracts with partners, employees and contractors. He also shares prudent advice on conducting due diligence when accepting investor money and the risks of relying on online legal templates.
Whether you’re a first-time founder or serial entrepreneur, this episode is a must-listen for anyone serious about building a startup in the emerging tech space. Tune in for David’s expert take on how to safeguard your startup, avoid costly litigation, and set yourself up for long-term success.
Recommended
Transcript
Podcast Introduction
00:00:03
Speaker
Welcome to this next episode of the What The Three podcast, the podcast where we teach you emerging technology startup founders how to go from zero to one fast.
Meet the Hosts
00:00:12
Speaker
Today, I'm joined by my co-host, Thomas Spandenbroke and David McArville. Do note, I am reshooting this in post, hence the different lighting, but I do have the same shirt.
David's Career Journey
00:00:23
Speaker
David's story is a compelling narrative of determination and the pursuit of opportunity. Awarded as Server Scholarship for University, David dedicated his non-academic hours to working in recycling and landscaping to support his education. After earning his degree, he took on clerking roles in international shipping, eventually advancing to manage international shipments of nuclear materials across the US, Europe, and Africa in the late 90s and early 2000s.
00:00:49
Speaker
Whilst working in this heavily regulated industry, he began attending law school at night in 2001 and changed careers to become a private practice attorney. David is currently a director at Fenimore's Business and Finance Practice Group.
Blockchain and Cryptocurrency Law
00:01:02
Speaker
His foresight into the transformative power of blockchain technology led him to pursue an ongoing role as an adjunct professor at Sandra Day O'Connor College of Law at ASU.
00:01:12
Speaker
where he continues to teach a course titled Blockchain and Cryptocurrency Law and Policy, one of the only courses of its type at that time, 2016. The comprehensive course covers a range of topics also supported by the insight of Jameson Lop, topics such as Bitcoin, smart contracts, DeFi, NFTs, stablecoins and applications of blockchain and real estate supply chain and other international contexts.
00:01:38
Speaker
In addition to his work in blockchain, David is also the chair of Fenimore Labs, which is focused on evaluating and implementing generative AI into legal applications for clients using flat fee and alternative fee arrangements. He is at the forefront of exploring new methods for delivering legal services through alternative fee arrangements and AI.
00:01:59
Speaker
Honestly, David's journey reflects not just as unwavering commitment, but also significant influence into how the legal profession addresses new technologies and innovation.
Impact of Blockchain on Careers
00:02:10
Speaker
We're really lucky to have him with us today to answer our questions and our community's questions. David, welcome. Thanks for being with us. Thank you, Charles. Looking forward to our discussion. I think we both share a bit of shared history here in that I started my career
00:02:25
Speaker
way back in Web 3 in 2017. Of course, I was consulting before that, finance before that, and was tapped on the shoulder to say, look, I'm going to work in this cool new thing called blockchain, to which my response was, of course, that sounds cool, what is it? I know your first story here is about the ICO times in 2018. I mean, I was operating in that space from London,
00:02:54
Speaker
I think we launched an average, I think 13, raising a serious amount of money for quite a few people. How was your experience back then? Because to me it was the Wild West, like anything was possible and lots of people were raising a lot of money.
00:03:07
Speaker
Yeah, that was my experience as well. So Phoenix was not exactly a hotbed for ICOs, but there were some people around and there were some conferences and some activities that we attended. The numbers were just eye popping as I'm sure you remember the amount of money that was being raised. And I still think that it will be remembered as a historic moment where crowdfunding at an international scale basically took off.
Legal Challenges in ICOs
00:03:32
Speaker
And yes, there were a lot of scammers. Yes, there was a lot of vaporware.
00:03:36
Speaker
But there were also a lot of people with really good ideas and really good teams that I think could have succeeded. It was interesting and fascinating for me because it actually put into focus an area of law that I really had never looked at.
00:03:52
Speaker
in such a close way, which is securities laws. And in the US, the restrictions on investors, if you're not what's called a qualified investor, you cannot invest in early stage companies. Basically, it's, to my mind, a bit of an elitist type of law where you have to have money in order to be able to invest in early stage companies, which seems rather unfair and undemocratic, and I still think it is.
00:04:18
Speaker
And because of that, plus this Howie test where you can apply these principles to determine what's a stock and what's not a stock, most things start to look like a stock, which is what the SEC's position has been and continues to be.
00:04:34
Speaker
I remember those early days talking to folks and talking to entrepreneurs who would say, look, we need an opinion letter from a law firm that says that this token we're going to issue during our ICO is a utility token and not a security. And the firm I was with at the time was a very old school Arizona firm, very conservative. And we looked at it and thought, you know, this just looks like a security. So you're going to have to register with the SEC. You're going to have to register with each state you raise funds in. You have international
00:05:03
Speaker
people contributing. Also, you have people who are not qualified investors. You're going to have a very difficult time doing this without spending a lot of money on securities lawyers and doing this the proper way. And then I would see from the same entrepreneur as a copy of an opinion letter from another law firm that said this is a utility token and not a security.
00:05:27
Speaker
And I said, okay, that's great. But what if they're wrong? What happens when the SEC comes knocking and you have to shut this down because their opinion is incorrect? Are you going to sue that law firm? And if you sue them, are you going to be able to recoup and damages what you've lost here? I mean, it's this realistic and
00:05:46
Speaker
It was hard to have that conversation and basically had it repeatedly from 2018 up to probably last year or two years ago when people stopped asking the question. But that was, you know, it was a painful period and still it is. I think in the US, unfortunately, our regulators have made it very, very difficult for
00:06:06
Speaker
launching in cryptocurrency startups to actually operate and we're seeing now the cases that are coming through and I think eventually these cases will decide the area of law going forward for cryptocurrency.
US Regulatory Issues in Crypto
00:06:20
Speaker
There's a chance but an outside chance that our federal government will actually pass legislation that will clarify things but that doesn't seem to be happening anytime soon. So that was my inception point was the ICO boom and you know I've been teaching at ASU Law School at class on
00:06:36
Speaker
watching the cryptocurrency law and policies since 2018 in the fall and that's been a great course to teach because every year changes and every year there's there are new things for me to learn and to talk to students about so that's that's a bit of my background and probably probably enough examples to discussing class as well like given
00:06:56
Speaker
the speed of how fast blockchain and I think emerging tech is moving in combination with law, right? Absolutely. Yeah. And I do, I best to try to get guest speakers to come in, people who are actually in the field and buying groceries in this field. And it's been great. The guests I've had have been phenomenal. I have to give a shout out to Jamison Wop, who has an excellent Bitcoin.
00:07:22
Speaker
And I was preparing for my very first class back in 2018 on Bitcoin, and I came across his website, which has incredible information. And it said on there, if you have an opportunity for me to speak to anybody about Bitcoin, please send me an email. I sent him an email thinking he's never going to respond to me, and he responded right away.
00:07:41
Speaker
He's been to each one of the Bitcoin classes since 2018. He's appeared for the full two hours and walked through the slides with me and helped educate the students on Bitcoin.
The Role of Guest Speakers in Education
00:07:51
Speaker
And I think a lot of them are more impressed as time goes on. They realize what illuminary he is in that space and having him teach the law students about Bitcoin, it's been a real pleasure.
00:08:04
Speaker
That's just one example of people have come into to really help out and that's I think speaks to the community too people In this community generally want to help each other out, which is a great ethos Absolutely. Absolutely. I mean what something that struck me was really interesting was the way the law encapsulated
00:08:24
Speaker
What I would classify as early ICOs, we saw it in a different way. We saw it as the third way to raise project finance during those times, which is the way we were pitching and having the conversation. So we were working with billion dollar businesses. We didn't make a billion dollars or whatever we weren't talking to.
00:08:45
Speaker
kind of thing. And the idea was that you had your standard two ways of raising project finance in the past, which was either going to give you some equity and you buy that in the stocks and shares as you imagine securities or
00:09:02
Speaker
going to essentially be load some money and then I'm going to pay you interest and that will gradually drag my profits into the dirt and continue doing that too long. So the third way was like we're going to provide value that's going to be tokenized, whatever value that may be, whether it be golem or
00:09:22
Speaker
Ethereum use of the chain, some form of value encapsulated into a token that you're going to buy ahead of time to support the production of that business or that piece of technology.
Crypto Regulatory Challenges in the US
00:09:34
Speaker
Was that a similar way that you guys saw it back in the day?
00:09:38
Speaker
Well, I mean, that was certainly the promise, right, was you could raise the funds and then use those funds to build out the network. And I think what ended up happening with the startups in the US was regulatory problems across the board. We have 50 states, which all have unique jurisdictional issues when it comes to securities law, but also when it comes to money transfer licenses.
