LinkedIn’s Open Source Risk Factor

LinkedIn filed a registration statement with the SEC yesterday. One of the risk factors was the following:

“[W]e use open source software in our solutions and will use open source software in the future. From time to time, we may face claims against companies that incorporate open source software into their products, claiming ownership of, or demanding release of, the source code, the open source software and/or derivative works that were developed using such software, or otherwise seeking to enforce the terms of the applicable open source license. These claims could also result in litigation, require us to purchase a costly license or require us to devote additional research and development resources to change our solutions, any of which would have a negative effect on our business and operating results.”

Oops.

1. What’s the issue with open source?

Chances are that, even if you’re building a proprietary software application, it will include some open source. This will either be a deliberate decision to take advantage of pre-existing, tested, and free (or affordable) code, or a reality that comes from developers choosing to incorporate open source into a product despite corporate policy to the contrary, most likely for reasons of perceived efficiency.

Even then, whether the open source code may cause a problem for your proprietary model will depend on the license terms that apply to the code. While you should always be aware of the license terms that apply, most people confine their concerns to “copyleft” or “hereditary” license terms such as the GPL or L-GPL license terms.

At a very high level, the terms of copyleft or hereditary open source licenses may require you to disclose or distribute source code for other code you “combine” with the open source (including your proprietary code), or license code “combined” with the open source to the general public to enable them to modify it. In other words, you may be required to make public code you would prefer to keep secret.

If you don’t comply with the disclosure and modification licensing requirements of copyleft or hereditary open source license, then your use of the open source code will very possibly be treated as an infringement of the copyrights of the open source owner (or an organization to which they’ve transferred their enforcement rights) – which exposes you to damages claims (i.e., financial liability) and the possibility that you may be forced either to comply with the requirements (i.e., disclose and share your proprietary code), or to remove the open source from your product (i.e., re-engineer, and force your users to upgrade).

2. But Don’t the License Terms Explain My Obligations?

The GPL licenses have been well-described as software developers’ revenge on intellectual property lawyers for making software the subject of copyright law. While the copyright law works “OK” for software, it isn’t a straightforward or intuitive fit. With the GPL licenses, software developers attempted to re-define copyright law concepts in a way that they believed both met their “free software” goals, and applied copyright law concepts more appropriately to software. The result, and I genuinely will not pick sides on this, is that it is incredibly complex to try to determine how the courts would apply the GPL license terms in determining the point at which a “combination” of GPL software and proprietary code would require disclosure and sharing of the proprietary code. Every time I get a call from a client saying, “Hey! It looks like we’ve included some GPL code in our proprietary product (and we want to release it tomorrow). Is this a problem?” I open up the GPL license terms and am reminded of Robert Falcon Scott’s words on reaching the South Pole – “Great God this is an awful place …”

3. But everyone’s using L-GPL, and plenty of people are using GPL – why can’t we?

This is true, and there are ways in which you can engineer your products so as to “insulate” your proprietary code from copyleft or hereditary software. But you have to do it right, and there will be some element of uncertainty owing to the challenging nature of the license terms for the open source code.

To be fair, this isn’t always the fault of the people who wrote the open source licenses or the lawyers who interpret them. For example, L-GPL is a less restrictive version of GPL designed to apply to libraries. But some developers don’t realize this and, thinking that L-GPL is simply a less restrictive version of GPL, apply it to code that isn’t a library at all. At that stage, you get an already complex license whose application to the technology it’s intended to cover is now incredibly difficult to interpret.

4. Why did LinkedIn disclose this as a risk factor?

My guess is that LinkedIn’s developers have built a significant portion of LinkedIn’s code using copyleft or hereditary code, but may not have sufficiently insulated LinkedIn’s proprietary code, so they may face exposure for infringement claims.  “Ideally,” LinkedIn would have had better controls on their inbound licensing processes – but as those experienced with start-ups and early stage tech companies know, controls and processes are not always a priority.

