The article and accompanying sidebar below appeared in the April 2009 issue of Technology Transfer Tactics. Click here to subscribe.

And though that sounds great to TTO managers who get buried under a pile of legal bills itemized to the Nth degree — with charges often over the expected budget — a discussion of the topic among attendees at the recent AUTM annual meeting in Orlando showed the issue is not as simple as the size of the bill. At least as many attendees cautioned that, when it comes to legal work, you get what you pay for — and fixed fee arrangements incentivize attorneys to cut corners, which may cost you more later if your claims are full of holes.

However, as one attorney who has moved to fixed fees told AUTM colleagues in Orlando, “you get what you pay for, but you also get what you manage. As the client, you’re in the driver’s seat — you have the right to say ‘who is doing the drafting,’ and good claims is what it’s all about.” The trick, experts say, is making sure the law firm you use is not only reputable, but is carefully monitored for quality. In the case of start-up work, it may also be possible to get your attorney aligned with your expectations by adding a tiny cut of the company to be created into the compensation mix.

That’s exactly the strategy being used by Stephen P. Rothman, a private practice attorney in Redondo Beach, CA. His fixed-fee package of services for start-up work will set you back $7,500. But you can get the same menu of services for $5,000 plus 1% of founder’s equity, which can provide some comfort that your lawyer has a stake in the venture’s ultimate success.

That’s not a cut anybody’s going to get rich on — or, if you’re the start-up, lose money on. But it provides the psychological boost many nascent firms need to feel confident they’re getting their attorney’s best.

A loss leader for attorney

Rothman began offering the fixed-fee deal in January, just a month after opening his new practice. He says the set fee “is something that I could not do as a partner at a large firm,” a fact confirmed by several attorneys in larger practices at the AUTM meeting, who scoffed at the idea. But Rothman and a growing number of smaller firms are making it work.

“Doing so saves the client a little cash at the stage when it has the least cash available, and gives me a little upside,” he says. The amount of equity, he notes, is “really a tiny sliver, because it is a small percentage of the founder’s piece, and then will be further diluted by investors and employee incentive grants.” He generally can’t consider charging even less in exchange for a bigger percentage, he adds, because of the economics of fixed-fee packages — and because of the vagaries of the tech transfer game itself.

“The cash discount given in exchange for the equity is not larger because the services are already being offered at a substantial discount to a market rate that would be charged by a big law firm,” he explains, “and because there is so much risk in a pre-funding start-up. By getting at least some cash, I make sure the client is serious about the endeavor.”

The discount is worth it to him in the long run, Rothman continues, because the fixed-fee set of services can act as something of a loss leader for his other start-up-related services. “The companies that succeed will use me for more work once they’re funded,” he comments. “Usually, that would be a financing transaction. A typical venture capital financing can generate $25,000 to $30,000 in legal fees, and once it’s completed, the company has the resources to pay for other legal services on an ongoing basis. If I become general outside counsel to the company, I handle VC financing, employment and consulting agreements, joint ventures and other transactional matters up to acquisition, if that occurs…. Although, of course, not all of the clients for which I handle the start-up package succeed and get to those later stages.”

There are benefits to the start-up company, too, of course. “A pre-funding start-up finds it disconcerting not to know exactly what it’s going to be charged,” Rothman explains. “The typical lawyer practice of charging by the hour leaves it with some risk. It’s not a big deal for a company that has received a $5 million round, but if a professor or founder is paying for the services out of pocket, it can be significant. Founders want their start-up companies to get good legal advice from the start, but they don’t have a lot of cash at that stage.” The bundle of services he offers for a fixed fee, he adds, would cost about $15,000, on average, if supplied by a large firm at an hourly rate.

What the fixed fee includes

So what do you get — and not get — under the fixed fee arrangement? With Rothman’s start-up package, “the services last from inception until the company receives its first financing, or for six months, whichever is shorter,” a written description of the package details points out. “If financing has not been obtained within six months, an extension package for another six-month period is available. Patent applications are not included.” Included services are:

• incorporation or formation of an LLC;
• university patent license option or license;
• stock option plan, if desired, with forms of option agreements and an explanation of procedures to follow regarding grant of options and tax treatment;
• standard form contracts, without customization, such as non-disclosure agreements and employee offer letters, and access to a library of legal forms;
• up to six hours of additional attorney work during the six-month period or until a financing transaction occurs.