00:09:58
Speaker
And then we have FinCEN, the Financial Times Enforcement Network, which sits at the federal level. So issues that some of the startups ran into is not just the SEC issues, which are huge and pose existential risks to startups in the U.S. here in this space, but also just getting the licenses. If you are considered a money transfer business, getting an MTL license in all 50 states and at FinCEN is going to cost you
00:10:24
Speaker
years of your life and probably millions of dollars to get that done. So when people started thinking about these crypto tokens that we're going to have some value attached to them that would be transferred around the US, that was another issue. Again, my consultations with early startups that point, I was basically just a dream killer and they would go off and find another attorney who would help them, you know, figure out how to launch. But, you know, in retrospect,
00:10:49
Speaker
I think I did them a favor. I'm just trying to be very um cautious and especially when you're dealing with other people's money. I think it's so important to really Be sure that you're not taking their money and One hundred percent risking it on a regulatory body shutting you down or you know worse putting you in jail I mean there's there's some real serious ramifications from securities law violations and mtl violations in the u.s so
00:11:16
Speaker
It's one of the reasons why securities lawyers are really looked up to in the legal community here and also why a securities issue that comes across a lawyer's desk who's not a securities lawyer, it'll make their blood run cold because you do not want to be messing around in securities law and get it wrong because you can definitely go to jail. Your clients go to jail and there are some serious ramifications. So it's a scary area of law which is also
00:11:42
Speaker
you know, something that makes it a little bit attractive in terms of understanding more about it, but it is definitely not one to, uh, to trifle with or to play around in.
Estate Planning for Founders
00:11:51
Speaker
Fair enough. I mean, given the go-to prison aspect, I think that's the onto, um, estate planning, because you get that wrong, especially if you're, you're not, you know, you're working as a partnership or you haven't got that limited tag.
00:12:08
Speaker
stamped on the ass of your product and then you're really in trouble. What's your take on estate planning and how have you seen that evolve since 2018?
00:12:19
Speaker
Yeah, it's been interesting. So for me, state planning is such a practical area of law. Everybody needs it, right? I don't know anybody who's immortal. We're all going to die. And I think statistics about disability and becoming pastated are pretty alarming when you think about it. 50% I think is the number of people who will have a serious disability during their lifetime. And incapacity is a growing issue as well.
00:12:44
Speaker
So, you know, all of those things taken together, if you're looking at it just from a rational, logical standpoint, this is something that you need to take care of. And when you start looking at unique assets and entrepreneurs who have interests in companies, not just cryptocurrency, but if you have shares in a company, a private company, or if you have membership interests in an LLC, partnership interests, these things are notoriously hard to value.
00:13:09
Speaker
And when you hear that phrase hard to value, you should be thinking about litigators and attorneys who love to argue and make money from arguing because that's what happens. And I've seen a lot of situations where business partners need to part ways for whatever reason, they have a different opinion or how to run the business.
00:13:27
Speaker
And how are you going to value the business? A lot of times they haven't agreed upon it ahead of time. They don't have a good buy sell agreement. And so they are left to their attorneys telling them what it's worth. And of course, they're going to have differences of opinions. And when you get into litigation, the U.S. overvalue their company, you can guarantee very high attorneys fees and very high accounting third party valuation expert fees.
00:13:53
Speaker
because lots of ways to value a company and your litigators are going to value it one way and then the other side will value another way. So it's just guaranteed litigation. The best thing that I've seen happen is preparing partners for eventual divorce or for one partner to step back. And I do have a real old story here where we had a client that
00:14:17
Speaker
it was a company was the client so we said we're not representing you guys individually representing the company and in the interest of the company we need to have a goodbye seller agreement that says how the company is going to be valued you'll all agree to it we'll have evaluation done so you can know what that looks like right now and you can agree to that value and then we'll have an insurance policy in place in case somebody's dead you can have that payout take place we'll have terms in place that show how long it will take the company
00:14:47
Speaker
to pay the estate of the deceased partner and on what terms of what interest rate, which we spread it out over 10 years. I think we changed it 15 years later at a very low interest rate. And by doing that, we were able to navigate some real challenging life situations. The first one was one of the partners went through a divorce.
00:15:08
Speaker
And in Arizona, where you have community property laws, that implicated his one half interest in the business. And so having that valuation done ahead of time and having a known process for liquidating half of his shares was helpful. Then he wanted to take a step back. He got remarried. He wanted to semi retire from the business. So the business started a stock buyback process, which made sense and everybody had already agreed to value. So we're able to handle that.
00:15:35
Speaker
Then later on, he became incapacitated and couldn't manage his work at all. So then we kicked in the real buy sell agreement and actually started buying shares. And then later on he passed away, which then resulted in litigation between the second spouse and the first spouse. And again, the company was able to stay out of all of those life events, right? If you think about all those events, the chances of them happening are very high.
00:16:02
Speaker
over a course of a lifetime. And so we're able to navigate all of that. I was very proud of that work and happy to help with the client through that process. I'm not sure which of our previous guests said it, but, and it might've been Ian that mentioned that there's a hundred percent chance that one of your founders will leave. And it's been stuck in my head and I'm hearing you say this again, that, you know,
00:16:26
Speaker
It always starts, and I come from a tech background, or at least I've worked with a lot of tech people. And I've seen a lot of young guys, or not even young guys, people in their 30s starting a company. And then like, oh yeah, this company is going to live forever. We're three guys, we're going to live forever. These three people, we're going to do really great together. And it never turns out that way. There's always one of those three that leaves at some point, sometimes early, but it will happen 100% of the time.
00:16:56
Speaker
Um, I think that, that, you know, when you're talking about estate planning in this, this case, I think it's so incredibly important to start early with that, like a lot earlier, uh, then I think your average, uh, entrepreneur expects.
00:17:12
Speaker
Yeah, I think that's right. And Thomas and Charles, I appreciate your view on this. But I think most founders, when they formulate their valuation for investors, that's one way to do it. But is that the way that you would want to be bought out? Or would you want to buy out of your partner?
00:17:28
Speaker
based on that valuation. Probably not, I'm guessing, right? So let's go ahead and have an agreement on how we are going to buy each other out. It's fair to both of us that we've agreed upon beforehand. And that's so important because that alone will limit the litigation at risk.
00:17:47
Speaker
A lot right just just having the valuation understood and known by both parties. So huge huge recommendation there Please just you know work with your partner. I recognize that one of you may want to leave uh sooner or later and how you do that is going to be either uh, The right way very smoothly or it's going to be the wrong way and it'll be uh, really destructive to wealth So I had two points on that when when you asked one was
00:18:15
Speaker
How do you value goodwill? It's just never a question. I've studied the accounting side of it. That's a mystery. And then the legal side I can only imagine. So yeah, so when you come to trying to value a company, especially if there is heated feelings around the quote unquote divorce,
00:18:39
Speaker
which are business divorce in this case, right? Like, what would you say are the steps? Let's say it's a young business that are sort of at the beginning of their journey, what would they do? What should they think about? Or should they bring this to a lawyer and say, just help us?
00:18:55
Speaker
Yeah, I mean, I think they should talk to an experienced lawyer in the jurisdiction that they're in too. That's another interesting point with regard to cryptocurrency and blockchain businesses because it is global and people reside in different jurisdictions and understanding your choice of law and where you're going to have any disputes resolved and how to apply that law to the facts is super important. I think it's important also to have a discussion about
00:19:20
Speaker
What is it that each one of the founders is going to contribute in terms of time, energy, skills? Because you've seen this, I'm sure, where partnership starts off. One party is doing maybe the technical side, the other party is doing the marketing side. And guess what? They don't both work the same amount of hours, or they're not as effective in their job.
00:19:43
Speaker
And so having real honest conversations with your partner is about, hey, this is what's expected. Here are the metrics. Here's what we're going to put into it and just checking in with each other to make sure you're holding up both sides of the agreement or if there's multiple partners, making sure everybody's doing what they're supposed to be doing. Because that becomes super important when you're coming to valuing their interests, right? If somebody is expecting to get paid out, but they haven't put in
00:20:10
Speaker
the effort, then that's going to be a challenging situation. So it's better to just be very frank about that and discuss those issues right up front.
Employee vs Contractor Classification
00:20:19
Speaker
Definitely. I mean, with that, once you get beyond once you grow beyond the core sort of founding team,
00:20:27
Speaker
We're then sort of talking about employees, contractors, outsourcing. I mean, Thomas and I are both fans of outsourcing. We think outsourcing is better than trying to hire a big team just as soon as you raise, because why you can't quite hire 10 people then expect them to be all be good. But beyond that, when you're looking at classifications of employer versus employee independent contractor,
00:20:53
Speaker
I mean, what are the things founders should be thinking about when they're starting on that journey versus trusted employee management? How does that work in your head from the legal point of view?