When legalese is not enough

The Washington State Attorney General’s office has entered into a consent decree with Intelius to settle allegations of deceptive marketing tactics relating to post transaction marketing. The consent decree involves a $1.3 million payment by Intelius, and Intelius’ submitting to a series of permanent injunctions restricting its advertising practices.

“Intelius chose cash over candor” Attorney General Rob McKenna said. You can see the AG’s press release, with links to the complaint and consent decree here .

The complaint makes for interesting reading. Looking at it from a high level, the AG’s office had two primary concerns.

First, according to the complaint, Intelius deliberately designed its web pages so as to get customers to sign up for additional services, even though this may not have been the customer’s intention.

Second, Intelius shared its customers’ personal information with third party service providers, despite its privacy policy saying it wouldn’t do so without the customer’s consent.

In both respects, Intelius disclosed what was actually happening and set the customer up to provide its nominal assent, but it did so in ‘terms and conditions’ language that was considerably less prominent and easy to read than its ‘click to proceed’ language. In other words, although Intelius provided literal disclosure to the customer of what was happening, the AG’s office contended that most customers would focus on the proceed buttons, and not on the legalese. The AG’s office concluded that the relevant web pages were deceptive when taken as a whole.

This provides some useful pointers for businesses that use consumers’ personal information, or which sell products or services to consumers online, especially when put together with comments by FTC staff at recent privacy and advertising law conferences.

I remember the senior partner at the venerable London practice where I began my legal career sharing his golden rule for determining materiality: ‘The less management wants to disclose it, the more material it is.’ It has to be said that many lawyers have nonetheless developed an art form around making the most material disclosures seem bland.

What the FTC and many state AG’s seem to be indicating is that mere disclosure in terms and conditions may not be enough to satisfy them that consumers aren’t being deceived. If a consumer’s being asked to do something with a recognizable downside (e.g., sharing sensitive information with a third party, or surrendering a legal right), then it looks like best practice will be to create web pages that are designed to ensure the consumer provides their informed consent. I think this requires appropriately placed, simple, plain English statements, in an easily readable font size, even if these duplicate disclosures already made in generic terms and conditions. I think this requires exercising some judgment as to what will be material to a consumer; depending on the business model, the disclosures may not always be palatable to management.

According to the Washington AG’s complaint, Intelius’ revenues from its post transaction marketing were significant. At some stage, I’d assume that Intelius’ management had to balance changing its practices against losing a portion of those revenues. Once the Washington AG became involved, Intelius had little choice but to take the revenue hit. Intelius had filed for an IPO – that kind of change in revenue growth can’t have looked good.

The Cassandra Complex

First off – apologies. This isn’t the opening chapter to a Robert Ludlum novel, nor a tribute to the (apparently) legendary Euro-goth band.

One of my close friends runs a mountain guiding business. He recently spent a week’s well-earned vacation in Mexico, where he took surfing lessons. One of his conclusions was that it was surprisingly beneficial to switch roles for a while and become a customer instead of a service provider.

On a less enjoyable note, my wife and I have spent the last 2 months up to our ears in doctors, dealing with a high risk pregnancy. I couldn’t help but compare my reactions to the advice given by the doctors to the reactions clients must have to their lawyers. None of this was particularly subtle, but I found it interesting nonetheless. In no particular order:

  • Technical knowledge isn’t much help if the professional lacks communication skills. Corporate and IP clients tend to be pretty smart. If they don’t understand what I’m telling them, I assume it’s because I’m not explaining it well.
  • Communication skills alone won’t help a professional explain risk and make recommendations. Over and over again, the best advice we got came from the doctors with the most hands-on experience of what we were dealing with. They didn’t need to use extremes to justify their recommendations, and they were able to address uncertainties in ways that contributed to our understanding instead of undermining it.
  • It wasn’t difficult to distinguish between doctors who became personally engaged in our issues, and doctors who preferred to keep their distance. Advice from the former was always more compelling than the latter. (But, several doctors who were initially distant quickly became engaged, and their advice became more useful when they did so.)