Services that are not included are:

• out-of-pocket costs, such as filing fees;
• patent applications;
• litigation;
• maintenance of stock book or minute book and individual option grants;
• services requiring referral to outside attorney.

Rothman says the fixed-fee deal has generated referrals from TTOs and a number of client inquiries. “I signed my first new client, a California Institute of Technology spinout, under the $7,500 option a few weeks ago,” he reports. “But we’re already discussing modifying the arrangement for the start-up company’s benefit. The founder decided to use an LLC rather than a corporation, so the company doesn’t need the stock option plan. And it happens the start-up won’t have a patent license, so it won’t need all of the pieces of the fixed-fee package, but will need other services immediately because it has already lined up a multi-million-dollar strategic investor.”

Sometimes even a low fixed fee will not fit in the budget of a fledgling start-up, as occurred recently with a new venture being launched by a UCLA business school student, Rothman recalls. Even the $5,000 and $7,500 options were too much,” he says, “so we worked out a scaled-back fixed-fee arrangement with less money and fewer services.”

The pre-defined package in a fixed fee arrangement can be customized, and that flexibility is key, Rothman observes. “I don’t think it matters so much if the university is small or large, nor whether it’s more or less active in spinning out companies,” he says. “A good candidate is any start-up that’s on a tight budget initially and that does not yet have a significant investment lined up. And if it does, there are other billing options available. If I’m pretty sure it’s really going to get funded very soon — say, if it has a signed investor term sheet — I’ll use a regular hourly fee but defer most of the payment until the financing closes.”

‘Wave of the future’?

Frederic Farina, assistant vice president for technology transfer at CalTech, says he likes the fixed-fee approach because every start-up is on a tight budget initially. “I don’t care if you’re MIT, Stanford, Harvard or CalTech,” he asserts. “If you only have well-funded start-ups, it means you’re missing a lot of opportunities.” And early-stage costs, he adds, can make or break many start-ups. “There’s great appeal to knowing the fees up front,” Farina says. “When initial funding is coming from the entrepreneur and a couple friends, it’s generally not very much.”

He doesn’t contract with law firms, he adds; his office connects inventors with them. But he does like to make sure fixed-fee products are on the list of offerings he makes to researchers with technology to transfer. “I think such packages are the wave of the future,” he says.

Earl Weinstein, PhD, assistant director of business development and licensing at UCLA’s Office of Intellectual Property & Industry-Sponsored Research, feels much the same way. Like CalTech’s his office often provides lists of counsel who might represent start-ups but does not recommend or endorse any particular firm. “Most start-ups are trying to be highly capital-efficient,” he notes. “A lot of the transactions, at least in the early stages, tend to be fairly routine, so it’s much better not to spend a lot of money on legal fees in that stage of a company’s lifecycle.”

He does not believe the potential for less than top-notch performance under a fixed fee deal is a major concern, and sees a trend toward this model of legal service growing as the recession has but a crimp in start-up budgets. “At the earliest stages of a start-up, you’re looking at how to incorporate, at some initial licensing transactions and so on,” he says. “What’s important is the level of experience the attorney has,” not the fee structure, Weinstein argues. In fact, he says, it’s the hourly rate structure that represents a more serious mismatch in incentives, since start-ups naturally want to keep costs low while law firms hope to maximize their billable hours. As a result, he adds, more law firms “are looking at how they can switch their model from an hourly fee structure, which misaligns people’s interests, to more of a success-based model. I can see where the equity model can make a lot of sense for a start-up. It’s another way to conserve capital and use it for technology development. Charging on a project basis has the potential to align everyone’s interests pretty well.”

Contact Rothman at 310-944-9089 or steve@stephenrothman.com; Farina at 626-395-3058 or fred.farina@caltech.edu; and Weinstein at 310-794-0214 or eweinstein@research.ucla.edu.