Should start-ups shun shares-for-fee deals?

Lastminute.com and drParsley.com may both be well-known dotcom companies, but they have different opinions about the wisdom of inviting external legal advisers to take shares in their clients instead of fees.
In one corner is Lastminute.com, whose advisers are Bird & Bird and Linklaters & Alliance. The company has grave reservations about the trend, and has not invited the firms it instructs to take its shares instead of fees.
DrParsley.com, on the other hand, thinks it is a good idea. It willingly gave its lawyers, Field Fisher Waterhouse, a stake in the company in lieu of fees.
So far, more law firms have come out in favour of the shares-for-fees option than have publicly rejected the option.
The reasoning behind this is that as fledgling clients are short of cash in the early stages of their development – it is a good idea to give their legal advisers shares instead of fees, thereby allowing them to reap the rewards for their patience at a later stage when these clients ‘grow up’ into a multi-million pound company.
In a volatile market with senior associates and partners enticed away to start-ups with the promise of large stakes in them, firms are also keen to take shares in an effort to hold on to their e-commerce stars.
Unthinkable 10 years ago, the pace of change in the e-commerce market has forced a rethink of the traditional lawyer-client relationship.

But is it what the clients want?
The comments of Christopher Heather, in-house lawyer at Boo.com, seem to suggest it is not. He jokes that shares should be the sole preserve of in-house counsel. “There is no lack of people here who want to invest in the company, so why give shares to external advisers.”
Joking aside, shares-for-fees arrangements are beginning to take a hold of the market.
Law firms say they are responding to the culture of the new market. Suppliers across the board are taking on share options in place of fees and e-commerce clients expect their legal advisers to fall into this culture.
Field Fisher broke the ground two years ago when it announced that it would take equity in clients. A raft of other firms keen to attract the e-commerce clients have followed suit, and it is not just the niche IT practices that are taking the plunge.
Linklaters became the first magic circle firm to dip its toe into the water earlier this year and Clifford Chance is “looking carefully at it”.
But leading e-commerce player Bird & Bird surprised the market last week by coming out firmly against the concept of taking shares in lieu of fees due to potential conflicts of interest.
Managing partner David Kerr said that although UK firms think they are following the US model, this is not in fact the case. “If you look at the US market you find that most firms react against the shares for fees – because of potential conflict,” he says.
For its part, the Law Society has given the green light to firms that want to take a stake in their clients saying that it does not want to stand in the way of commercial change.
It is currently drawing up guidelines to deal with potential conflict of interest issues that can be thrown up by a law firm taking an interest in its client and is adopting a ‘wait and see’ approach.
The attractions of ‘share options for fees’ to the start-up client are obvious. With a good idea but limited resources, the appeal of free legal advice at an early stage is strong.
IT/Telecom specialist David Naylor at Weil Gotshall & Manches, which is understood to have recently approved in principle the idea of taking shares for fees, believes clients are keen.
“There are clear advantages for the start-ups. At the beginning of a venture, cash is extremely valuable and the equity they have is available in spades,” he says.
By taking shares in the client, the firm is also showing faith in the business, which some believe is more important to start-ups.
Mehmet Golhan, chief executive of drParsley.com, who describes himself as the “chief gardener” of the venture, says lack of funds was not the main issue.
“It was not the money issue – we can always negotiate fees. It was the belief in us that was crucial. I was touched that they believed in our mission enough to take shares in the company,” he says.
Golhan came over from the US nine years ago and worked in the City before coming up with the idea for drParsley. He says the legal profession has to adapt to the new economy.
“The new economy challenges the way that everyone does business. There is a major change happening, it is challenging pre-conceived ideas and everyone has to develop new ways of operating. If the UK firms do not adapt they are in danger of lagging behind their US counterparts.”
An in-house lawyer at a well-established internet service provider agrees. “It is definitely a US thing – it is a good idea to get a company off on the right foot in cost-effective way. But it is also good for the client to know that the lawyer is close to the business. In my view, it makes for a better adviser; if they have a vested interest in the company they will dedicate more time to understanding the business.”
But some believe that law firms are a different animal to other service providers and are taking the concept of partnering too far by taking shares in a client.
The danger of getting too close to the client is that it exposes the firm to the risk that it will no longer be perceived as being completely independent.
There is also potential for perceived unfair advantage. Start-up clients, by their nature, rarely have in-house lawyers. This is a luxury reserved for the pundits that have already made it in the e-commerce world.
As the client matures the potential for conflict of interests emerging grows with it.
At the early stages of the start-up, legal advice is normally confined to issues relating to the corporate structure. Problems arise when legal advisers are called in to advise on issues that affect share value and the law firm’s own financial interest in the group. This becomes a crucial issue as the client moves towards an initial public offering.
One start-up that has reservations about the shares-for-fees trend is Lastminute.com which has become the by-word for successful start-up ventures. Finance director Justin Culhane said the group had opted not to offer shares for fees. Although he can see the advantages, he is concerned about how the market reacts to dealings by advisers close to the company: “What does it look like when outsiders find out that your advisers have sold stock? Even if the information is not publicly available, my view is that the information is bound to come out and the risk is that the market will react accordingly.”
Advocates of law firms taking equity in their clients say that an outside adviser with shares is no different from management and employees holding equity.
But Culhane feels that the potential for conflict of interest is too great.
“There is a risk that this affects the impartiality of the advice given – I am not suggesting that it would necessarily be a problem, but there is always the potential for it.”
But those in favour of shares-for-fees point to the professional obligations of law firms, which they say will mean that they always advise objectively in the interests of the client.
One e-commerce in-house adviser who did not want to be named said: “Good lawyers will not allow their interest in the business to influence them. It is in a lawyer’s interest to maintain their independence – it is in their interest to maintain their reputation – bad PR would not be good for a firm.”
Golhan at drParsley.com agrees with this, he says the firm’s commitment to the start-up creates an environment of trust.
“If the firm believes in us enough to take an equity stake, we believe that they will deal professionally and truthfully with us.”