Lawyers stocking up on payday

More taking equity in client companies

Legal affairs

November 07, 1999|By Sean Somerville | Sean Somerville,SUN STAFF

The model is familiar: A cash-starved but promising start-up, unable to afford the talent it needs, entices employees and outside contractors with shares of stock. When the company goes public, the shares soar, making them wealthy overnight.

The new twist on the East Coast is that more and more of those reaping the riches of initial public offerings are lawyers, who have traditionally maintained an arms-length relationship with clients.

For more than a decade, the practice of lawyers taking equity in client companies has been a staple of Silicon Valley's fast-growing high technology economy. But some of those Northern California law firms, which have set up shop in Northern Virginia and New York, are paying East Coast lawyers the same way.

"It's on everybody's lips," said Steve Riddick, a former partner at Baltimore-based Piper & Marbury who heads the business and technology practice in the Washington office of San Francisco-based Brobeck, Phlegler & Harrison LLP. "It's getting attention now, because it's new to these stodgy old buttoned-down East Coast guys."

It also has Baltimore's old-line large law firms thinking about changing the way they pay lawyers.

This year, before its merger with Chicago's Rudnick & Wolfe, Baltimore-based Piper & Marbury enacted a program allowing the firm and partners to invest in start-up clients.

"It's to give them a little piece of entrepreneurial ventures," said Frank Burch, co-chairman of Piper Marbury Rudnick & Wolfe.

The American Bar Association has taken notice of the trend. In a paper published last year, an ethics task force reminded lawyers of rules that govern relationships between equity-holding law firms and their clients. The task force told firms that investments in client companies raise "very specific ethical concerns" and are "fraught with dangers of self-dealing."

"It's become increasingly common, and that's why we decided to take a look at it," said John Olson, a partner at Washington-based Gibson, Dunn & Crutcher and task force chairman.

Stock's prospects

A lawyer holding stock in a client company, he said, could be tempted to discourage the company from taking a necessary step because it might hurt the stock's prospects. Or a lawyer might go along with an improper action because he or she is reluctant to rock the boat.

"You have the potential of thinking about something other than the client's interest because you have your own economic interest at stake," Olson said.

West Coast law firms began abandoning the traditional practice of paying lawyers exclusively by the hour in part because client companies were luring partners and associates with lucrative compensation packages that included stock and options.

"We have it happening all the time," said Abe Isenberg, Brobeck's executive director. "Associates and even partners are being recruited by our clients. Our clients know them, like them and like their work."

One Brobeck lawyer who went to an Internet company less than a year before it went public has $60 million to $70 million in stock, said John Missing, managing partner of Brobeck's Washington office. Another was hired by a company less than six months before it went public. That partner has shares worth $20 million.

Former Brobeck partner

One of the best examples is John Place, a former Brobeck partner and general counsel of Yahoo!, who sold shares and exercised options this year to the tune of $14.9 million.

"It's an unbelievable opportunity to make a tremendous amount of money with relatively little risk," Missing said.

With that kind of competition, some law firms saw changing their compensation structure by taking equity in clients as a way to keep legal talent, legal headhunters said.

"Right now, the companies have a competitive edge, and the firms are trying to mitigate that edge," said Matthew Feuer, a principal with San Francisco-based McClure & Feuer, a legal search firm that represents both law firms and companies.

Feuer predicted the practice would become more common in technology-heavy areas, such as Northern Virginia, Washington and suburban Maryland.

At Brobeck, an equity stake can get into the law firm's hands in several ways. The firm might ask for an equity stake, generally 1 percent to 3 percent, in a company that is short on cash. The law firm might also deliver services to start-ups and wait for cash instead of taking equity.

"Typically, [start-ups] need financing," Missing said. "They've got to get from here to there. What Brobeck will do is keep track of the hours but not expect to get paid until the company gets its financing."

The firm has two venture capital funds, one for associates and another for partners, which can invest in a client company side-by-side with venture capitalists.

Stake is limited

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