Where does Cassandra come into this? More often than not, providing professional advice is less a matter of technical acumen, and more a matter of risk management. It’s hard to predict the future in a professional capacity and either (a) get believed, or (b) get credit for getting it right.

At one stage during our medical adventure, in a situation rife with uncertain outcomes (both good and bad), the doctors told us ‘We recommend you do X, because we’re worried about Y. Y may very well not happen, but it might.’ Doing X was onerous, but they pitched their advice right, and we followed it. Y did happen, so we had the luxury of knowing that the difficulties we’d incurred had been justified.

Every so often, lawyers will see clients heading down a path they’ve seen other clients follow with bad results. They’ll explain the risks to the client and make recommendations accordingly (ideally, by recommending a better way of achieving the same goal). At this stage, one of two things happens:

(A) The client decides that the risk won’t affect them, and goes ahead with its original strategy, usually because there’s some urgency in getting from point A to point Z. Subsequently, tactful lawyers will refrain from saying I told you so, and help extricate the client from the mess. (This is a more difficult scenario to deal with when you’re in-house counsel – you have to fix a mess you advised against, and not only do you not get compensated for the extra effort involved, but the cost of fixing it typically comes out of your own budget!) Alternatively,

(B) The client follows advice. Nothing bad happens. The client is never sure whether the lawyer’s foresight was correct, and whether the extra effort involved in following the advice paid off.

Maybe if Cassandra had had more experience of Greeks bearing gifts, and were able to communicate it, she wouldn’t have had to stand by and watch the Trojan horse wreck. But she’d have had to live with the subsequent complaints about looking a gift horse in the mouth.

Software licensing fundamentals

We do a lot of software licensing transactions. This article addresses two fundamental areas of software licensing legal practice that I think often get missed, but which can be critical to getting the deal right.

A.     Revenue recognition. How revenue is recognized on a software licensing transaction is plainly an accounting issue (as opposed to a legal issue). However, for most software businesses, the manner in which they recognize revenue is a critical component of their licensing program. Investors, partners and customers evaluate a software business’ performance by reference to its revenues. If a company is unable to recognize revenue on a transaction in a manner consistent with its standard revenue recognition policies, then the fees underlying the transaction may not qualify as revenue for the intended period – this can have a detrimental effect on the company’s ability to demonstrate its performance as it would have preferred.

Most software companies’ revenue recognition policies will be established and policed by its accounting team. However, it’s not always practical for the accounting team to be involved in every stage of negotiations around licensing and pricing terms. In these circumstances, it’s helpful to have a basic understanding of the rules affecting revenue recognition, and the specific manner in which the company applies them. Ideally, a lawyer representing a software vendor will have some familiarity with the vendor’s revenue recognition policies.
The primary authority for software revenue recognition in the U.S. is AICPA Statement of Position (SOP) No. 97-2, Software Revenue Recognition. This is a lengthy document; it is, however, surprisingly readable.

At a very high level, revenue will generally be recognized once the following four conditions have been met:
  1. Persuasive evidence of an arrangement exists, e.g., an enforceable contract.
  2. Delivery has occurred.
  3. The vendor’s fee is fixed or determinable.
  4. Collectibility is probable.
There are many intricacies to SOP 97-2 and each vendor’s individual revenue recognition policy, so don’t take the list above as all that’s necessary to understanding the issue.

Because revenue recognition is so critical to measuring a company’s performance, software companies may not have much flexibility when negotiating certain of their licensing and payment terms, especially if deals have been structured so as to enable the company to recognize revenue within a specific period. For example, if a vendor has provided price concessions based upon its recognizing revenue from a transaction by September 30, 2010, but the customer insists that payments will be refundable if the software does not conform to acceptance tests that the customer won’t complete until October, 2010, then both parties will have a problem in closing the deal as they’d hoped. (Acceptance testing with refund rights would be problematic under item 3 above: the fee wouldn’t be fixed or determinable.) Lawyers negotiating the transaction may be called upon to find compromise solutions that conform to the vendor’s revenue recognition policies, but still provide the customer with an appropriate level of comfort regarding the software it’s acquiring.

