Tip 2: Hiring an Attorney for You – Not the Group

This is part 2 in our series of tips for new investments. In part one; we discussed the disadvantages of using standard form documents to govern the new investment or business. Now in tip #2, we are going to talk about the role of attorneys in the process.

The disadvantage of hiring one attorney to represent a group of investors.

Attorneys are supposed to represent the client that hired them and give that client their devotion and loyal advice. What an attorney is not supposed to do, as a general rule, is represent two parties who have opposite interests. But what happens when a group of several individuals plan to start a new venture and approach a lawyer and ask for help forming the company. This represents a potential conflict situation because what might be the best deal structure or terms for one of those investors may be a bad deal structure or terms for another. The interest of the person who is putting up cash for a 60% stake might be adverse to the interests of the person who plans to work at the company and provide services in return for a 10% stake. If true, one lawyer can’t give both of those individuals their complete loyalty–their interests are adverse.

The Ethical Rules in Texas

In Texas, the Texas ethical rules for attorneys, called the Texas Disciplinary Rules of Professional Conduct, make it clear that an attorney can’t represent adverse parties (Rule 1.06(b)). But there is an exception where the attorney is basically just serving as a “scrivener,” a sort of Ebenezer Scrooge type term for a lawyer who agrees to represent multiple clients at once but whose work is basically limited to setting out the parties’ agreement in writing. (Rule 1.06(c)). A lawyer taking on this kind of task cannot advise one of the investors to the exclusion of the other–basically it can be hard for them to give much useful advice at all.

Pay now or often, pay later.

When a group of people come to an attorney and ask the attorney to represent them jointly in setting up a new business entity, the attorney typically hands over a standard form document. Although it can work out to pay a lawyer a flat fee to get a set of form docs that have no real applicability to your unique business, it can also be a mess. As addressed in our first tip, right away this puts individual investors at a disadvantage. Once the attorney is asked to address the needs or requests of one particular attorney, he or she risks crossing the line from just preparing documents to memorialize the parties agreement to advising one of their clients in a ways that are adverse to the others. In effect, the lawyer for all is often the lawyer for none and everyone is frustrated. A much better solution for purposes of protecting your interests is to hire an attorney to represent you, as an individual owner and investor; not the group.  If you don’t, and later have a dispute about the company, it can be much more expensive to try and address that dispute through litigation.

The pros and cons of getting your own lawyer

Let’s get the obvious out of the way – hiring more lawyers adds costs, and those costs have to make economic sense in light of the size of your investment and your economic leverage entering into the deal. However, the more money you are putting at risk in this new venture (and the more important you are to the overall venture) the more it makes sense to have an experienced attorney reviewing the deal on your behalf.

Hiring a lawyer to look out for your individual interests gives you the benefit of their experience in reviewing and revising those standard form corporate documents to protect your interests as an owner and investor. Even if you can’t get every provision you want in the deal, you will know what you have and better understand the downside risks. If everyone else does not hire their own attorney then you get the benefit of professional advice while everyone else flounders about. While one lawyer, trying to represent the whole group, will want to avoid getting involved in negotiations between the client group members, your individual lawyer will be there to do just that and can help you avoid traps for the unwary and identify red flags that you may not have seen in those standard form documents.

As we will address in our next tips, some of the most important provisions that an attorney should address are how the business will handle key decisions and the investor’s exit strategy. But most form documents bury these issues in boilerplate or don’t address them at all. Worse still, exit strategy is often never discussed and the investors create a new venture with no mechanism for an owner to monetize their investment and exit the business. The consequences of failing to address these key issues can be substantial.