The payment of legal fees by issuing stock or other equity to the law firm in lieu of cash became popular in the late 1990s with Silicon Valley startups and has gone in and out of fashion since then. The appeal of the structure, particularly with startups, is obvious. Before these companies start generating revenue, cash may be hard to come by, so if both sides are willing, the payment of service providers like attorneys, at least initially, with equity, may be an attractive alternative. It is also possible to have hybrid structures where, for example, the law firm is granted a small piece of equity issued in exchange for the firm’s agreement to discount cash fees and/or defer their payment for a period.
The status of the law firm as stockholder can create a conflict of interest, as the attorney’s obligation to provide the corporate client with impartial advice can conflict with the attorney’s desire to enhance the value of its equity investment in the company. The potential conflict can be addressed by having the client affirmatively waive the conflict after disclosing the details and advising the client to seek separate legal representation in agreeing to that waiver. (This last point is a bit impractical because the whole exercise is likely predicated on the fact that the company is short on money to spend on lawyers. Is the company going to pay the second law firm in equity also, and if so, who will provide impartial advice on that arrangement?)
Regarding the conflict of interest itself, in some ways the company’s and attorney’s interests can be more aligned than they may seem. Take, for example, the attorney’s review of a commercial contract that, if signed, would result in significant revenue to the company. That revenue would, of course, enhance the value of the attorney’s equity. However, suppose the other party to the contract insists in the negotiations that the client agree to unfair and onerous liability provisions that increase risk for the client. While this seems like a conflict – the attorney might downplay the liability provision so the deal gets done – in reality, if the liability provision truly does increase the risk to the company, the attorney-as-stockholder would share in that risk if it comes to pass, since the value of its stock would diminish.
Also, conflicts can exist in traditional, cash-only arrangements. For example, if the client already owes the attorney a significant amount of fees, the attorney could be incentivized to rush the client into ill-advised transactions that would supply the necessary cash to pay the fees, like a financing or sale, on bad terms.
Conflict of interest issues require case-by-case analysis, and broad-brush approaches like ruling out all equity fee arrangements as inherently conflicted aren’t warranted.