The Value of the Battle Never Fought

In his famous book, The Art of War, Sun Tzu makes numerous profound observations regarding military strategy – many of which have great applicability in the business world, and in the intersection between your business and legal matters. A couple of my favorites are the following:
• He will win who knows when to fight and when not to fight.
• He who wishes to fight must first count the cost.

I have always believed that there is great wisdom in these words – particularly in deciding how to approach (and equally importantly, how to anticipate and avoid) business disputes. After all, business is about making money, not winning battles.

Every business will find itself from time to time involved in disagreements. This is unavoidable and often outside your control – it’s just part of doing business. What is often (but not always) within your control, however, is how you anticipate, avoid (when possible), approach, evaluate, respond to and attempt to resolve these disagreements. Disagreements generally do not need to (and should not) rise to the level of adversarial disputes and/or litigation or arbitration – there is almost always another alternative which may or may not be acceptable, but should always be considered in a business-minded, even-tempered manner.

Owning and operating a business inherently involves risks, costs and uncertainty. However, with careful planning and conscious, deliberate strategies, you can generally predict and in large part control these factors and steer the company to a profitable outcome. Litigation, on the other hand, involves risks, costs and uncertainty that are often unpredictable, uncontrollable, and in some cases unacceptable. For these reasons I would urge you, the next time you find yourself in or approaching a possible business disagreement, consider all alternatives short of litigation, and only proceed with that alternative if you have considered the cost and made a reasoned determination that now is time to fight.

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Teamwork and Communication Versus Too Many Cooks in the Kitchen – Part 1 of 2

Team approaches in contract negotiations can be very effective. In fact, for some contracts, a team approach is essential – particularly when the contract will impact various divisions or facets of a company’s overall existing and future operations.

Consider hypothetical ABC Manufacturing Company (ABC) that has multiple divisions (including Aeronautics and Renewable Energy) operating independently, but within the same general industry groups. Further assume that ABC’s Aeronautics Division wants to license certain technology to Third Party Company (3P), but only for use in wind turbines – not in aeronautics or aerospace – because ABC has plans for use of the technology in those fields, but not in turbines. In this circumstance, it’s likely critical that ABC involve numerous parties in the contract process (although not necessarily in the actual discussions with 3P – see Part 2 on this topic). Who might those parties include, and why?

• Obviously, the heads of the Aeronautics and Renewable Energy Divisions – so that the precise scope and nature of the license can be considered, along with its impact on those divisions (now and in the future). Also likely those who are not division heads, but who may have a deeper understanding of certain products, projects and relationships.
• Research and Development – so that those negotiating the contract terms know what the current state of the technology is, where it may be headed, what rights are licensable, and what rights should be excluded/retained.
• IP – so that there is a clear understanding of what protections exist currently, who will be responsible for maintaining those protections, who has rights to derivative technology, etc.
• Strategic Planning – so that something that seems unimportant now doesn’t “unexpectedly” become important in the future – especially if there are parties within ABC who already knew it’s important.
• Legal – so that rights granted in this contract don’t conflict with rights previously granted to other parties, and the current contract ultimately says what the business people intend.
• Others – there may be any number of others that should be consulted or at least kept informed as to the discussions with 3P – accounting (budgeting and cost), marketing (brand and image), etc.

The point is, many contracts have far reaching and (sometimes) difficult to foresee implications for a company. Involve as many people and divisions as necessary to make sure you are aware of and consider all of these implications.

In Part 2, I’ll discuss the importance of speaking with one voice, notwithstanding the involvement of multiple parties.

Approach Every Contract Like a Construction Project

It struck me recently as I worked on a multi-million dollar construction project that parties would be well served if they approached each contract (at least initially) like a construction contract. So, why do I say that, and what does it mean?

A construction contract is the beginning of a project and a process – one that requires (a) careful planning, (b) trust and cooperation by multiple parties, (c) segregation of duties, (d) faithful performance and execution, and (e) recognition that circumstances will arise that may be beyond the parties’ control and will require flexibility, problem-solving and often change. These factors are actually present in most projects and transactions – not just construction projects – which is why I think the construction approach makes sense.