00:21:07
Speaker
Well, there's a lot there. And in the U.S., that is a highly litigated issue, both by the potential employer, independent contractor, as well as by the government agency. So one thing to really understand here is that in how do you classify an employee as an employee or a contractor is going to implicate the tax liability that the business has to the state and federal tax authorities. And the last thing any business wants to do is end up in litigation with a state or federal agency.
00:21:37
Speaker
because you're going to lose and they're probably going to drag it out. They're going to have resources that you just can't match. So being very clear on what your tax obligations are, whether it's an employer independent contractor, that's super important to make sure that you are compliant with state and federal law in the US with regards to tax payments because you do not want to accrue a large tax bill.
00:22:02
Speaker
The IRS is the ultimate creditor and they can put you in jail. They do have guns. So you don't want to mess around with them. And the same states are very aggressive, too. Some states more than other. California is very aggressive in collecting on taxes. And the tests that they use to determine whether somebody is an independent contract or an employee are very heavily weighted towards finding that a person is an employee rather than an independent contractor.
00:22:28
Speaker
So you have to be extremely careful in how you classify. Do talk to an employment law attorney, especially in the jurisdictions your employees are coming from or your independent contractors are coming from. Make sure you have a good agreement. This is a place where having a form from the internet is probably not a good idea because the risk to your company is large, disproportionate. When you talk about litigation from the employee slash the independent contractor who
00:22:57
Speaker
There are a lot of plaintiff's lawyers out there who will represent them and take a percentage of what's collected on a contingency fee. Those can just be pure nuisance lawsuits where they really don't have a case, but they know it's going to cost the business 100 grand to litigate and win, which at the end of the day, if you can pay them 50 and have them go away, they might take that deal. So you just want to be on point with regard to how you bring these people on board.
00:23:21
Speaker
make sure you understand the proper classification, make sure you have a good agreement, and just try to mitigate all that risk because it is significant. I think that's excellent. Thomas, do you have any questions on this piece?
00:23:34
Speaker
No, I mean, I've been working with a lot of US startups and I would always argue that even with outsourcing, make sure that your contracts are watertight. As you said, jurisdiction matters. If you sign with a European entity, then European law is
00:23:55
Speaker
being used, if you're signed with a US entity, then US law is used. And I think that people sometimes forget about that, because they go with the assumption, yeah, but I am in state one, or I am in country X. So, you know, it goes for that. It's like, no, it goes where your business entity is and where the contract comes from, right? I think for me also,
00:24:17
Speaker
the IRS, as is the HMRC in the UK, they, you know, police needs a warrant into your house. The HMRC does not. They will take your door in and take your TV, you know. They've got the special dispensation, which is something that people don't really know. Like, you have that conversation over a barbecue that like, what? Like, yes, the tax man can come in and grab your stuff.
00:24:43
Speaker
And they are belligerent about it when you get
International Hiring Legalities
00:24:45
Speaker
to that point. So it is one of those things that's really worth considering and having top of mind when you're thinking about a way you're going to set up your business. For me personally, you know, do I want to go for a Delaware C being an English national? Probably not.
00:25:02
Speaker
Are there better options for me here in Europe? Definitely, right? So it depends on whether you want to have the IRS as someone that you even want to be in the same room as or not. So I think it is a big deal. And it's also a big deal with respect to hiring people on a contractual role. For example,
00:25:28
Speaker
We experimented with hiring people from Latin America and sort of a program where we wanted to bring opportunity to that part of the world. And it was just really, really difficult to navigate their taxation system, ensuring that we were the right side of they are contractors performing a specific task versus performing a role. It's really difficult because you want to offer an opportunity, but there are all of these hurdles to being able to do that.
00:25:56
Speaker
And it's something to keep top of mind when you're thinking, all right, this is a contractor, or is this a firm? Is this a one-man show that's a company, or is it a company that has numerous people that are going to do the job for me? One of the things to think about when you're hiring an individual, especially here in the UK, is that you can hire them to do the job. You can't tell them how you want them to do it. And that's a really important
00:26:26
Speaker
differential when you ever get asked a question as to whether or not they're an employee or a contractor.
00:26:33
Speaker
I mean, is that is it the same in the US? Yeah, it's similar here. I think if you're going to dictate to people when and where they work, what tools they're using, and you're going to basically manage their their work product to a degree, you're going to end up probably having to classify as an employee. And then you have situations where an employee can, especially in this day and age, bring an action for unpaid wages because maybe they received a text during off hours or they
00:27:03
Speaker
Um, we're looking at email in the middle of the night. Um, you know, those emails sent in the middle of the night show as evidence that, hey, you expected this person to be on call working at these times. And now you owe them back wages for overtime. Uh, and also you own the state, uh, wait, you know, some of the taxes associated with those overtime wages. And so it becomes a very tricky proposition to try to prove that, okay,
00:27:30
Speaker
this was sent that they didn't actually look at it or they weren't actually supposed to be working at this time. We didn't expect them to be doing overtime and all those issues become very challenging for the company to win those arguments. And so that's why you do have a lot of plaintiffs lawyers out there who love those cases because they can win them most of the time and they usually will sell before they go to court. So, right. Another reason to outsource
00:28:02
Speaker
Okay, so thank you, Thomas, a little bit of background, a little bit like three little anecdotes around where you come from and experiences that you've had things to watch out for. I think the next component I'm going to hand over to Thomas, this is where we go through the 10, I think key, quite like fundamental questions when it comes to legal, where if you're a startup founder, you're thinking, okay,
00:28:25
Speaker
I've got to build the product, I've got to run the product, I've got to keep my team happy. And a lot of the time, some of these things fall by the wayside and are or not taken as giving them as much attention as they need to until they become a problem. So I think the piece I'll add to the introduction of this section is
00:28:47
Speaker
You don't know how big of a problem these things are until they become a big problem. So to learn from our experience in England, we have a phrase which is the five marks on my ass. You'd rather not have and do take in these insights from David. Thomas, over to you, chap.
00:29:09
Speaker
I am very glad that I can actually ask David all these questions about his 10 startup advices, because I do business in at least three jurisdictions. And in the prep of this episode, David threw out some nuggets that I was like, shit, I think I need to engage David after this podcast to probably use his services. So I hope that our listeners also feel the same way, or at least get some more clarity after this.
00:29:36
Speaker
So let's start with the first one, David. What should I look for in the first lawyer that I'm hiring for my business? Yeah, I think the first thing you want to look for is somebody that you communicate with effectively, especially when the lawyer is getting paid by the hour. You want somebody who can communicate with you in a way that you understand the risks and is not drowning you in legal ease. You want somebody who's going to be responsive. And that's one of the biggest complaints to all of our associations in the US is that
00:30:04
Speaker
a call was made or an email was sent to an attorney and they didn't respond. So having somebody who can communicate effectively with you and timely is probably what you're looking for. And realize that this person is not going to be able to answer all of your legal questions. If they do or if they attempt to, you should be very afraid because no one lawyer is going to be able to provide all these answers for a certain
00:30:29
Speaker
So you should kind of have a lawyer with a big black book that can at least recommend other lawyers if there is a need.
00:30:37
Speaker
Yeah, I think so. I mean, we, so the firm I'm with has, you know, hundreds of attorneys and we're in the Amazon 200, 200 biggest firms in the US. But we also are in other jurisdictions through SCG legal as one of the groups that we work with. And they have attorneys in different countries and different states that we're not in. And we also will refer work back and forth. So having a network of
00:31:00
Speaker
Attorneys of law firms that you can connect with quickly is very very important for an international type startup for sure
00:31:09
Speaker
This is very interesting. And it kind of goes back to my own experience with lawyers here, at least in Europe. I found, to the credit of US lawyers, generally quite responsive to foreigners. But I have a lot of issues with timely responses. And I think that that is such a major issue. And this was for some sole tradership issues and not for an LLC. But I can imagine that if you run a high-flow LLC,
00:31:36
Speaker
or whatever entity you run, you want to have your lawyer almost on a speed dial. And it kind of rolls into that second point. It's like, OK, so let's say I have David on speed dial. In what kind of situations is it critical to have your advice as a lawyer?
00:31:54
Speaker
I think the situations where you want to have a lawyer are those situations where litigation is not out of the question and the dollar value associated with that litigation is high. So, for example, if you're signing an agreement with your cell phone provider, you probably don't need a lawyer to look at that.
00:32:11
Speaker
But if you're taking investment from venture capital, you definitely want a lawyer to look at that. If you're hiring somebody, you want a lawyer to look at that. And I would just add to that, to be very clear what the scope of the legal services you're requiring is. I mean, that's something that we...