In summary, persons involved in software licensing transactions will be more valuable to their principals if they understand the interaction between the deal terms and the vendor’s revenue recognition goals and policies.

B.     Copyright. Software programs constitute intellectual property that may be protected by a variety of intellectual property laws, including trade secret, trademark and patent rights. However, software’s fundamental protection lies under the copyright laws.

In very broad terms, the intellectual property laws provide the owner of intellectual property with certain ‘exclusive rights.’ These rights enable the owner to exclude other persons from doing certain things with the intellectual property, except to the extent the owner has specifically granted a person the right to do so (e.g., under a license agreement).

Under the patent laws, an intellectual property owner has the right to control how others ‘make,’ ‘use,’ or ‘sell’ a patented invention. Under the trade secret laws, an intellectual property owner has the right to control how others ‘use’ the protected invention, unless the others develop their invention without access to the protected invention, or unless the protected invention no longer qualifies as secret. Under the trademark laws, a trademark owner has the right to control how products and services are associated with the owner’s trademark (e.g., I can’t associate my software program with the MICROSOFT mark unless I have a license from Microsoft to do so).

Most software lawyers will readily acknowledge that, while the copyright laws don’t provide the most intuitive intellectual property law vehicle to protect software programs, software programs fall under copyright. Because the copyright laws evolved out protecting (in rough order) literary, dramatic and musical works, then audio and audiovisual recordings (such as music recordings, radio broadcasts and movies), the application of copyright law principles to software can look a little odd. This is evident in the exclusive rights under the copyright laws. These exclusive rights are as follows:
  • The right to reproduce a work
  • The right to distribute a work (i.e., to provide a copy to a third party)
  • The right to display a work
  • The right to perform a work
  • The right to create derivative works of a work (i.e., in very general terms, to create modifications)
Surprisingly, many software licenses, especially forms pressed upon reluctant vendors by their customers, don’t address any of the exclusive rights under the copyright laws. They simply provide the licensee with the right to ‘use’ the software. This is all well and good to the extent the licensee needs rights under the software licensor’s trade secret and/or patent rights. But, it doesn’t do much in the way of specifying what rights the licensee has under the copyright law. For example, if I have a license to ‘use’ software, do I have a right to make modifications to the software?

Ideally, a software license will expressly address each of the necessary exclusive rights under the copyright law. For example, a typical license grant might state: ‘Vendor grants Customer the non-exclusive, non-transferable, worldwide right to make up to [####] copies of the Software, and to distribute such copies internally within Customer and install them on up to [####] personal computers owned or under the control of Customer. Vendor grants Customer the further right to create derivative works of those portions of the Software identified as ‘modifiable code’ in the Documentation. Vendor reserves all other rights.’

If the software is also protected by trade secret or patent rights, then the Vendor could also impose restrictions on use of the software, e.g., ‘Customer may use the Software solely for processing data related to the business of its [XYZ] division.’

Different rights may apply depending on different licensing models and technical architecture. For example, if the customer is acquiring rights to a cloud-based application that will make information available to the customer’s customers via web pages, then the customer would need a right to ‘display’ the web pages generated by the software.

In summary, since licenses are governed by the intellectual property laws, it’s important to give some consideration to which intellectual property laws apply, and whether the license correctly addresses each of the rights made available by the intellectual property laws. A simple license to ‘use’ software is a recipe for confusion if a dispute arises over the scope of the usage rights.

Early Stage Tech Companies – When Should You Involve a Lawyer?

