Legal fees are a fact of life for entrepreneurs, but they’re not always easy to understand. Different lawyers use different fee arrangements, and figuring out which structure is right for you can be daunting, especially the first time around. While the fee structure you and your lawyer agree on is ultimately dependent on the particular needs of your company, it’s a good idea to have a background understanding of the options at your disposal.
How are attorneys traditionally paid?
The classic model for paying a lawyer is hourly—they’ll inform you of their rate ahead of time, and then track the amount of time they spend working on your behalf as you go. Then, every month you’ll get presented with a bill that represents the hourly rate quoted multiplied by the number of hours of work you’ve received. If you decide to go with this pay structure, you’ll normally pay a “retainer” before any work is done (more on that next).
What is a retainer?
A retainer is an upfront payment made to an attorney to reserve their time and indicate that you’d like to retain (hence the name) their services. It is, essentially, a down payment, and can be any amount specified by the attorney. Once you’ve paid it, any legal work done will be charged against this amount until it’s been exhausted. Your retainer will also be used for any early disbursements—payments that your lawyer makes on your behalf, such as filing fees. After that retainer has been used up, you’ll start paying for legal services and any disbursements on an invoice-by-invoice basis.
What is a fixed fee model?
In lieu of an hourly pay structure, you might also choose to pay your attorney a fixed fee. In a fixed fee model, you pay a single upfront cost for a predetermined amount of work to be performed. This model is appealing to entrepreneurs, especially those with limited and/or fluctuating funds; it makes budgeting for legal services as simple as a single line item, and you don’t get hit with an unexpectedly hefty bill. The attorneys, on the other hand, get the benefit of knowing exactly how much they’ll make for the work they’ll provide, and can leverage similarities across different clients to increase efficiency.
In fact, there are so many commonalities between the legal needs of startups that many firms have begun to offer startup packages, whereby they offer to prepare all of the basic documents that a fledgling company might need for a predetermined cost, usually around $5,000.
A key to the fixed fee model is understanding what is covered by the fixed fee and what isn’t. Typically unique legal issues, such as immigration or litigation matters, or non-standard requests, such as multiple classes of common stock, may be outside the scope of the fixed fee arrangement. Be sure to discuss any questions with the lawyer providing the services to avoid surprises.
What are deferred fees?
Let’s say you’ve got a software company that’s ready to incorporate, grant founders shares and perfect a product. Here’s the problem: you don’t yet have any sales yet, which means you haven’t made enough money to pay for things like legal counsel. What can you do?
Deferred fees are one way to resolve this situation. With this sort of payment structure, your startup will get billed monthly, but you won’t have to pay anything back until you receive your investment capital. Then, once you’ve raised the money and are on solid footing, you can pay your legal fees.
It bears noting, however, that a deferral may not always be the best option. Because you’re not billed immediately, it can be tempting to farm out more work than usual to attorneys. In addition, you may get charged higher-than-usual hourly rates, which can lead to higher legal bills than you’d encounter under a different fee structure. To recoup these costs, your attorney could be incentivized to have you raise money quickly, regardless of whether it’s in the best long-term interest of the company. Some firms may even require a small grant of equity in your company as part of the deferral arrangement. For these reasons, you should carefully consider whether fee deferral is necessary.
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