00:32:26
Speaker
put in every engagement letter is our scope is limited to X and We do not like just being general counsel for a company on all issues because that's impractical and it's way too broad So we want to be very specific and I'll do free initial consults with clients all the time just to say alright let's talk about your issues and let's figure out exactly what the scope of services will be and
00:32:50
Speaker
And then I'll disclose to you who's going to be working on it. They're out and great. And we'll talk about what the desired outcome looks like. But being very clear with your attorney and crafting what it is you want them to do in terms of scope of services is super important.
00:33:05
Speaker
Yeah, no, I think that and definitely if you pay a lot of money for it, you want to you don't want to call your lawyer indeed for like, hey, my, my provider is like, I don't know, changing my contract, what should I do? Yeah, well,
00:33:21
Speaker
That just cost you 500 bucks. No, that's fair. To that point, and this is something that I have found in either companies that I've worked with or looked at myself because there's fast ways of doing things here in the world. We now have GPTs out there. We have templates on
00:33:43
Speaker
uh, on the internet. Um, and the question that I, I always have, and I think everybody probably shares, but you know, never can ask is like, how much can I trust these legal documents that I find online or our GPT generated? Like our, is that 90% is 80% should I actually not look online for these things? And should I just talk to a lawyer? Uh, it probably depends case by case, but how do you, how do you look at that? What's your advice here?
00:34:11
Speaker
Yeah, I mean, I think you can't trust what you're seeing online. I think there's a lot of nuance in the law that just doesn't show up in online documents. And I could tell you from experience as the chair of our Federal Labs Committee looking at AI applications, even the really good ones have hallucinations and have errors and will give you conflicting information depending on how you prompt them.
00:34:32
Speaker
And this is with very specific legal tech AI applications, let alone chat GPT, which is pulling from the entire internet. You can get some good information. I'm not saying that they all have value. It's just that when you're dealing with other people's money and you have litigation risks that are tremendous and potentially pose existential risks to your company,
00:34:54
Speaker
You definitely want to have a lawyer who understands those issues and is familiar with the jurisdictions you're working in and can give you some good legal advice based on experience as well as, you know, what is current in terms of the correct form be using, but also helping you look around corners that you otherwise wouldn't be looking around. It's super important.
00:35:15
Speaker
It's interesting that you're saying that I heard that advice a while ago where somebody said, a lawyer said to me, it's like, well, if you need to, if you're in need of a legal document, you should probably talk to a lawyer. I'm like, okay, that's something. And the interesting part was that I asked the same question to the specific lawyer. He's like, Hey, I found a couple of templates and I'm not even sure what it was, but it was something relatively simple. He's like, well, even looking at the templates, and this was, I think for European jurisdiction, but also, you know, countries here in the EU are also different.
00:35:45
Speaker
It's like why you wanna look at not these templates let me help you find the right legal document and do this just to get it right.
00:35:55
Speaker
Very important and I think very easy mistake to make because of so much accessible information, I guess. So let's then hit the next point, which is, I kind of mentioned it already, right? Like it's easy with so much information lying around, like playing your own legal advice, but what are the most common legal mistakes made by startup founders?
00:36:17
Speaker
Yeah, I think not engaging an attorney early on and ending up in litigation is obviously the one that I see the most. But that can be from forms they were using and just pretending to be a lawyer at the same time they were a startup founder.
00:36:32
Speaker
or it can just be not appreciating what we talked about earlier, which is the need for a real agreement amongst our parties about what the value of the company is worth and how their interests are going to be vested over time, how they're going to get paid out if they decide to leave or if they
00:36:50
Speaker
Basically just stop working right and that's all of these things end up in litigation or at least the threat of litigation and That will destroy a company's value so trying to minimize your litigation threats should be at the top of your agenda because
00:37:06
Speaker
Part of making a successful company is just surviving. And it's very difficult to survive when you're involved in litigation. It's so expensive. It's such a distraction. It takes an emotional toll, too. I see it on clients. It's very challenging sitting through depositions and having requests for productions of documents and things. It's just a grind. And so if you can avoid all of that, you're better off.
00:37:32
Speaker
How often do you see those cases? I mean like obviously you're a lawyer so you seem pretty often but how often do you see those cases where you see like oh shit they they've been too late or they've not looked for legal counsel early enough.
00:37:46
Speaker
Yeah, often. I mean, almost all the time because the nature of the startup is that we're running on a shoestring budget. We need to get things going. We need to be fast. We need to break things. And so there's a supreme amount of confidence that goes with the startup founder and that's good for some things.
00:38:02
Speaker
But generally speaking, you're going to end up in a situation where the company is in a compromised position with regard to a third party who has a lawyer that knows you're compromised and they're going to take advantage of it because they have a client whose interests have been affected. And so, you know, trying to survive through the early stages is going to be
00:38:26
Speaker
important. It's really about mitigating your risk. So when you think about your legal spend, think about it that way, that this is going to keep us alive so that we can see if our business actually will make money, will survive the early stages.
00:38:40
Speaker
It's interesting you're saying that it's one of those points that we actually have. I think it's point 10. You know, your budget spent, and I would like to address that in a little bit, but that you did already mention. It's like some red flags, right? Like what kind of red flags you see in startup founders, like you already mentioned, like, you know, survival, who's choose string budget.
00:39:08
Speaker
And how how do you like steer them away from that like. That must be not an easy task to do and but also as an advice to a founder. From you as a lawyer like how can you see as a founder that you're. Actually having those red flags right.
00:39:27
Speaker
Yeah, I mean, I think it's important for your attorney. This goes back, I think to the first question too, which is effective communication between the attorney and the startup founders means that they're going to tell you when they think you might be making a mistake or you're needing some assistance here from a lawyer. Too often, I think founders will basically override legal advice they've been given for the pursuit of a business interest, which
00:39:56
Speaker
Sometimes that's the correct decision, right? Business judgment is always going to be an important part of being a founder. But recognizing when it's important to take legal advice and to seek legal advice as a founder is paramount to just keeping alive. So a red flag for me would be a founder or a group of founders who's just extremely overconfident in terms of not appreciating the legal risks that they might be taking with other people's money.
00:40:27
Speaker
Do you see a big difference between first-time founders and serial entrepreneurs, for that matter? Yeah, I think that's true. I mean, it's just like with lawyers, right? Lawyers who are relatively new don't have a lot of experience to draw on, whereas founders who are more experienced, like a more experienced lawyer, they'll have their life experienced to
00:40:48
Speaker
to learn from hopefully, and to course correct when they start to see things that should have patterned a lot of, you know, most professions, I think is just pattern recognition. You start to see the same things over and over again, and we start to deploy that harder and wisdom over time. So it's important to respect that, you know, when you're, when you're hiring a professional to help you, and, and they have that pattern recognition, they're trying to tell you something, it's good to take that kind of advice.
00:41:19
Speaker
See, I thought that was interesting because when we were setting this call up, I read that differently, Thomas. I read that as what are the red flags you see in startup founders that make you not want to work with them, David? Well, I think in between the lines there, you can probably see what I would be avoiding as a super overconfident founder who doesn't listen to what I'm saying. I think those are the kinds of clients you don't want to have because
00:41:47
Speaker
It's just, it has to be a good two-way communication, right? You can't have it be just my way or the highway. It has to be a partnership. And in fact, between the lawyer and the founder to try to accomplish the specific work scope that's being worked on.
00:42:02
Speaker
It's interesting because I think that we all share that. When I have overconfident founders, that generally is not a good sign because when we definitely build blockchain tech, sometimes people are actually really good blockchain founders, but they won't know the rest of the business. We always say, know what you don't know and hire for that, or outsource for that.
00:42:26
Speaker
The reason why Charlie and I started working together and collaborating and starting this podcast was exactly this point. Know what you don't know as a founder. And if you don't know that, hire for it. And then, more importantly, listen to the advice that the people that you hire, because you pay them, give you.
00:42:44
Speaker
So yeah, it's a pretty common topic. And we see that kind of as a red thread throughout all the episodes and all the people and all the guests that we've spoken to over the last month or so. Like an extension to the most common legal mistakes is term sheets. What are the main things that startup founders need to think about with respect to term sheets? Because this is the bug where there are so many traps in this.