Early stage tech companies know that they need to hire lawyers. This post provides some help in figuring out when to spend the company’s hard earned cash on legal advice, and when it might be OK to do without. As with many things legal, there are no clear boundaries, but these are the guidelines I tend to use when working as general counsel with my own budget to manage.
General principles
Value and Risk Management. When I think about the need for legal involvement, I consider two primary drivers – value, and risk management.
Value. Value goes to the creation and preservation of value in the company. This may take the form of revenue generating transactions, or of events that will affect exit strategy.
It’s a surprisingly disregarded truism that businesses run on cash – if you’re going to be bringing revenue into the company, you need to make sure (a) you can collect, and (b) you can do so within the resource commitments you expected. If a deal or contract form is going to drive a lot of revenue, it makes sense to get your lawyer involved.
The inevitable precursor to most exits is “due diligence.” If you’re exiting in less than exuberant times, or if your revenues or page views don’t far exceed the norm, due diligence can become a mechanism by which your buyer will try to drive down the purchase price. Due diligence will turn up sloppy contract processes or poor protection of key intellectual property (IP), and you’ll be kidding yourself if you think you won’t be called upon to explain it. That having been said, not every issue will be a red-flag issue.
Risk Management. This one is easy to describe, but more difficult to assess: “What’s the likelihood of this event or transaction biting me, and how hard will it bite?” As a rule of thumb, I don’t get too worked up about transactions involving less than $35,000 – sad to say, this amount is seldom worth litigating, and I think resources are better spent on building a good relationship with the other party, so that difficulties can be handled in that context. I also think that many of these issues can be effectively managed by using good contract forms for your service providers. Many service providers to early stage companies are willing to work with the company’s forms.
Fairness. I’m a firm believer that acting fairly helps keep legal cost down. My preference is to avoid using one-sided contract forms, or taking positions that I’d reject outright if I were on the other side of the table. My experience is that taking fair positions helps builds trust, and makes negotiations more efficient. I’d encourage your lawyer to provide you with fair forms.
Categories of Legal Work
I categorize legal work as follows:
· Ownership and funding / entity formation
· Intellectual property
· Internal staffing / HR
· Suppliers / outside vendors
· Customers
· Marketing and channels / strategic relationships
· Mergers and acquisitions
· Litigation
Ownership and Funding / Entity Formation. To my mind this is one of the easiest areas to determine whether to use lawyers.
Equity and Convertible Debt. As a successful local CEO memorably told me: “Don’t f*ck with stock.”
You should treat any issue involving equity as a minefield. The securities laws are nothing if not arcane, and ensuring your compliance is a thing of joy to the lawyers who will subject you to their due diligence. Shareholder rights and your ability to issue stock can also quickly become complicated, especially if you raise money from angels or VCs. Managing a stock option plan is also something where you should work very closely with your lawyer – it’s very easy to mess up, and expensive, time-consuming and often embarrassing to fix. In summary, you should always involve your lawyer at the outset in any matter involving equity.
Conventional Debt. In my experience, the sad truth of trying to negotiate the legal terms of conventional debt agreements is simply that … you can’t. Most banks who are willing to lend you money are very reluctant to alter their loan agreement terms. This isn’t to say that you shouldn’t have your lawyer review the terms, but the review is more to let you know what you’ll be agreeing to and living with, as opposed to improving the deal. I do, however, recommend that you have your CFO / Controller carefully review the covenants and any related ratios to ensure that these are practical for you – there may be scope for negotiation here.
Formation. It’s possible to do this yourself, but you’ll spend twice as much again when you have to fix it when you raise your first round. Many firms in town will do this on a very reasonable fixed fee basis for you.
Intellectual Property. While customer acquisition and retention and staying ahead of your competition will likely have more practical effect on the value of your business, investors and buyers will want to know that you have clean title or all necessary license rights to any intellectual property that you use in operating the business.
Developing IP In-House. If you develop IP in-house, you should be able to restrict legal involvement to providing you with appropriate contract forms for employees, contractors and outside vendors. As long as you have all of these people sign those forms, you should be OK. If any of them want to change those forms, then I’d recommend that you get your lawyer involved. One word of warning – make sure your lawyer (or their firm) has real IP experience – general practice lawyers without good tech experience may not be sufficiently familiar with the issues.
Licensing IP In. If you acquire IP from third parties, I’d recommend you have your lawyer review the license agreement to ensure you’ll be able to use the IP the way you want to. Even though there may not be scope to negotiate the terms, the review can help ensure that you avoid any pitfalls or inadvertent infringement. This is also the case for open source licensing – as you’re probably aware, open source licenses such as GPL 3 can affect your ability to control distribution of key IP you combine with the open source. You can also save substantial legal fees down the line if, at the outset of your development work, you create and implement a process to track all third party code that you use in your technology, including files containing license terms, and attribution / liability mitigation terms required by the licensor.
