One of the most (long-term) costly mistakes founders make in choosing their startup’s corporate counsel is ignoring conflicts of interest; meaning background relationships between lawyers and VCs. It often stems from a misunderstanding of what startup lawyers really do.

Yes, there are check-the-box compliance and procedure-like tasks, the kind that ensure founders aren’t doing anything unlawful. But a foundational role of seasoned counsel representing a startup is to serve as an equalizer for founders and common stockholders; to close information asymmetries that benefit experienced VCs.

The startup ecosystem is unique compared to other business contexts as to the wide gap of experience and knowledge between business parties. When one Fortune 500 company does a deal with another, the executives on both sides are going to be highly experienced.  

Yet in the world of elite startups, you very often encounter young first-time entrepreneurs negotiating extremely high-stakes issues with people who are 10-30 years their senior. The VCs have seen and negotiated dozens of term sheets, sat in on dozens if not hundreds of board meetings, but for the founders this is their very first rodeo.

This information asymmetry is extremely valuable for investors, and they know it. It can allow them to reflect an appearance of “friendliness” while offering terms, and making governance decisions, carefully calibrated to benefit themselves (in economics or power), without inexperienced founders even knowing what is happening. That is unless someone else in the room (or Zoom) speaks up.

When founders are smart about vetting their advisors, that someone is usually company counsel. More so than in any other business context, startup lawyers serve as strategic advisors, not just legal compliance technicians, to entrepreneurs. They ensure startups aren’t taken advantage of on financing or corporate governance matters by misaligned counterparties decades more experienced than the startup’s leadership team.

VCs, being highly intelligent people, have strategies for blunting counsel’s ability to serve this equalizer role. One common method is that VCs will build economically valuable relationships with prominent startup law firms to sway their advisory.

In addition to working directly with these law firms for their own legal needs, many VCs maintain a roster of “preferred” law firms to whom they channel referrals. Founders should not be so naïve as to think those referrals are free. This is an extremely dangerous conflict of interest for founders to unwittingly expose their companies to.

Before engaging a startup law firm, ask about their relationships with the venture community, particularly venture investors who lead rounds and serve on boards of directors.

• Which venture capital firms does your law firm represent?
• Do you regularly receive referrals from any venture investors who lead rounds and serve on boards?
• Will your firm commit, as a condition to our engagement, to not represent my lead investors on any legal matters for the duration of our representation?

The answers to these questions will be illuminating. Some lawyers will argue that, yes, they do have relationships with key VCs, but that’s somehow a good thing. They claim their relationship will make negotiating easier with those VCs. Don’t drink that kool-aid.

You are one company. A prominent venture firm, as a repeat player, has the capacity to refer dozens of companies and deals to a set of lawyers. When the stakes are very high, and negotiations are potentially tense, startups need strategic counsel who isn’t biased by background relationships with the people on the other side of the table.

Optimal is a company-focused elite boutique startup law firm. We’ve turned down dozens of opportunities to work with the world’s most prominent venture firms, because we take our trustworthiness for startup executive teams seriously. Our clients have been funded by household names among elite venture investors, all of whom we politely refuse to represent.

Among the many variables for assessing whom to engage as your startup’s company counsel, don’t ignore conflicts of interest with the VC community. You want strategic legal advisors who will equalize the information gap between you and your lead VCs on the most high-stakes issues. That will never happen if your lawyers and your VCs are best friends.

‍