00:43:14
Speaker
Where do you start? Where do you begin? What are the things that you want to tell the audience and get the word out about? Yeah, I think when you're looking at term sheets, you have to appreciate that, you know,
00:43:26
Speaker
The term sheet itself probably was drafted by an attorney for the investor who's coming in. And so you want to have an attorney on your side look at it from the perspective of the business and you may want to have an attorney look at it from your personal perspective as well. And those are different interests. And like the example I talked about earlier,
00:43:48
Speaker
We were representing the company and made it very clear to all of the owners of the business that we're not representing you. We're going to represent the company and we're going to advocate for the best interests of the company in terms of cashflow and how this is going to work. And so in a term sheet, you really have multiple parties with different interests being represented there. You have the investor's interests, you have the company's interests, and then you have the individual founder's interests as well.
00:44:14
Speaker
And those are different. And so recognizing that inherent conflict of interest and getting legal counsel so you're comfortable from the business perspective and from the individual founder's perspective that the term sheet is going to work for you is super important. And I think within the term sheet, there are a lot of variables that
00:44:33
Speaker
can be manipulated to the advantage of one party or another. A lot of times founders will rush in to take the money and not appreciate maybe what can happen with a further dilution of their interests or vesting periods. I mean, there's a lot of terms that
00:44:52
Speaker
you know, can work against them if they're not fully appreciating what is in there and how this can play out. And so I would always recommend clients think about best case scenario and worst case scenario. Probably neither one of those can happen, but make sure you go through that thought process and then recognize it's probably going to be somewhere in between and get comfortable with the legal advice you're getting for the company and to you individually.
00:45:18
Speaker
That's such a stoic answer. I'm going to impress you for something a little bit fun. What would you say are the top three clauses or things that startup founders have to be aware of? For example, vesting periods, who gets paid out first. If they get the sense that something smells a little funny,
00:45:42
Speaker
What should they read first to get an indication of how things are going?
00:45:48
Speaker
Yeah, I think vesting period, also ownership of intellectual property rights, how that's going to be helped. Vesting definitely is huge because the founders need to know how long they're going to have to stay in this business to get their money out. Also dilution of their interests over time because additional investment probably is going to be needed down the road and when that happens, they're going to lose more of their share of the company.
00:46:15
Speaker
Um, and ultimately control over the direction of the company is usually, you know, in the term sheet somewhere, somehow, and recognizing that when you start taking other people's money, you're going to lose some of your, uh, independence and how that's going to happen, whether that's board seats that are, that are going to be pointed by the investors. And hopefully that's all good, right? I mean, ideally you're getting money from somebody who's going to help your business.
00:46:43
Speaker
and actually take an interest in it and give you good advice and position you for success. But that doesn't always happen, as we know. And so, yeah, there's a lot to that and a lot of moving parts and super important to get good counsel when you go into that process. I just wanted to say, this is the kind of conversation I wish I had. Like when I started my business, I was like, so many questions.
00:47:10
Speaker
that you just kind of had to work your way through without any advice because you just didn't have the money. I couldn't call a lawyer and be like, listen, I've got all of these questions. Could you please just give me an hour or two of your time to help me figure out when I need a lawyer, how I need a lawyer?
00:47:32
Speaker
What is it exactly that I need a lawyer for? Cause you get into that space when you're sort of early days in your business and you're thinking, okay, I know I need a good contract in order to be able to sell stuff. I don't want to sell a product or a service and then get that wrong kind of thing. And I just, yeah, I just want to say thanks for taking the time. It's really, it's really being illuminating. I appreciate the opportunity. So thank you.
00:48:01
Speaker
No, more than welcome. So I guess the next bit, and this is kind of a trigger question for a lot of people. And I've seen some people burnt by this, some people not. And it actually strikes quite close to home for a lot of people in terms of
00:48:17
Speaker
How do you secure your IP? And we're talking tech products here and a lot of standard founders I feel are concerned about sharing too much when it comes to pitch or not sharing enough when they're looking to raise capital or sharing too much when they're trying to just sell their product and get people get users, right? How do you protect your IP, secure your IP and even your brand name? Should you even care in the early instances? I mean, where do you land on that?
00:48:47
Speaker
Yeah, I mean, I think you should care about it, especially if you're planning to build something over a long period of time. And it really goes back to some of the things we talked about, which is,
00:48:57
Speaker
What is the value proposition of the IP? How unique is it? Do you have a brand you want to build in a specific location? Jurisdictionally, where do you need an IP lawyer? Do you need one in the US? Anyone in the EU? Maybe you need them in all those places.
00:49:19
Speaker
cannot emphasize enough that you need to talk to an IP attorney. And we have some great IP attorneys in the firm and there are great IP attorneys around the world, but you have to have one that understands your business model or you're hoping to do with that IP going forward. When you come
00:49:35
Speaker
to business valuation issues, the IP is going to be a big part of it. And how that IP is owned, how it's licensed, you know, that could potentially be a huge revenue generator for you. So yeah, anybody in technology working through
00:49:53
Speaker
a startup needs to understand what their IP potentially could be worth, how to protect it, and make sure that they're taking the right steps to protect it on a regular basis. It's not a fire and forget. This is something you want to revisit frequently, I think. Okay. I'm going to push you on this one a little bit. What should a startup founder in the emerging technology space, we're talking Web3, we're talking AI, what should they have locked down?
00:50:24
Speaker
like from the variances, from when they start trying to get customers. What are the key phrases or documents they should look to have drawn up?
00:50:35
Speaker
Well, I mean, if they think that they have a unique process and that they can get a patent, and this is where they want to talk to an attorney who will tell them, like, what you're doing is unique and there is something here that we can protect, then by all means, get that done and get that locked up as soon as you can. And that's where, you know, again, having the right attorney and the right jurisdiction advise you on that is super important.
00:51:03
Speaker
Most of these startups are trying to do something unique. I think you know, otherwise They wouldn't be in business, right? So what is that unique thing that you're bringing to the table at the market? Hasn't seen before what is it that makes your process or your blending of the different technologies? Something that not anybody could do right? This is this is what is your unique value proposition and typically there's going to be some ip components that so
00:51:30
Speaker
Understanding not being able to articulate it and having an attorney who is an IP attorney in the jurisdictions you're working in and can help you protect those things is important. And just a quick follow up to that one, should startup founders be scared of the big bad corporate trying to steal my idea? Should they just go for it and try and get some traction and then just think about that later? Should they do it from the outset? And I know there's a very wide question, but in general,
00:52:01
Speaker
No, I think it's good to be paranoid in this situation, but there are limits to that. And eventually you're gonna have to take some business decisions about who you share that information with. And you're not gonna get an investor who, you don't tell them what your unique selling proposition is. You have to be able to communicate to people what it is you're doing. And you should be concerned about somebody taking your IP, but that goes back to understanding from your IP attorney
00:52:31
Speaker
What do we do when somebody steals our IP? Are we going to have to litigate? What are the chances of that? What is it going to cost? How long is it going to take? Do you have that as a line item in your budget? If you're fiercely going to protect your IP, you should have some money allotted for litigating over IP rights.
00:52:49
Speaker
And if you don't, then maybe you're not that serious about your IP. I don't know. I mean, it's hard when you're a startup, but you have to be thinking next round, next round, because you're going to be going back for funding again and again. When and where you protect your IP and what resources you dedicate to it, it needs to be part of your business plan.
00:53:13
Speaker
Can I ask a question on this because I see a lot of back and forth on NDAs when it comes to pitch decks for venture capital and I see like yays and nays on it. I think the general consensus is like we don't have time to sign an NDA and don't worry, we're not going to steal your idea kind of perspective. What is your take on that?
00:53:38
Speaker
Uh, that's a tough one because I, you know, you can see both sides. Look, as an attorney, I'm always going to tell you to have a very good NDA and have it locked down. That's my advice. Um, I, I do see situations where people I look, we're, you know, we're not going to sign an NDA. So don't even bother sending it to us if we're going to invest in you. Um,
00:53:59
Speaker
You know some of that comes down to just character judgment and your track record with the investors and what other people might know about them. You know fortunately in this day and age people who don't treat other people well
00:54:15
Speaker
usually will leave a trail of bodies in their wake. So do your due diligence. Anytime you're talking to somebody about your very precious business ideas and your intellectual property, either get an NDA in place that you understand and you recognize what limitations are, or if you're not going to get an NDA in place, do some background check. And that's some of the work that we can do for clients too, is we can do a search on a person, an NDA,
00:54:40
Speaker
How many lawsuits have they been involved in? What is their track record? What do some of their business associates say about them? Having that kind of intelligence helps you make an informed decision. And certainly, you wouldn't want to just plunge in blindly and give somebody all of your IP. Because who knows what could happen to that, right? It could take a walk and you could end up competing against somebody who has the exact same IP that you have.