Non-Disclosure Agreements. If you are relying on a trade secret program (most likely, you will be), then I do recommend using NDAs with third parties where you are likely to disclose confidential information such as technical information, roadmaps, pricing, your financial condition or marketing analyses. Ask your lawyer to provide you with a fair form of mutual NDA. Most NDA legal reviews and negotiations take an experienced tech lawyer less than 10 minutes – good value for your legal spend in my mind. Don’t expect VCs to sign NDAs.
Branding. If branding is important to your business, then I do recommend working with a trademark lawyer. To save money, focus on a single core brand and logo, and use that to qualify each subsidiary brand. Your trademark attorney should be able to provide you with a budget and timeline for their work, and advise you on an efficient strategy for your money. I’d encourage you to work with a lawyer whose primary practice is trademarks – the extent to which they’re familiar with the Patent and Trademark Office (PTO) procedures and personnel will affect the time it takes them to get your application registered. Although you could complete the PTO forms to register a trademark yourself, I don’t recommend it – the key value in a trademark is that you should be able to litigate successfully to preserve the goodwill you’ve established in the brand. If you cut corners with your application, it will probably become apparent in litigation, and may affect the enforceability of your mark.
Patents. Whether you choose to patent your IP is very much an “it depends” issue. Suffice to say that you should engage in a thorough cost benefit analysis before doing so.
Copyright Registration. If the value of your IP is embodied in source code, then it’s very affordable to register copyright in the source code. Registration puts you in a stronger position to enforce your copyright and obtain damages awards. It’s possible to register your source code without significantly disclosing it – consult your IP attorney to find out how.
Internal Staffing / HR.
Paperwork. Your law firm should be able to provide you with templates for standard terms of employment and generic workplace policies, intellectual property assignment and confidentiality agreements, and offer letters. They should also be able to provide you with a services agreement form for independent contractors and bodyshops. You should be able to use these without too much legal involvement.
However … I recommend having your lawyer review any offer letter or services agreement before it’s finalized in any of the following circumstances:
· Offer letters for any member of your executive team
· You describe option awards, warrants, restricted stock arrangements, or commission arrangements outside of your standard arrangements
· You want to provide a contractor with equity for services
· You provide loans, refundable advances or contingent signing bonuses to the employee
· You provide change of control rights such as vesting acceleration or cash payments
· You provide parachutes or deferred compensation
· You’re having a vendor develop IP for you outside the US
HR Issues. My experience is that exposure to most employee claims can be avoided by treating your employees decently – treat employees as you’d like to be treated yourself. Most likely you’ll want to create that culture anyway, to help attract and retain good talent. That having been said, I recommend contacting your lawyer in advance (so far as practicable) in the following circumstances (as with all things in this article, this is a non-exhaustive list – if in doubt, bite the bullet and make the call):
· Prior to any termination of an employee by the company
· If you suspect any discrimination or harassment, or the prospect of a claim
· Workplace violence or the possibility of workplace violence
· If you want to reduce one or more employees’ compensation
· Reductions in force / layoffs
· If there is any chance that you won’t be able to make payroll (ideally, well before you have anyone work when there’s a possibility they won’t get paid).
· If you’re bringing on employees outside the U.S.
Suppliers.
Service Providers. Your law firm should be able to provide you with form services agreements for you to use with service providers. You will typically need to generate a statement of work to describe the services and compensation arrangements. In particular, the form should address IP ownership assignment and license rights, the vendor’s use of open source, and the vendor’s obligations to provide regular source code updates. If the IP development effort is significant, if you’re spending a chunk of change, or if the service provider insists on using their own form, I’d have your lawyer review the documents. I’d also consider milestone payments and an acceptance testing mechanism for these kinds of transactions.
Licensors. If you’re licensing in a third party’s IP, then you should have your lawyer review the docs. I’d typically agree to work with the licensor’s paper.
Marketing, PR and Headhunters. Marketing, PR and headhunter firms tend to insist on using their own contract forms – in my experience, they typically do a poor job of protecting the customer. Rather than have your lawyer review the provider’s forms, insist on using the form of services agreement your lawyer provided, and take care with the statement of work. I’d take care (and at least consider legal review) to ensure that you can terminate on short notice, that the payment arrangements are clear and fair to both parties, and that you won’t have to pay for poor performance.
Real Estate. I think that a cost benefit analysis is appropriate here to determine if legal review is appropriate, but I’d typically ask a real estate attorney to do a quick review of the docs and let me know if there are any truly awful provisions I should try to change. A lot will depend on how comfortable you are with your non-lawyer real estate professional.
Customers.
Internet Companies (e.g. social networks). For the most part, internet companies’ legal interactions with their customers or users take place via Terms of Use (TOU), a Privacy Policy, and any payment terms. I do think you should get legal review for these items, but because this work tends to be pre-revenue, I’d work with your lawyer to figure out the most efficient way to get them involved. I’m increasingly of the view that it makes sense to prepare these forms on a fixed fee or capped basis.
