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Tech startups, the once-dazzling clients that made every law firm in Silicon Valley salivate, seem about as glamorous these days as a trip to Kmart. That doesn’t mean lawyers are turning them away. In a bad economy, any client with a pulse is better than none at all, and some firms, in fact, are getting even more aggressive about enlisting startups as new clients. Yet it’s a strategy fraught with financial risk. Tech lawyers say they are increasingly writing off bills from startups that can’t pay, and they are encountering demands for discounted rates they wouldn’t have dreamed of entertaining during the height of Silicon Valley’s boom. The new environment “means you have to be more flexible,” said Cooley Godward partner Mark Tanoury. “And how flexible depends on your view of the opportunities.” Given the uncertain economy, it’s no sure bet that fledgling enterprises will get the venture backing they need to pay their bills. In all, VCs put out just under $17 billion in the first three-quarters of this year, compared with nearly $85 billion in the same period in 2000, according to investment data compiled by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association. And the drop in the number of startups actually getting funding is just as dramatic, according to the same study. VCs backed just 119 startups in the first three-quarters of the year, compared with 526 in the same three-quarters of 2000. The sour news may leave tech firm lawyers with the question: Do they dump startups altogether and use their time to go after bigger, more mature companies? For lawyers like David Healy of Fenwick & West, the answer so far has been “no.” Healy and others still say they have faith that many of their startup clients will be successful. After all, the gamble could pay off with another titan like Cisco Systems Inc. or Sun Microsystems Inc. that will yield huge legal fees for years to come. “It’s like a bet,” Healy said. “You have to figure out when leaving your money on the table and extending your bet is appropriate, and I certainly have companies where I’ve lost this bet.” Healy acknowledges he’s not immune to the write-off phenomenon. He had four companies die on him this year. They translated to several hundred thousand dollars in lost legal fees. And he’s still carrying about a dozen startups that have yet to be funded by venture capitalists. “The write-off percentage will be higher this year than in prior years,” Healy said, adding that firms will likely write off twice as much in unpaid fees in 2002 as in prior years. And even if the clients do cough up the dough, they may not be paying the rates of a few years ago. Healy said he regularly fields requests from entrepreneurs who want discounts and their bills deferred for long periods. Clients also no longer pay premiums for initial public offerings and mergers and acquisitions as they once did. The tough times, however, haven’t stopped Healy from asking for equity in the more promising startups. Some of his more common terms include attending board meetings for free or at a cut rate until the company is funded. Then the company has to cut him in for 1 percent, which vests over four years. “That shows I’m committed to a long-term relationship and not a quick hit, ” he said. For Cooley Godward’s Tanoury, the environment for startup clients feels much as it did during the mid-1990s before the Internet bubble — when cut-rate fees and competition for the work was commonplace. But on the upside, startups don’t usually require a great deal of complicated legal work to get started or to look for venture capital. “If they raise it, great, and if they don’t, you’re not that exposed,” Tanoury said. “Most lawyers are willing to have a few of those going on at the same time.” At Venture Law Group — a firm created specifically to take on startup clients — lawyers are actually being encouraged to throw their arms around technology upstarts. The firm used to observe what it called a “three-dog night” rule. That limited to three the number of startups without venture funding each partner could carry at one time. Earlier this year, the firm upped the limit to five. “It incentivizes everyone to go out and have their pipeline full of companies,” said Donald Keller Jr., a VLG partner. “We are being more aggressive about business development.” Throwing resources into companies that might not pay their bills may seem like career suicide for lawyers struggling to find billable corporate work. But as Brian Beard, a Wilson Sonsini Goodrich & Rosati partner put it, this year’s startups are next year’s mid-size operating companies. “It’s trying to feed our next batch of big companies,” Beard said. With all the focus on larger companies in recent years, Beard finds he has a shortage of well-funded, midsized companies to round out his practice. He’s trying to rebuild that category of clients now by enlisting more startups. Still, he checks their bills and their progress quarterly, and he’s making sure they are aware that venture capital is much harder to come by. “We spent more of our time educating them on how difficult it is to raise funds these days,” Beard said. “It’s such a different playing field.”

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