Here are the most basic elements of a construction project/contract that I believe should be considered and addressed in most contracts.

• Scope/Nature of the Project – what are we doing here? This should be defined as clearly as possible (even where, as in the construction process, this will change and develop as the project progresses)?
• Responsibilities – what is each party required to do, how and when? Again, this should be defined as specifically as possible.
• Standard of Care/Performance – is there an objective or subjective standard which a party must meet (e.g., codes, industry standards, the best or accepted practices in the relevant geography, the other party’s discretion)?
• Legal Compliance – who’s responsible?
• Subcontractors – who will actually perform the work, and can it be subcontracted?
• Communication/Authority – who has authority to bind each party, and how do we ensure constant communication to avoid misunderstandings?
• Foreseeable Risks – if they’re foreseeable, define them, how they will be addressed, and who bears the risk.
• Unforeseen Risks – since they’re unforeseen, they likely can’t be defined, but you can still do your best to allocate responsibility.
• Changes/Change Orders – how will we handle changes? The best answer – see Communication/Authority above. If your deal has to be changed, communicate and make the change in writing as promptly as possible.
• Disputes – how will we (hopefully) avoid, and in any case deal with disputes?
• Insurance/Bonds, Indemnification and Guarantees – how do we protect against the downside?
• Completion – how do we know, and who determines, when a party has completed its task satisfactorily?

There are other elements of a construction contract, but hopefully you see my point – think construction.

How to Handle Partners Who Are Bullies

Bullying and bullies are in the news a lot these days. Usually these are kids who physically or mentally torment and intimidate their classmates. In business partnerships, we frequently see a different kind of bully – the partner (who never should have been a partner in the first place) who refuses to listen to other points of view, puts his own interests ahead of those of the partnership, and generally wreaks havoc on the business. So, how do you deal with these bullies?

The first and most effective way is not going into business with them in the first place. There are plenty of articles warning you to choose your partners carefully, so I won’t belabor that point, but it’s worth noting once more – there is virtually no business decision that will affect you more than the decision of who you go into business with – choose well.

Second, have clear, detailed and well thought out organizational and governing documents that all partners understand and agree to at the outset. These documents should cover such basic issues as: (i) who gets to be an owner; (ii) who participates in management and how management decisions are made; (iii) what your general business objectives are; (iv) what happens if the company needs more capital; (v) how you avoid or address disagreements; and (vi) how and when you will make the decision to sell, merge, dissolve or otherwise exit the business or the owners’ partnership.

The third strategy follows logically from the second – having those governing documents in place is not enough – follow them. The easiest way to handle a difficult partnership disagreement is to simply follow the rules that you’ve laid out for the business.

The final strategy is more of an admonition – do NOT allow your difficult partner to bully you into making bad decisions or otherwise treat you or the business unfairly or act unwisely and then claim to be a victim! I see this frequently, and it is NOT an excuse to simply say your partner is a bad person and made you do these things that were bad for you or the company. You’re the caretaker of your business, and no one said it would be easy. Stand up to the bully!

Is Your Lawyer Disruptive? Shouldn’t He/She Be?

When people think of the qualities they want in a lawyer, disruptive doesn’t always come to mind – in fact, it rarely does. However, this is one of the most important qualities in growth stage and entrepreneurial/start-up companies wanting to revolutionize their market segment and change the world. So why don’t clients (especially the kind mentioned in the preceding sentence) insist that their lawyers – in addition to being outstanding technical lawyers – be disruptive? After all, doesn’t it make sense that the most innovative and forward-thinking lawyers would relate best to the most progressive companies and clients? Sadly, I think the reason people don’t generally seek out these qualities in their lawyers is because they don’t know they exist. And, why is that? Because lawyers and the legal community have set the bar so low when it comes to innovation, creativity and client-centric business practices – choosing to require clients to conform to the traditional attorney-client model, rather than the attorneys focusing on what the clients want and need. In my opinion, clients should insist on more – and lawyers should deliver more.

