Article

One Step Ahead

Be Proactive to Manage Legal Risk

Howard Young

January 20, 2012

As a young boy, I was very committed to saving the meager cash that flowed to me from birthday cards and allowances. My older brother teasingly referred to it as “hoarding.” Initially, a ceramic Abe Lincoln-head bank protected my small net worth. When I was 10, a job mowing my neighbor’s lawn increased the cash flow, and as my older brother entered his teens and his funding needs grew, honest Abe started to let me down. With a simple twist of his neck, easy access was gained by any passing cash-poor brother. Abe was replaced by a tin box with a key until my brother admitted, many months and pilfered dollars later, that a paper clip gained him access. Eventually as my personal revenues grew, I acquired a small but secure combination safe, which served me well through my brother’s departure to college. Building Early Legal Sophistication The legal protections that come from the services of a trusted attorney are a bit like my early wealth protection efforts. New businesses generally have less to protect. Not only are the assets and revenues fewer, but risk is often a startup company’s modus operandi. During the early stages, most entrepreneurs just add legal risk to the two dozen other risks that they take every day when they switch on the lights. They take on partners without clear records, hire employees without checking backgrounds, manage trade secrets loosely—they generally wing it. Of course, this isn’t the ideal—most early stage companies would benefit greatly from having all their legal risk tightly contained through the help of a good legal advisor. But those services come at a price and, for better or worse, purchasing inventory and meeting payroll usually move to the top of the priorities. But when a company begins to grow and develop meaningful shareholder value, it becomes a more foolish proposition when management continues to treat good corporate legal services as an unaffordable extravagance. Betting the company on a novel marketing strategy or new product initiative has a justifiable upside, but playing legal roulette to add a couple points to the profit margin is difficult to defend to the shareholders. The key is to proactively manage your legal risk just as you do other business risks. Here are a few suggestions on how to best do that: 1. Put it in the Budget This may be obvious to some, but it’s important to capture the management of legal risk as an item in your annual budget rather than viewing all legal fees as an unplanned (therefore unpleasant ) expense. Sure, some legal expenses may defy planning, such as a surprise lawsuit or regulatory inquiry, but many preventative legal expenditures can be planned. Your attorney shouldn’t resist sitting down with management and analyzing the company’s risk profile to determine what efforts during the coming year would best mitigate that risk. Management might identify the need for key initiatives that fall within a reasonable annual budget such as a corporate document clean-up, an improved set of customer contracts, increased intellectual property protection or better human resource practices. Your lawyer can help you create budgets for these activities. What is the benchmark for your legal budget? In a recent national survey, companies under $100 million had an average legal budget of 3 percent of revenues. Just over half of that, 1.57 percent, was spent on outside legal services. Some companies have businesses that are legally intensive, such as companies that are raising large amounts of capital, chasing multiple patents or operating highly regulated industries, so needs vary widely. But even the smallest, least exposed of companies should put a line item in their annual legal budget to address two or three key legal initiatives, or anticipated legal review, or advice through the year. 2. Reduce the Surprises A disciplined, proactive approach to addressing your legal checklist will result in fewer surprises. Contractual or intellectual property measures can protect product or market advantages. Most attorneys hate to get calls like the one I received last month from a company that was the recipient of a nasty-gram from the state securities regulators. The regulators were looking for non-existent documentation supporting a recent equity investment. This unbudgeted surprise will be far more painful than the inexpensive legal efforts needed to document the investment. Like the combination safe did for my early financial stash, with some preventative efforts, you can create solid protections for your increasingly valuable company assets. 3. Treat Your Lawyer as a Partner While some legal projects are difficult to price due to the number of contingencies, with enough information, most lawyers can set a fairly solid target, or at least a range. Lawyers are also increasingly willing to consider fixed fee projects, in particular with loyal clients who are committed to a long-term relationship. And some firms have even negotiated monthly fixed fee arrangements that provide a defined set of “outside general counsel” services for a client. Don’t be shy about addressing sensitive fee issues – it’s your attorney’s job to find the most cash flow and budget-friendly ways to address your legal expenses. Ignoring available legal protections for your company is not good business management, just as my Abe Lincoln bank failed to protect my growing cash reserves as a young boy. Well-run companies build the cost into their budget and work proactively to address protections for the hard-earned value that they have created. Howard Young is a partner at Jones Waldo and head of the firm’s business department. He serves as outside general counsel to numerous technologies, manufacturing, medical, consumer product and other companies in the Intermountain area. He can be reached at 801-534-7294 or at hyoung@joneswaldo.com.
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