If you were getting a divorce, would you ask your soon-to-be-ex-spouse for a divorce lawyer referral?
No, you wouldn’t, because that would be so obviously stupid that no rational person would ever consider such an idea. Your soon-to-be-ex-spouse would be the last person you would want to help you in that scenario.
Then why would you ask your investors for a legal referral when raising capital?
From a legal perspective, it’s the exact same dynamic. When you’re getting a divorce, your interests are adverse to those of your soon-to-be-ex-spouse. When you’re negotiating a deal with your investors, your interests are adverse to those of your investors. If you negotiate away liquidation preferences, dilutive terms, or other material rights to your investors, those rights and terms are lost to the company or the founders.
Yet, it is a shockingly common thing for startup companies to take marching orders from their investors when looking for legal representation. So common, in fact, that some startup law firms actually bake conflict-of-interest provisions about this obvious conflict of interest into their formation documents (I will not name names).
The fact is that most larger firms that work with startups only earn a small fraction of their revenue from startups. Rather, most of their income comes from working the other side of the table, in representing the VCs. It’s very lucrative work if you can get it, because VCs are negotiating legal terms all the time, against many startups and with many investments. This work is so good, in fact, that the revenue from representing VCs dwarfs what these firms could ever earn representing only individual startups.
Anyone who’s ever worked in business knows that it is only natural for any business to pay particular attention and give particular care in wooing the biggest clients. There are clients for whom losing their business would be merely a rounding error in the yearly financials and there are clients for whom losing their business means people losing their jobs, decreased pay, or people leaving the firm.
If you’re a startup and you’re working with a big law firm, chances are, you’re the rounding error, and your investors are the meal ticket. This has serious consequences for your business. Imagine going into a divorce proceeding with a lawyer whose main financial incentive is not to rock the boat with your soon-to-be-ex-spouse. If your soon-to-be-ex-spouse is benevolent, you might end up with something when all is said and done. If he or she is not benevolent, however, you might end up with nothing.
Many lawyers downplay this conflict-of-interest. And, as long as you as the client sign off and give informed consent to the conflict of interest, it is legal for a lawyer to represent your VC in many transactions and you in one single transaction, so long as they are not representing both in the same transaction. These lawyers may tell you there is no problem with them doing both. And, most likely, they will provide reasonable diligence in telling you whether a deal term is investor-friendly or startup-friendly. These are good lawyers; they will not commit malpractice.
But, as long as you work with your investors’ lawyers, there will always be little things you are missing. Maybe they won’t mention some deal term when the range of what is considered a standard deal term could be skewed more in your favor. Maybe they will convince you to just “get a deal done” even when getting a deal done means there is a real chance that if and when the company exits, you get little or nothing.
As long as you work with your investors’ lawyers, the table will always be tilted against you—slightly or substantially.
Which is why investors love to intervene in helping you choose a law firm. But that is exactly why you should respectfully decline their assistance.
The reality is that capital raises are like snowflakes and small children: each is special and important in its own way. A capital raise isn’t just about shuffling documents from one side of the table to the next. It’s about making a series of carefully calculated decisions to create the right growth and exit strategies for your business. It’s hard to do that right when both your lawyers and your investor’s lawyers are both primarily concerned about your investor’s point of view.
Most investors aren’t cynical or evil; they’re just used to getting things their way.
It is entirely possible to create win-win scenarios with your investors without having to rely on lawyers with conflicts-of-interest to get you there.
There are plenty of lawyers who focus all their time and energy doing precisely that. Our firm is not the only one. And with so many good lawyers to choose from who don’t have a conflict of interest with your investors, why would you ever work with a lawyer who does?
 Incidentally, the same logic applies to lawyers who promise to make investor introductions if you work with them. There’s nothing wrong with leveraging professional relationships when appropriate and mutually beneficial. We do that, too. But if this is the primary reason you decide to hire one law firm as opposed to another one, you can expect a hidden cost in your legal fees in terms of compromised relationships.