So, I ask, is your lawyer disruptive, and if not, why not? The answer, of course, depends on what it means to be disruptive as a lawyer and whether/how that disruptiveness can benefit you and your company as a client and consumer of legal services. When I think of disruption in the legal world, I don’t mean reckless, hasty, rude or destructive. Rather, what I mean is not just the ability, but the desire, and in fact the affirmative goal, to think outside the box and provide creative client-driven solutions to your business and legal challenges – not canned or pre-scripted “one size fits all” responses from a dusty legal treatise.

With the foregoing definition in mind, you may say, “thank you but no, I don’t want my lawyers to be disruptive – I want them to provide the same “buttoned-down” black letter responses that their forefathers provided to my predecessors and leave creativity to me. If so, then this article probably hasn’t resonated with you. If, however, you like the idea of a creative, disruptive thinking lawyer and law firm, find one – they’re out there!

Understand What No Lawyer or Document Can Do For You

I was recently helping a client with a stock purchase in a deal that just felt wrong to me. Each time we asked a question or reviewed a document, it seemed additional issues, questions and concerns arose. Notwithstanding this fact, the investment bankers, company officers and selling stockholders assured us in each instance that there was no problem – usually with the excuse that it was simply bad record-keeping, a lack of attention to detail or a favorable related party transaction that would not adversely affect the company or my client going forward. In fact, they said, it was precisely because of these circumstances that my client had been presented with this amazing investment opportunity. I did not find these explanations to be persuasive or reassuring, even when the sellers agreed to provide a litany of warranties and representations, broad indemnification rights, and other contractual protections.

In this circumstance, I was compelled to explain to my client a very simple fact – while a lawyer can draft an all-encompassing contract in which virtually every possible risk is anticipated and addressed with detailed indemnifications, aggressive remedial provisions, escrows, etc., that does not turn a bad deal into a good one or provide the same level of protection as walking away from a bad deal.

The simple truth is, if your due diligence yields more questions than answers more uncertainty than certainty, and more risks than opportunities – and if you find yourself spending an inordinate amount of time and effort trying to protect yourself from known and unknown legal risks and possible bad behavior or misrepresentations by the other party (versus ordinary course business risks) – no amount of lawyering and no legal document can adequately protect you. In that case, you really only have 2 choices – (1) walk away from the deal, or (2) draft that over-the-top contract with all of the bells, whistles and protections and “hang on for the ride.” And if you opt for alternative 2, understand that a good lawyer and a good contract do not make a good deal.

Negotiating With Investors – Focus on What Really Matters

Negotiations with investors are tough – especially when you’re not accustomed to these kinds of discussions and the party across the table engages in them on a regular basis.  What’s the most important advice (right after hiring a good/experienced lawyer who understands your business) – focus on what’s important – economics and control.

Having stated that you must understand and try to aggressively protect, retain and preserve economic/financial upside and control, it’s also essential to understand that the investor has something you need – money – and it’s inherently reasonable for that investor to expect in return for providing you with that money that he or she will receive both (a) substantial economic upside in the event the company is successful and downside protection if it’s not, and (b) a degree of control in order to protect that investment.

Unfortunately, I can’t provide a detailed explanation in a blog post of all of the terms and variables that arise in negotiating economics and control, but here are a few you must understand (Note – if you don’t know what these terms mean, find out before negotiating):

• Valuation – what ownership share will the investor get for invested dollars?

• Dividends – if the investor is to receive dividends, how much, when, who decides, and are they cumulative?

• Preference – assuming the investor gets paid first upon a liquidity event and that payment is more than the initial investment (i.e., a preference), how much more?

• Participation – after receiving the preference, does the investor get to “participate” in the remaining proceeds, and if so, to what extent?

• Dilution – how can various parties be diluted (including by an employee incentive pool), and what impact will this have on distribution of proceeds?

• Board Seats – who fills the Board seats, and what is the “balance of power”?

• Voting Rights and Protective Provisions – what issues does the investor get to vote on and/or veto?

• Conversion Rights – assuming investors receive preferred stock, when can they convert to common, and what impact might that have?

• Tag-Along and Drag-Along – under what circumstances can parties force others to participate in a sale or allow them to participate in a sale?

The above list is, admittedly, abbreviated, but it should give you an idea of the most important issues in negotiating with investors – everything else pales in comparison.