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Teaching
Legal Ramifications
Lawyer limns law's pitfalls for entrepreneurs.
The lawyer, dressed in an open-neck denim shirt and loafers, bears down on the two entrepreneurs sitting before him.
"What's novel and non-obvious about your technology?" he asks the two young men. One of them wears the requisite techie goatee and tousled sandy hair. The other is a clean-cut and stylishly dressed.
Before either of them can answer, Goodman hits them with two more questions: "Are you sure nobody else is using it? Have you done a patent search?"
"We've done one in the U.S.," answers the clean-cut member of the duo. They aim to sell a robotic device for clearing landmines.
"Have you filed for a provisional patent?"
"Not yet."
"You guys have got a lot of work to do if you want to satisfy investors. They'll at least want to see that you've got an opinion of patentability from a lawyer."
Murmurs fill the room of over fifty onlookers.
The lawyer is Steve Goodman, an emerging-growth company specialist from the Philadelphia office of law firm Morgan, Lewis & Bockius. The entrepreneurs are Samuel Reeves and Josh Koplin, founders of Humanistic Robotics. And the audience is a group of Wharton students and staff.
In February, Goodman gave folks at Wharton an inside peek at how lawyers who work with young entrepreneurial companies operate. Reeves and Koplin agreed to be the guinea pigs.
His message: Lawyers like him are eager to help — "we want to see young companies succeed." But one of the most important roles they serve is helping entrepreneurs understand whether they're ready to face professional investors such as venture capitalists. They do that by asking lots of hard questions, which ideally help entrepreneurs see the weaknesses in their plans.
As Goodman explained, "If you can't answer my questions, the best thing I can tell you is, ‘You may want to consider your alternatives to entrepreneurship."
Though hesitant at first, Reeves and Koplin held up well under Goodman's interrogation. Reeves is only a Wharton senior, but he and Koplin, a New York industrial designer, are further along than some entrepreneurs whom Goodman sees. They've already incorporated their firm. And they're ready to build a prototype of their invention, which would detonate landmines with a weighted roller pushed by an inexpensive robot.
It is Goodman's practice to meet with entrepreneurs at no charge before agreeing to represent them. So his mock interview gave the Wharton group a sense of what to expect from a lawyer who, as Goodman described himself, likes to represent "shaggy-haired people with bright ideas."
Besides questions about intellectual property — "Do you own your idea and can you exploit it," as Goodman summarized them — the lawyer also quizzed Reeves and Koplin about how they'd organized their business.
At first, they looked at him blankly. "I'm not sure what you're asking," Reeves said.
"Have you incorporated? And how?" Goodman shot back.
"We're an S corporation in Texas," Reeves said.
"I assume you did that for tax reasons."
"I'm not sure," Reeves volunteered. "My dad's a CPA. He suggested it."
Though not what Goodman would've recommended — he prefers limited liability companies or LLCs incorporated in Delaware — he applauded the choice. S corporations, like partnerships and LLCs, give shareholders the ability to recognize tax losses from a startup's operations, he explained. By law, the company's losses and gains pass through to shareholders and appear on the shareholder's tax returns, not the company's.
With a conventional corporation, gains and losses are retained by the corporation. Because startups typically don't have income, they don't enjoy the full benefit of their losses if they're organized this way.
Goodman also challenged Reeves and Koplin on how they planned to raise the $400,000 that they need to build a prototype of their mine-clearing robot. "Who are you going to raise it from," he asked.
"Not venture capitalists," Reeves responded.
"You're right — this isn't a VC investment. This is strictly for angel or strategic investors." VCs look for companies with big market potential, which means lots of customers in rich countries. The biggest potential customer for Reeves and Koplin's device is the United Nations, and the machine would be used in poor, war-torn places such as Bosnia and Afghanistan.
As startup entrepreneurs search for investors, they need to ask themselves a series of questions, Goodman said. Who might benefit from your investment? Who knows you and might be willing to back you? Who's retired from the industry and has done well financially? Might they be willing to sit on your board and introduce you to others in the industry?
Goodman also cautioned that some entrepreneurs are confused about the lawyer's role when it comes to raising money. "We're not investment bankers," he said. "We're not going to hawk your deal. You have to sell it."
Then came questions from the crowd: "How can a startup afford a top law firm's rates? Do you take equity in the companies that you represent?"
Goodman doesn't. He, like many lawyers, believes that doing so would compromise the independent judgment that he has to have to give a company sound advice. Instead, his firm will essentially sell its services on credit to startups, letting them pay the bill once money is flowing in.
"We're not going to give you a scholarship," he quipped. "But we will give you a student loan."
Sure, that sometimes means that the firm doesn't get paid. After all, plenty of startups fail, despite good business ideas and hard-working founders. But a number succeed, too--and a few become blockbusters like Google or Dell.
Take Verticalnet, a Malvern, PA.-based maker of supply-chain management software and a Goodman client. In 2000, it had a market capitalization of $12 billion. "We had 42 lawyers working on Verticalnet matters in 2000," Goodman said.
"Your companies are going to succeed, too. And when they do, you're going to need a lot more legal services."
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Sol C. Snider Entrepreneurial Research Center