00:55:06
Speaker
Hey, so yeah, I think it pays to be a little bit paranoid. Ultimately, it's going to come down to a business judgment. But have have an informed decision, whatever you do. Yeah, I like that. And I just want to add before you go to the next point, like, from from our company, we proactively send NDA's with our clients. So if our clients come like, hey, we want to build software like, hey,
00:55:28
Speaker
Great first conversation. Here's an NDA. We're also very happy to sign yours, but here's an NDA just to make sure that we're
00:55:37
Speaker
Uh, we're at least looking at trustworthy and we're recovered so far, right? Like we're not going to steal our clients ideas because we're no means like having looking forward to raise a large amount of capital for an idea. That's not us. Um, but it, it, we also see that the clients generally are very glad about it. Like, Oh, that's nice that you think of that. A lot of some of them, there's like, Oh, we don't need it. But some of them are like, yeah, we're very happy or actually say, okay, we only, we only want our NDA sign.
00:56:03
Speaker
to your point, right? Like as I probably have a good lawyer that says, no, no, no, only sign, sign, uh, are MDAs. So that's great. Um, you know, we, we are the next advice, uh, piece that we already talked about. It's like the most disputed topics. It's basically, it just said like litigation, right? Like that's, that's the thing that you've seen coming over your desk most.
00:56:25
Speaker
Yeah, and I think when you think about where your litigation risks are, think about where the money is, because that's where you're going to have it. It doesn't make sense to litigate for most things. And I do try to talk clients out of litigation as often as I can. But when it's about a large sum of money, it's almost always going to make sense to litigate. So you have to understand that mindset as well.
00:56:52
Speaker
that there is a point in time where you have to litigate. There's just too much riding on it. And understanding what that threshold is for you and for your business is important before you get involved in it. Because a lot of times people get wrapped up in emotions and start making decisions that are not rational around litigation and then end up regretting that and having to drop the litigation later.
00:57:19
Speaker
If you're going to get involved in litigation, you should have a clear understanding of how much time it's going to take, how much money it's going to take, and what your risks are. And the resources that you're going to deploy into it need to be weighed against the risk of losing and understanding that this is worthwhile to litigate or not. And understanding that quickly is going to be very, very helpful. Perfect.
00:57:47
Speaker
Um, the next one, I think we discussed it as well as like how much, uh, attention should have founder paid to contracts is downloading them from a rocket lawyer enough. Like we already said, like the moment you, you, you need to draw up a contract. It's probably good that you're talking to a lawyer, right?
00:58:01
Speaker
Yeah, it's good to talk to a lawyer again, think about the gravity of the contract. Is it a six-figure contract or not? So understanding where you want to have an attorney spend the time, is this something that's actually critical for the business? Yes. And is it a lot of money? Yes. Then, okay, let's get a lawyer in here. And understanding that the impact of those contracts and where you want to deploy lawyers is very important.
00:58:26
Speaker
So the last two and then we're moving on. How should startup founders navigate conflict of interest from your perspective?
00:58:35
Speaker
I think that they need to be aware of conflicts of interest. First of all, I think a lot of times they just consider all the co-founders are in this together. We're all doing this. We're all pulling for the company and we're all going in the same direction. And reality is that's just not true. Even then, you know, a completely equal distribution of equity, which is rare. Individuals have different skill sets and some skill sets are more replaceable than others. And some skill sets are more in demand than others.
00:59:03
Speaker
Some people just have a unique thing about them, an X factor that is going to make the business go. Recognizing all of that and recognizing the differences is important and that there are going to be inherent conflicts of interest. And the business has a different
00:59:20
Speaker
interest as well. I mean the business is there to make money and to return capital to the investors and that may not line up with all of the co-founders intent or capabilities at the beginning as well. So just taking a step back and trying to be objective I think would probably be the advice to really think about conflicts of interest from an objective viewpoint which is hard when you're in it but very important skill to have.
00:59:45
Speaker
This is also a piece that is not fire and forget, but continuously evolving. Yes. It goes over time for sure. Cause people change over time, right? And business interests change over time. All right. Sorry, that one business, a developer, uh, becomes a CTO and actually turns out to be really good at it. That might just be the case. Right.
01:00:07
Speaker
Sorry, Charlie. I'm just super keen on this last question, which we had come in, which is, how much should companies budget for legal? And I was going to qualify that. Let's say you raise half a million dollars, a million dollars, and two million dollars, because those are the instances I see most frequently, especially for specifically geared to our audience, right there. They're right at the beginning of their journey. If you raise half a million bucks, what should you put aside?
01:00:34
Speaker
I want to add one more tier to this, and that's something that you sometimes forget, Charlie, but that's our audience at bootstraps. The bootstrapping, so the bootstrapping, half million, million, two million, I think those are like four categories. I think that is perfect to have something inside on.
01:00:52
Speaker
Great question, and I think you have to think about what scope of services you're going to be requiring. So if you're going to be going out in the hiring attorney to look at all of your term sheets, you're going to be hiring attorney to look at all your employment docs, hiring attorney to look at all your IP interests, that is probably not all going to take place on day one, right? So figure out the scope of legal services you need and when you're going to need them.
01:01:16
Speaker
and be strategic about it because you don't want to be deploying your resources out of order. So you need to be thinking about it from the perspective of what is the first, second, third, fourth, fifth legal service I'm going to need this year, you know, and start with that. And just like any good startup, you're going to use iterative decision making and go through that process. But I think
01:01:41
Speaker
You know, realistically, you're going to want to spend money on legal services, probably more than you think, just to avoid getting destroyed by either litigation from a third party or somebody inside the company or from a government agency that you are violating their compliance rules. So those are the things you have to think about. You want your business to survive.
01:02:08
Speaker
And you can skimp on a lot of things in starting up, but I think skimping on legal services, I've seen it destroy a lot of startups. And so recognizing what those legal services you need and when you're going to need them and budgeting appropriate for that is going to allow your business hopefully to survive and eventually thrive. But you've got to, you've got to get to that terminal velocity at some point and you're not going to get there by skimping on legal services. At least that's been my experience.
01:02:37
Speaker
So if I would say, let's say 10% for bootstrap, 20% for 500K, 30% for a mill, would that be realistic? And obviously, we're doing a little bit of guesswork here based on you didn't specify the industry and the company and the product. But because I can't imagine that if you're bootstrapping, it's like kind of POC. You throw it on the market, you see what happens. You probably don't need.
01:03:07
Speaker
a lot of legal services whereas like you know you're just raised two million and you're gonna I don't know take on ticket master for instance and as an as an example you're probably going to need a lot of legal right yeah I think that's right and I think that's the important thing is for you to understand when you're going to need legal services and what type of legal services you're going to need and that's going to help you with the budgeting and again order of operations like
01:03:35
Speaker
Do you need that in the first quarter, the second quarter, third quarter, fourth quarter? When are you going to be engaging legal for the legal span? If you have a proof of concept, maybe you want to spend some money early on with an IP attorney that you can grow with and try to just understand what's going to happen. And with a good lawyer or law firm you're working with,
01:03:54
Speaker
They can help you navigate that. Say, okay, right now you need these services from us. Come back to us next quarter. We'll talk about these services and here's what we think that's going to look like. And, you know, go through a process just like you would in engineering anything you want to have, you know, sort of milestones that you're going to hit and you want to have a schedule and you want to resource live that schedule the same way with lawyer. You got a project manager, lawyers, basically is what you do. If you're going to do it the right way.
01:04:22
Speaker
I really like that. I think that is a perspective that I've never heard before, but it makes a lot of sense. Uh, definitely from a milestone perspective, because I'd always assumed like, okay, you just, you know, you have continuous lawyer support, but as you said, like, you know, planning it out over different quarters and, and actively manage that engagement as well. Um, yeah, that makes, makes so much sense. I'm mindful of time gents. I think.
01:04:52
Speaker
Having had the conversation we've had so far, brainstorm number one is kind of moot, because we've done that to death. What are the frequent steps you have to take? That's pretty much been the conversation up till now, having that again. I don't think we'll add as much value and might be a bit boring for David, frankly. What are the most common lawsuits? I think we've tangentially covered that.
01:05:18
Speaker
Three how to build relationships investors and raise capital while signing papers are beneficial to both sides We haven't quite covered and by I think also it's a super hot button topic That will get your name and your face out there a bit bit faster What do you think guys? I'm mindful of time and I'm thinking Probably hit the hot button topic because we've done one already and
01:05:44
Speaker
Well, I think we did one and two like the most common lawsuits. I think we've discussed it like a litigation and as you mentioned a couple of times like risk of claims, spending more and more hours. Yeah, I would be up for talking about the relationship with investors, how to build them and raise capital.