If you’re going to be taking payments from your users or customers, then I strongly recommend outsourcing this function to a reputable payment processor. While the primary benefit is to reduce your risk around PCI compliance and storage and processing of personal data, you’ll reduce the need for your lawyer’s involvement in the contract and payment processes.
Product / Service Companies (e.g., enterprise software, SaaS). I would work with your lawyers to create a set of customer contract forms that reflect your technology and business model. I’d be very wary of your lawyers taking a one-size-fits-all approach. Your contract forms should be reflective of your business processes (not the other way round). You should also consider the tone you want to strike with your customers, and what kind of review you’ll get from customers’ procurement and legal teams. Many standard forms for early stage tech companies are, in my opinion, overly defensive, which only encourages push-back from customers. Not only does this interfere with the efficiency of your sales cycle, but it can lead to increased legal costs in negotiating changes to your contracts, and just as often to you and your lawyers having to work with the customer’s standard form contracts, which are generally very customer-favorable.
A Word About Purchase Orders (POs). Many tech customers and some resellers will want to make purchases just on the basis of their purchase order terms. This is a superficially attractive option, because all that’s needed from the customer is budget approval for the purchase, and you can avoid legal review of contract terms. However, almost without exception, PO terms suffer from two defects from a tech seller’s perspective: (1) they are generally geared to the purchase of goods and services, and not technology licensing; and (2) they contain terms which are very, very onerous for the seller.
For example, most POs will include provisions assigning title to products and services deliverables to the buyer – these terms often extend to the underlying IP rights. You really, really don’t want to assign ownership of any of your IP to your customers (and if you do, you want to be sure that you will never need to re-use it, and that your customer pays a premium for it). Also, most POs will have lengthy warranty periods, and very customer favorable acceptance and payment clauses. Not only does this cause revenue recognition issues, but it can leave you leave in the position where, realistically, you’re relying on the customer’s goodwill to get paid, without an easily enforceable contract.
Marketing and Channel Relationships; Strategic Relationships.
Market Partners and Channels (a.k.a. referral deals and resellers). You can deal with many of these relationships with a good set of form agreements. These should be driven by your business model, and should be a collaborative work between the VP running the program, your CFO/Controller and your attorney. It’s very important not to let the legal forms drive your process – you need to have the forms reflect the process that’s going to work for you. I think this is an area where you want your lawyer to have a lot of hands-on channel experience, because their practical advice can be very valuable.
If your potential partners push back on the form agreements, I’d involve your lawyer in resolving the differences. The legal structure for these deals can be surprisingly complicated, and there are pitfalls for the unwary.
Strategic Relationships. Strategic relationships tend to involve a significant commitment of company resources, and often a fair amount of new IP development, some exclusivity or limits on competition, and occasionally some equity element. For all of these reasons, you should be involving your lawyer. As with the channel deals, I’d make sure your lawyer has hand-on experience of these kinds of deals. The paperwork for these deals is usually complicated; although you and other members of your exec team (and board members) will be anxious to get the deal finalized as quickly as possible, you can make the process much more efficient (which includes lower legal fees) if you run your initial rounds of negotiation off a term sheet. You should involve your lawyer in the term sheet preparation from the outset. If you can’t get your proposed partner to commit to a term sheet then, in my experience, you’re likely spinning your wheels in trying to negotiate full agreements. Either you’ll open the door to your partner’s legal team negotiating business terms (shudder), or you may find that the people you’re dealing with don’t have sufficient authority to push the deal through the way they’ve sold it to you, if at all.
Mergers and Acquisitions.
This is an easy one – get your lawyer involved early in the process, even if only to get their strategic input on the way the deal is shaping up. Make sure they have plenty of experience in M&A work in your sector.
Litigation.
No question – unless you can very, very quickly resolve the dispute at an executive level, you need to bring your lawyer in. Even then, I think there’s much to be gained (and pitfalls to be avoided) by getting your lawyer involved early – if they have experience of the kind of dispute in question, their strategic advice can be very helpful in resolving the dispute efficiently, and without shooting yourself in the foot.
Conclusion
Knowing when to involve lawyers is a learned skill. Just as important is understanding how you can use your lawyers efficiently. I find that many early stage companies shy away from calling their attorney because of cost concerns. If you’re paying your lawyer based on time spent, you’ll find that calls for strategic advice tend not to run too expensive. Things don’t generally get expensive until time consuming activities such complex document drafting or review begin. There are many occasions when involving your lawyer sooner rather than later will cut down on your legal fees. For example, it’s less generally less expensive to pay your lawyer to help you avoid a dispute than it is to pay them to help you resolve it.
You’ll have seen that a key theme of this post is that you should be working with a lawyer who has significant experience of the matter for which you want their advice. While it makes sense to have one key lawyer with whom you coordinate most of your legal activities (be it your primary corporate lawyer or an outside general counsel), you’ll get more bang for your buck on specific matters if your lawyer can provide strategic advice that reflects their experience of seeing how similar matters have panned out for other companies.

