It’s good enough for Jessica Alba… is it good enough for you?

shutterstock_141790201I suspect that many of you have seen the TV advertisements for LegalZoom featuring the actress Jessica Alba, who tells us that she used LegalZoom to help her start Honest Company (a provider of eco-friendly products for children), which is now a multi-million dollar enterprise.

So should entrepreneurs use an online legal form provider (like LegalZoom, RocketLawyer or Clerky) for their startups?

My answer may surprise you.

If you are a small business or sole proprietorship with just a handful of employees and you do not intend to expand your shareholder base or raise outside capital, then online legal form providers may be the right answer for you.  These types of service providers offer simple incorporation documents (and even assist in making the requisite corporate filings) that enable small business owners to form a corporation, obtain necessary licenses and registrations, and file simple trademarks.  For owners who simply want to run a business and do not intend to engage in any corporate transactions such as issuing stock options, raising money through debt or equity, or buying or selling companies, this could be the best alternative for you.

However, remember that these legal form service providers are not lawyers.  They are non-lawyer legal forms and document preparation service providers.  As a result, they cannot and do not provide any legal advice (unless you subscribe to separately-offered monthly pre-paid plans whereby you are connected with a network of attorneys).   These providers have a limited capacity to make sure that the documents you are completing are the right ones for you.  Their “review” process involves ensuring that the pages of your document are numbered, that names are spelled correctly, and that the dates and the other data you supply are consistent.  Moreover, because these are non-lawyer organizations, they are not required to conform to bar ethics rules, they are neither licensed nor regulated by a state bar, they are not obligated to check for conflicts of interest and they do not need to adhere to state bar confidentiality requirements.  In addition, because online legal form service providers are not attorneys, there is no attorney-client relationship between you and them.  This means that anything you disclose to them could be obtained by a third party during the course of litigation against you or your company outside the scope of attorney-client privilege.  Indeed, these providers come right out and say that in their terms of service and recommend that you seek the advice of an attorney to review the documents they prepare since such documents are not customized to your particular needs.

Okay, so you understand the risks, but online legal form providers are so much cheaper and there are fewer associated startup costs as compared to most law firms.  So, why should start-ups use a law firm to assist them with their incorporation process and other legal needs?

Expertise.  Although incorporating a new company is a fairly straightforward process, there are a number of questions to consider as you start your new corporation and build the foundation for your company’s future.  Should you be an LLC or a corporation?  An S-corporation or C-corporation?  Delaware or Washington?  How many shares should you authorize?  How many shares should you issue?  Do you need preferred stock?  Who should be on your board of directors?  Do you need an equity compensation plan to issue stock options and restricted stock to your employees?  What is a shareholders agreement and do I need one?  What about a non-disclosure agreement?

By working with an attorney who is familiar with start-ups and possesses expertise in this area, you will get customized advice that is based on your needs and also reflects what is “market” for start-ups that intend to grow, raise outside funds and expand their shareholder and employee base.  This area of law is not simple; there are a number of risks involved with forming a corporation and operating a business, especially if you intend to issue stock options and/or raise money by selling stock or borrowing money from friends.  An experienced corporate/securities attorney can help you avoid common corporate law mistakes that may haunt you in later years as you try to raise funds or sell your company (and the potential buyer discovers corporate missteps during the due diligence process) and also assist you in steering clear of securities law violations that may result in liability, including criminal liability in the most egregious of circumstances.  There are also a number of important tax considerations involved in the formation process for which it is important to seek the advice of an experienced tax attorney.

Relationships.  By working with a law firm and dealing with the same attorneys on a consistent basis, you will get personalized service from lawyers who will take the time to learn about your business and understand your strategies, and will apply corporate and securities law to your specific situation, as appropriate.  It is important to be able to pick up the phone and know that you will be able to talk to someone on a first-name basis – an individual that you have met in person and who is familiar with your business plan.  This attorney will be there for you if issues arise and can help prevent such issues from arising in the first place.  In addition, this attorney can help you build your team – by referring you to attorneys with expertise in other areas of the law (including tax, employment, litigation, trademark and patent) and connecting you to accounting firms, insurance brokers, bankers and even potential investors such as angels and venture capitalists.

Legitimacy.  Speaking of outside investors, it is commonly understood that when venture capitalists and angel investors are evaluating companies for a potential investment, the strength of the company’s management team (including its outside advisors) may be just as important as the company’s product(s) or service(s).  An investor wants to see that the founders have made good choices in terms of the outside service providers that they have retained, and that the founders have been willing to make an investment in the future of the company by hiring an experienced law firm with names that are recognized in the financing community.  Even if a start-up used an online legal document company to form its corporation, outside investors will require these companies to retain an outside law firm as a condition to moving forward, and will likely want to “help” the start-up select which firm to hire.  Many entrepreneurs would prefer to choose their own law firm, build a relationship with an attorney, and have someone “in their corner” before meeting with outside investors.  In fact, a lot of hassles can be avoided if experienced outside counsel is brought in well in advance of receiving a term sheet from prospective investors.

It is Possible to Manage Legal Costs, Even for Startups.  Many firms are now offering fixed fee packages for such legal services as incorporation and simple financings.  For example, Summit Law Group offers a variety of fixed-fee packages and alternative pricing models, such as the “Base Camp” startup package that includes all of the documents and agreements that a start-up will likely need for its incorporation, initial capitalization, and first year of existence, as well as providing attorney consultation on matters that most startups will face in their first year.  In addition, as a start-up matures and engages in other transactions, it can ask its law firm to provide budgets, work on other fixed-fee arrangements, exchange equity for fees and/or enter into other alternative fee arrangements.

Bottom Line.  Online document preparation services do provide a reasonable alternative to small businesses and sole proprietors who do not foresee requiring legal services beyond the simple incorporation process.  However, if you are a start-up with a dream of growing your company and expanding your business, it likely makes sense for you to partner with an experienced law firm from the outset – one that can help you build a solid legal foundation, advise you on what is market and what outside investors will expect, guide you through potential legal minefields in an ever-evolving legal landscape, learn your business and offer customized advice.  Throughout my career, I’ve found time and time again that the costs of building a relationship with a law firm are nominal compared to the costs of not doing so.  Starting and running a company is hard enough – it might be best to leave the legal issues to the lawyers so that you can focus on the fun stuff.

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