01:06:04
Speaker
all signing papers that are beneficial for both sides. With regards to investor relations, ideally you're going to have investors who really are going to put more than just money into the business that they're going to help you with contacts, they're going to help you with exposure, they're going to help you from a strategic standpoint get to where your business is successful. Your interests are aligned, hopefully,
01:06:28
Speaker
your economic interests are aligned and so they should be able to advise you on a number of different things that you can then take and implement that advice. Where we see problems is when there is a miscommunication between the founders and the investors or worst case scenario there's a misrepresentation about what's going to actually happen. That's the last thing you want. You want to absolutely be clear with the investors
01:06:58
Speaker
The threat of litigation from the investors is real. They have money. They're deploying money. This is how they buy groceries and they have lawyers. And if you misrepresent them, progress you're making or things you can do, you will find yourself at a loss. So you don't want to do that.
01:07:16
Speaker
You want to be very clear with them about your goals. You want to have, you know, real achievable milestones and goals. Investors will look at, you know, how you're performing and want to know. And they have a right to know because you're using their money. Are you meeting the milestones you set out? So be very realistic in terms of setting those milestones and communicating them with the investors and just have a good communication workflow with the investors too. Some investors don't want a lot of updates, but I think that's
01:07:44
Speaker
probably not good for you. If the investors don't want to engage with you on a regular basis, um, it might make your life easier in the short term, but you're probably better off having regular reporting to the investors and making sure they know what's going on with the business. And if you struggle, which you will, you know, make sure you communicate that a timely manner and say, Hey, this is a struggle we're having, the challenge we're having, we're going to,
01:08:06
Speaker
look at doing X, Y, and Z to mitigate it. Do you have any advice? And look, a lot of times these investors will have advice because they have been doing this for a long time. They'll have pattern recognition. They'll be able to say, hey, we've got three other companies that have the same problem. Here's what they did that worked and here's what they did that didn't work.
01:08:23
Speaker
and really just try to learn from those investors as much as you can. But recognize that this is a litigation risk for sure. Having poor relations with your investors is not good for you or for the business. So having good counsel also that you can talk to about these issues and can communicate with the investors on your behalf. Sometimes that's the best service a lawyer can offer you is
01:08:48
Speaker
having hard conversations with people on your behalf and making sure that communication is clear and concise. That's a good use of legal services. Charlie, remember we were speaking to a bunch of venture capital funds last year and they all said
01:09:09
Speaker
It's always so hard when startups are not transparent about the progress. Like we would love to have an information clause in our documents. They want access to doc libraries, yeah. Yes, because they always say like, we'd love to help them. We really do because that's why we're on board. Like at least most of it, some investors or some VCs will just be cash VCs, right? But most of them actually come with a blackbook.
01:09:34
Speaker
And he also said, we really want to help. Because we deploy capital in you, we want to help you succeed. But if you're not telling us where you are in the milestones, it's not looking good. But we also can't help you moving forward. And it doesn't matter if you're a serial entrepreneur that goes into a new industry or is in the same industry or in a first-time founder. Talk to your people. Talk to the people that deploy capital towards your company. And be very transparent about it. Also, if it's not going that well.
01:10:03
Speaker
Because generally, as you said, Beth and recognition, they will be able, like most of these people will be able to say like, yeah, hey, we've seen that problem before in different companies. We will help you or we need to, you need to talk to X or Y or Z or we'll open our phone book and you need to have a meeting with this person in order to move forward. It's very, very interesting that like, you know, we keep on hearing kind of these signals back now from you, David, but you know, before that also from, from venture capital firms that we've been talking to.
01:10:32
Speaker
uh, last year, but what I, what I found very interesting. And I learned that through experience. And I think a lot of speaking with different people, like, and I still find that really hard. And, you know, I'm, I'm an, uh, a contractor or like we're outsourcers. Like we help people build their company, but how do you spot, um, like investor want to take you for a ride, right? That are fake, that are not like credible. How do you spot that as a first time founder?
01:11:02
Speaker
Or as a serial entrepreneur that starts in a new industry, for instance, emerging tech. Well, I think you have to do some due diligence on the investors. So that's again, you know, part of the little services that you should be looking for is if you are getting investment from somebody and you don't know them very well to begin with.
01:11:20
Speaker
have a background check though, you know, because that usually will tell you, Hey, this person's been involved in a lot of shady deals. They've got lawsuits that have happened. Um, maybe interview some former, uh, partners, et cetera. I mean, you can spend some money on due diligence and save yourself a ton of problems. Um, again, it's, you know, being strategic about your legal spend part of it should be on due diligence, not just with investors, but strategic partners, people who come in hot and heavy and ready to work with you.
01:11:50
Speaker
You know, if you don't know them, you might want to pump your brakes and find out what is their background and their story, you know, where they come from and how does this play out. It's important to have that information.
01:12:02
Speaker
I can imagine that for some of our listeners, they're like, whoa, background checks, like these people want to give us, these people want to give us money, you know? And, and I, I generally, I think when we're talking about larger checks, but are there also certain checks and, and perspectives like the founders can do on themselves before they engage legal? Are there recommendations that you would say like, Hey, look at this or look at that.
01:12:27
Speaker
Yeah, I mean the internet's an amazing thing, right? There's so much information available right now. So doing your audio diligence for sure is helpful. Specifically the crypto space, I will tell you recently you've had some situations where people have been paid in USDC that ended up coming from tornado cash or got dusted from tornado cash and ended up causing real problems. So that's another issue too. When you're accepting money in cryptocurrency,
01:12:51
Speaker
I know it's probably not popular with a lot of folks, but know your client any money laundering laws are real and Recognizing where that money is coming from what wall that's coming from having clear representations and warranties that this money is you know
01:13:08
Speaker
from the people who are supposed to be investing and that it's not tainted by some sort of, you know, since then lock up on the wallet or something like that. I mean, I've seen that cause real heartache for people. So having that extra level of care about where the money's coming from and who it's coming from is super important.
01:13:27
Speaker
I think that kind of like also sits with that point of when to involve your lawyer into talks and investors, right? Because I think for a lot of people that do their first round or first ever round, or again, like in a new industry, like when should you involve a lawyer? Is that from the start? Like, or is that, you know,
01:13:48
Speaker
Is there a certain level of venture capital where you say, okay, now you should actually deploy a lawyer in order to make sure that you're not being screwed? I think it'd be time to take another people's money to have a lawyer, you know, just because that creates a fiduciary duty and you as a fiduciary can get sued.
01:14:08
Speaker
So anytime you take money from somebody else, you have a fiduciary duty, you have the potential for a lawsuit, you should definitely get legal advice. So I would say anytime you're taking money, have a lawyer help you with that transaction.
01:14:23
Speaker
Is that, and maybe that's, I'm not sure if you can answer that, but would you say that that goes for any continent? Because, you know, obviously you're based in the US and maybe some of our European listeners maybe think like, oh, well, that's the US, you know, like everybody sues each other there. What about Europe? Like, would you say the same thing? I don't know. I mean, I don't practice in Europe, so I can't say. I think morally and ethically, look, anytime you're holding somebody else's money and deploying it,
01:14:53
Speaker
and they expect a return on investment, you probably should have an attorney advise you on what are the terms and conditions of using that money and getting it back to these people. Whether you're in a litigious society like the US or not, just seems like the right thing to do. I fully agree. This next piece I find really interesting is, and this has been referenced to your point earlier about
01:15:22
Speaker
legal advice and clear communication. When you're negotiating your deal, how do you steer the balance of building a relationship with an investor whilst not, for lack of a better term, pissing them off with proper legal documentation? I mean, I've seen a few investors try and strong arm their way to a better deal through doing that. What's your feeling on that? Is that something that
01:15:51
Speaker
Should we just take the money and run as a first time founder? Should we? Should we, you know, because we don't know when you first start off, you don't have to call out where, you know, who are you? Right. Yeah. I mean, I think in some of these things, you do have to try to trust your gut in the sense that if you get the impression that these people who are giving you money are a strong arm, you are putting you in a compromised position.
01:16:19
Speaker
that probably shouldn't sit well with you at the beginning and it probably won't play out well at the end. So it needs to be a partnership even though, yes, they have money. There are lots of people who have money and if they're willing to give you money, probably other people are too. And if they're the only people on the planet that are willing to give you money, that raises some serious questions about
01:16:43
Speaker
whether you should be getting money at all, right? If you can only get money from these people, then maybe you need to revisit your business plan. But I think ultimately a lot of this business judgment comes down to understanding who your partners are, understanding, you know, can I work with these people a long time? Because you're getting into a very
01:17:00
Speaker
Uh long-term hopefully relationship, but it's a serious relationship one That involves a lot of money and the serious threat of litigation. So it should be uh, You know something you take very seriously not uh, just take the money and run attitude. That's that's probably getting a pertinent lot on it. Oh cool
01:17:23
Speaker
So, if I was to say, potentially, not use the word strong arm, but generally, I think there's a perception that if you're a first-time founder and someone's willing to invest in you, that comes with a lot of excitement. It comes with a lot of, look at me, I've made something that's viable.