Out with the billable hour?


I’ve welcomed the shift that, based on the media at least, seems to be providing clients with more choice than the billable hour model. As everyone recognizes, it’s a model that ‘can’ be fraught with conflict. However, I think we’re at some risk of throwing the baby out with the bathwater.

I’ve always been struck by the somewhat elitist tendency of lawyers to view their business model as unique. The reality is that we’re service providers like many others (except for unlimited personal liability, but that’s another story). We run a technology practice, and many of our clients are deeply involved in buying or providing complex services. They’ll apply different models depending on the circumstances – sometimes fixed fee, sometimes time and materials, often volume discounted, often with milestone payments. Many of their customers have strong preferences for either fixed fee or time and materials contracts – the former because they fear run-away services and want budgetary certainty, the latter because they fear the ‘premium’ that’s built into the fixed fee arrangement, and reckon that their vendor management skills are good. Service providers will often be reluctant to take a fixed fee deal because they believe the proposed project doesn’t lend itself to clear scoping, but equally sometimes may prefer a fixed fee transaction because they have confidence in their efficiency, or because they believe it necessary to win the deal.

My point is that there is no one size fits all, and that different models work well for different circumstances. The key to a good time and materials contract is that the service provider is incentivized to be efficient – like most service providers, many lawyers rely heavily on happy customers to act as reference accounts, and that incentive shouldn’t be underestimated. Equally, clients should be wary of situations where that incentive is diluted, for example in circumstances where the work is performed by a lawyer for whom the incentive is less critical, e.g., a lawyer other than the partner that owns the account.

All of which leads me to wonder whether what clients should really be asking about is the compensation structure within their service provider – does it provide customer-focused rewards?