Monday Morning Dead Horse Beating

I will start off by saying that the legal industry’s business model sucks. The billable hour isn’t good for lawyers or clients, and while many have tried, we haven’t yet come up with a viable alternative. Lawyers are expensive, and we are often only brought in as a last resort when things have gotten out of the client’s control, which makes the impact of our cost feel that much worse for the client. I always feel a great sense of satisfaction when I can help clients out of a tough situation, but then feel bad when I have to send them what is often a larger bill than I’m sure they would like. I know my value, but they don’t always. And that’s ok–I’m not in the position where I feel like I need to justify my worth to clients who don’t get it–but I can’t help but feel frustrated that they don’t know what they just got.

The clients who would benefit the most from solid legal advice from the start are often those who don’t have the funds to pay for it. I get it.  So enter the startups who are nobly trying to commoditize the legal industry to help bring the law to those who don’t feel they can afford it. LegalZoom, Clerky, and now StartUpDocuments, are in this space. I will just say this very predictable and oh-so-cynical-sounding phrase: you get what you pay for.  I am sure I sound like the old guard protecting my cherished bill-by-the-hour-and-screw-the-client territory, but it’s just true. If you’re cool with living with the result of incorporating your business–your baby that you plan to grow and nurture into a thriving example of your hard work and intellect–for $279 dollars, alright. But understand that all you are getting for that is a form.  And for some, that form will be just right and exactly what they need. For some, if they had spent two hours with a lawyer at $400/hour, that lawyer might have told them that they need to be in a Delaware c-corp. That’s $800. Then that lawyer might have drafted the documents and sent that individual on their way. That’s another $1500 (and used to be MUCH higher, btw).  If that person skipped the lawyer part and paid $279 for document incorporation through one of these legal startups, they’d be better off. But they got lucky.

The problem with many of these startups, and the reason actual lawyers are still valuable, is that the client doesn’t always know what they need. I hate to sound patronizing, but it’s just true. I may go to the doctor’s office thinking I have it all figured out, but I might have been way off on my initial assumption of what was wrong with me, which then skewed the rest of my analysis. It’s the same for law. These companies market their product to “startups.” Well, what if you’re not a startup in the way that they mean it? You might be starting a new business, and perhaps you’re even seeking a seed round, but does that put you into the relatively narrow definition of “startup” as that term is now used? What if you’re in an industry where it would be absolute stupidity to be a c-corp (real estate, oil & gas, etc.). If you get that initial analysis wrong and then incorporate as StartupDocuments suggests–as a Delaware c-corp–then you are screwed if you decide to change your tax status later. A conversion to a partnership will be a deemed sale of all of your company’s assets. A deemed sale is a very, very bad thing if you’ve built up some value. Basically it is a sale for tax purposes, meaning you’re taxed on the gain, but it’s not a sale for your bank account’s purposes. You haven’t sold anything, but the IRS says you have, so you have to pay tax on the gain without actually receiving any proceeds from a sale with which you could pay the tax. Bad news. That’s just one example of many in the list of things that can go wrong from bad incorporation advice.

So maybe the Delaware c-corp is the right choice for you. But oops! You didn’t realize that you actually needed more than one. There is often a benefit to separating intellectual property from other assets of the company, particularly when you might want to sell the operating assets but retain the IP to collect a royalty stream. Well, in an asset-for-stock transaction, you can do that sale on a tax free basis (either a “C reorganization” or a “forward triangular merger”), assuming you have housed the IP in a separate entity. If you haven’t, you’re at the mercy of the buyer to agree to an “A reorganization,” which many won’t due to the requirement to assume seller liabilities. If you can’t get that straightened out with the buyer, you’re looking at gain on the receipt of buyer’s stock you’re receiving in the sale, but no cash with which to pay the tax on that gain.

And just one more comment on internet lawyering in general: Someone I met at a startup event here in Austin called me the other day to ask about reincorporating his company in Texas from California. He had been doing internet research on how to do it, and had come up with something that was essentially a corporate dissolution and then reincorporation in Texas. This would have been detrimental from a tax perspective, when there’s a much easier, tax-free way to accomplish his goal. We had that figured out in 15 minutes on the phone, after he had done hours of online research.

Bottom line is that it is almost always worth your money to spend just a little bit of time with a lawyer before engaging in any DIY or docs-in-a-box legal work. At the very least, the lawyer will help you identify your needs and the path to a solution.  It’s up to you at that point to determine if you think the lawyer will continue to bring enough value to your situation to justify the additional costs. If you don’t think they will, then at least you can say you’ve made that decision in confidence, and you’re only out a couple hundred bucks. If you think they will, then you’ve probably just saved yourself thousands of dollars in repairative legal work, despite the fact that the bill will be more than the cost of the docs-in-a-box.

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