01:17:45
Speaker
As a legal professional, when you're with clients who are looking to raise or are in the process of raising, how do you think you turn that balance of power and say, okay, listen, you shouldn't buy the first deal that you've been offered, but actually take a step back, sleep on it? Yes, I know they've said sign this by the end of the week, but how would you negotiate? What advice would you give to startup founders who are, I've got a deal on the table.
01:18:12
Speaker
you know, kind of want to jump at it. You know, startup founders and myself personally are optimistic by the nature, right? Which is good because otherwise wouldn't be taking any risks. Yeah. You have to go through the worst case scenario with these kinds of agreements and you have to understand what will happen in the worst case scenario. And in some of these agreements, what would happen is that your business might continue on without you, right? They might come in and replace you and move forward with the IP and you know,
01:18:42
Speaker
just completely take you out of the business. So understanding what is the worst case scenario and are you willing to take that risk? And if you're willing to take that risk, then okay, it may not happen. It probably won't be the worst case scenario, but one of the things that
01:18:58
Speaker
a good attorney will do for you is tell you exactly what the worst case scenario looks like. And they probably can give you some inkling of the percentage likelihood of that to happen, right? But ultimately you have to be comfortable with that worst case scenario before you take the money because there are going to be things that happen that you don't have any control
01:19:23
Speaker
You know, COVID was a good example of it, right? I mean, we can't predict it. But there are really bad things that can happen that will destroy your business, even if you do everything right. So understanding what that worst case scenario looks like with taking this money is super important. And having to explain that to you is probably a good idea. Yeah. So I think one of the
01:19:47
Speaker
And I certainly felt this when I was starting out. So I think this is quite a personal question, I suppose, which is without being drowned in legalese or feeling like I'm completed, when you're setting up your business, you're going to raise capital. What's the menu? What should you ask for of other legal professionals when you're
01:20:13
Speaker
Yeah, we've talked about a lot of stuff, but if we're going back to basics and we're saying, all right, I want to start raising capital. I know I'm like, I've got to the point where I know I need some legal advice. I vetted the firm. I know what the red flags are. What is it? I'm, you know, what's, what's the starter pack, you know?
01:20:32
Speaker
Yeah, I mean, I think what you want from the attorneys is advice now, like what are you going to need right now? And then what are you going to need in the next six months, next year, next three to five years? And, you know, a real discussion about whether or not that attorney can actually deliver that with their firm or if they can't, which they probably can't, they're probably going to have to associate with others, especially with international blockchain, their currency type business.
01:21:00
Speaker
You know a business in this space can have and i've seen and worked with clients that have had 10 15 20 different law firms working for them around the globe, right? It it can grow to that scale and so
01:21:15
Speaker
What you wanna do in the beginning is have a good scoping conversation with the attorney to say, hey, this is what our plan is. Realistically, what do you think? Are you gonna be able to help us grow from here to there? We understand you can't do everything, but do you have the capability to connect us with other people to help us get from here to there? And then what does that look like? And having that sort of big picture discussion at the beginning is probably gonna be very helpful.
01:21:42
Speaker
to set expectations for the future of, you know, services and you're going to have me expectations are huge in this business. I mean, whether it's investors expectations or the clients expectations, you know, you have to set those expectations up front and then revisit them often.
01:21:58
Speaker
I can't imagine that it's not always easy for founders to do, right? To come in with that scope of like, okay, what happens in the next six, one, two, five years, right? Like, I guess that like a large part of what you do or what any lawyer would do is kind of come in and help scoping that out, right? Like as Charlie and I would do in our respective industries, we won't take, generally won't take the client and say,
01:22:24
Speaker
Give us a bag of money. We'll run with it until it's empty. Yeah. What's your exit strategy? That's always a good place to start. I know it's, it's weird to ask that question when you're starting a business, but that's a good question to think about because if you just want to start it up and get out and go, sorry, another business, that's one model. A lot of people do that. You know, if you want to start it up and this is your baby, you need to do it for the rest of your life. That's a different deal, right? So understanding that upfront is super important.
01:22:49
Speaker
Okay, so thank you so far, David. This is the, towards the end of the episode, we have a little tradition, which is if you were yourself going to start a startup, you have no bags, so no capital, you haven't got your reputation, you haven't got your black book. What would you bring, if you were gonna go back in time and start a business, what would you bring to your startup desert island from now, knowing what you do know now?
01:23:20
Speaker
Yeah, I mean, this is probably one of the more boring lists because it's all going to be legal concepts. But the first one would be a good buy-sell agreement. So I'd want to have a good buy-sell agreement with my partners that lays out how we're going to value the
Mitigating Litigation Risks
01:23:33
Speaker
business. If somebody wants to exit, how long it's going to take the business to pay them off. If we need to have disability and life insurance policies to replace key members of the partnership and understand what everybody's tasks and roles are. But a good buy-sell agreement would be the first thing I would want.
01:23:49
Speaker
And that's so important for any business starting up. Secondly, I'd want to make sure we have a good understanding of how we're going to acquire resources in the form of independent contractors or employees or outsourcing and make sure those contracts are locked down, that everybody's clear on them and that they don't want to foul of any jurisdictional issues.
01:24:11
Speaker
specifically with tax authorities in different jurisdictions. So making sure that those internal contracts with individuals and companies that are going to be providing services are clear and mitigate litigation risk there. Third thing would be for the investors that we're going to have.
01:24:30
Speaker
We're probably going to be going through successive rounds of raising funds, hopefully, if we're successful. And so understanding who those investors are, making sure that they're committed to the cause and that they're going to help us, not just with money, but with strategic advice and making sure that we understand the fiduciary duties we're taking on.
01:24:50
Speaker
and that we're going to execute a plan that we can actually, you know, make work that we have realistic milestones and we're going to be able to report back to those investors on a regular basis. Hey, here's what we're doing with the money. Here are the milestones we're hitting and here's how we're working. So you maintain those good relationships and also mitigate your risks from litigation there.
Succession and Estate Planning
01:25:11
Speaker
Fourth thing would be succession planning inside of a company. So
01:25:15
Speaker
You can't do everything right. You're going to have different people taking on different roles. But what happens when one of those people decides they don't want to work anymore or, you know, God forbid, if they pass away or if they become incapacitated or life just deals with bad hand and they just simply cannot work for you anymore.
01:25:32
Speaker
How do you provide for a seamless transition for those tasks and what succession planning do you have in place for your business to be able to withstand a bump, whether it's you that gets taken out or one of your partners. You need to be thinking about these things. Those are real, real risks and real world concerns. And then lastly, and related to that,
01:25:53
Speaker
How am I going to provide for my people, my family, my loved ones? If I do pass away in the middle of this startup, are my estate planning documents in order? Are they going to be able to access the resources that I put into this and the value I put into it? And if so, how long is it going to take? Do I have all my other
01:26:13
Speaker
issues tied up, especially when it comes to cryptocurrency. You know, if you have crypto, making sure that you have a good estate plan that your people understand how to liquidate it or if you want them to liquidate it, how to access it, how to secure it. All these issues from an estate planning perspective are just going to give you peace of mind so that you can sleep at night and make sure that you can function properly and also just be confident that your affairs are in order.
Recommended Reading for Entrepreneurs
01:26:39
Speaker
So those would be the five concepts.
01:26:41
Speaker
That's fantastic. I'm going to add a quick bonus round to this five for two books I recommend that I found super useful at the beginning of my startup journey. The first one is Venture Deals by Brad Feld and Jason Mendelsohn. They are some of the authorities in essentially raising capital and ensuring that you have
01:27:05
Speaker
the right term sheet in place. And the second would be The Secrets of Sandhill Road by Scott Kapoor. That was essentially understanding how the game is played and how you get in front of VCs.
01:27:20
Speaker
So with that said, I'd just like to thank you, David, for your time today and explaining all the perspectives of how we should be looking at legal when we're thinking about taking a business zero to one in the emerging tech startup space. Could you tell our audience where they could find you?
01:27:37
Speaker
Yeah, so David Bocarble, I'm the director of Fennemore. My email address is dmocarble at fennemorelaw.com and you can find us at fennemorelaw.com. Happy to interact with anybody who has any follow-up questions and thank you for the opportunity, Charles and Thomas. It's been great talking to you. Appreciate it. Likewise. Absolutely likewise. It was a great conversation and I really, I personally learned a lot. Thank you, everybody. Like, subscribe and all that jazz and we'll see you on the next episode.