The price is right: if legal fees are taking a bite out of the capital you raise, consider a flat fee arrangement

Entrepreneur, August, 1996 by David R. Evanson

Supplicants to the capital markets, public or private, would do well to read Dickens, Bleak House, the famous Victorian yarn about a generations-long court battle over an estate. It's almost as difficult to read as a prospectus or private placement memorandum, and thus does double duty by helping readers bone up for the jumble of documents about to descend upon them.

The climax of the book - the settlement of the case - is quickly followed by its denouement, the disclosure that the estate has been consumed by legal fees. After years in chancery court, there's simply nothing left, a result that causes the book's handsome young protagonist to expire on the spot.

With modern entrepreneurs, the bill for legal fees that come on the heels of a financing, successful or unsuccessful, may provoke a similar reaction. The common lament is that when two lawyers negotiate the details of a financing deal, each one earning an hourly retainer, they argue all day because there is an incentive, subliminal or otherwise, to do so.

Whether this is true or not, potentially steep legal fees are endemic to the process of raising money. "If you go to a large law firm, they are going to charge you $150 to $200 an hour," says Jim Holmes, whose Carson Capital Management Inc. in Reno, Nevada, specializes in raising money for emerging businesses. To raise $5 million, he says, the bill might be $150,000. "Even if you're raising $1 million to $2 million, it might be $100,000."

On the one hand, none of this should come as a surprise. "You have regulations [affecting] every sentence you are writing, so its easy to see how [attorneys can] take issue with seemingly harmless passages," Holmes says. On the other hand, he is quick to point out, when raising $1 million, a legal bill of $75,000 takes a substantial bite.

Small wonder, then, that many entrepreneurs are taking a long, hard look at the fees charged for corporate rate financial transactions and looking for lawyers that will accept flat fees instead.

* CASE IN POINT

Holmes says flat fees can work and, to illustrate the point, recalls the $1 million financing he arranged for a Boston-based client, Bell Fidelity Corp. Bell's founders, says Holmes, were pursuing a significant niche: marketing retirement and saving plans consisting of insurance products to young professionals and married couples. By combining direct-response advertising with network marketing, Bell hit upon a formula that could be rolled out across America.

The only catch: Bell needed capital to launch the marketing program in other metropolitan areas. Holmes structured a $1 million, self-under-written public offering - which, given the total proceeds of just $1 million, had to be done very, very frugally.

As a result, Holmes put a lid on the legal fees right away by negotiating a flat fee for the entire deal. In fact, he says, the legal fees, which included filing a registration statement with state and federal securities regulators, were just $7,500. This is an almost unheard-of amount and is even more amazing when you consider that attorneys regularly request a $25,000 retainer just to get started on a public offering and $15,000 to draft a private placement memorandum.

Incidentally, other expenses related to Bells self-underwritten public offering came to another $40,000, including $7,500 for an audit of the financial statements, brokerage fees of $2,500, travel expenses of $5,000, and other professional and miscellaneous fees of about $20,000. The aggregate expense: $48,000, or about 5 percent of the total funding amount of $1 million. Quite enviable, considering many initial public offerings have expenses of as much as 20 percent of the total proceeds.

But with respect to legal fees charged on an hourly basis, the problems are more subtle than meets the eye. "Obviously," says Holmes, "the fact that you don't know what your final cost is can be a rather significant disadvantage." But the larger drawback, he says, has to do with efficiency.

"An attorney working on a flat fee will, to protect his or her interests, ask for a lot of information upfront, then try to produce the required documentation in one shot," says Holmes. But, in his experience, lawyers paid by the hour work differently. "They tend to get to work right away and continue working until they run into an obstacle and require more information from the client." Unfortunately, the act of shutting down on a project for perhaps two weeks while they await the information, and then getting up to speed again, in Holmes' words, "grinds up the hours." The result: a legal bill far higher than it needs to be.

* LET'S MAKE A DEAL

Since flat fees are unconventional, Holmes says you'll have to shop around to find a firm or lawyer willing to work on this basis. In doing so, there are some risks to be aware of.

For starters, he says, you shouldn't sacrifice experience just to get a flat fee. Don't hire an attorney who's using your deal as a learning experience: "Securities law is a big black hole," says Holmes," and you can find yourself running around lost because your attorney took a wrong turn in the beginning."