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INSIGHT: Lessons from WeWork—2020 Will Be the Year Start-Ups Recognize Legal Debt

Jan. 6, 2020, 9:00 AM

For most technology start-ups, an IPO or acquisition is a dream scenario. By the time companies are in a position to go public or be acquired, they’ve overcome plenty of financial and operational challenges and they’re in the top 1% of start-ups overall.

It implies the hard work is over. But that’s hardly the case, especially for legal teams.

What companies in this position don’t anticipate is the legal work it takes to prepare for a successful exit. 2019 was a massive year for tech IPOs, with the most anticipated milestones coming from closely watched unicorns. Many of these exits cost each company upwards of $2M in legal fees—a figure that doesn’t even include the prices companies continue to pay after they go public or get acquired—when the legal issues they face are likely relatively novel and unanticipated.

Ironically, for tech-enabled companies renowned for their innovations, paperwork tends to be one of the most significant obstacles to an IPO or exit. With experts predicting 2020’s IPO market to grow even more, there will be a bigger emphasis on the role of the general counsel across companies of all stages to mitigate headline-grabbing IPO pitfalls.

The Debt No One’s Talking About … Yet

As a general counsel in Silicon Valley, I often hear executives talk about technical debt when they are on the verge of going public or executing M&A deals.

Technical debt is the accumulated cost of applying temporary fixes to software issues that require deeper structural changes. It’s common in the Valley because start-ups often focus on rapid development at the expense of long-term scalability. It makes sense in the short-term, but fixing code months or years later requires more development work, and often money, than would have been necessary.

When start-ups feel compelled to demonstrate success early and often, technical debt is a common subject among engineers. But technical debt’s legal analog—legal debt—hasn’t come up until recently.

Why? Because the current wave of IPOs and M&A activity, coupled with the promising IPO market in 2020, has shown companies just how costly legal debt can be.

Avoiding Legal Bottlenecks

Before a company can go public or be acquired, it needs to produce documentation that shows how it makes money and details its myriad legal obligations. In other words, it needs to produce and analyze every contract.

Companies that have to investigate and document years of contract history during an IPO or M&A spend millions on internal and external resources to sift through tens of thousands of emails and files looking for details for regulators and/or acquirers. Contracts relating to customer and supplier agreements, equity agreements, leases and anything that materially impacts company finances are particularly important.

A salient example of legal debt includes one of the highest-profile IPO filings in the last year—WeWork’s parent company We Co.—whose muddled prospectus was criticized by investors as “sloppy” for misstating financials.

Experts predict the company will be under a microscope during their next filing. While inconsistent reporting was certainly not alone in preventing WeWork from going public, the company’s disorganization amid rapid growth certainly didn’t help their legal team. Companies with public-filing plans for the coming year are taking note of cases like WeWork’s.

With such a focus on scaling and growth, it’s unsurprising that slender teams cut corners in contract management. But without the required documentation, deals can’t move forward. Investing in a company sans contract documentation is like buying a car without knowing its mileage and accident history. And acquirers are just as unwilling to inherit your legal debt as they are technical and financial.

Addressing the Debt

Bearing these factors in mind, leadership and general counsel will be curious to know what the proper strategy is for managing the legal debt they already have.

The answer lies in another parallel to software engineering. While proposals for revamping and replacing technical debt with single, large-scale projects may stem from good intentions, these approaches are often recipes for failure. A singular focus on debt reduction comes at the expense of growth- or customer-oriented projects. These projects only succeed when incorporated into broader business objectives.

In terms of legal debt, strategies are similar—it’s essential to align debt reduction with business milestones. Rather than dedicating time and attention to legal debt, businesses should focus on developing contracting processes and systems that will facilitate successful, well-organized agreements in the future.

Prepping for the Next 10 Years

It’s natural to think that the process for addressing legal debt begins by looking backward. But opening the door to a successful IPO or exit starts by realizing the ideal state of your contracting systems and taking actionable steps toward making them business realities. As we welcome the new year at the turn of the decade, companies are thinking about their next big milestone and how they can prepare— and legal teams are at the forefront.

This past year was a banner one for investment in legal tech, with upwards of $1.2 billion in venture capital cash in the first two-thirds of 2019 alone. As a result, we’ll start to see a shift in in-house legal teams’ role across organizations.

With smarter technologies and automation for process-oriented tasks, general counsel will not only have more time to make more strategic business decisions, but they will also have access to some of the most business-critical data—which can make a world of a difference in informing an S-1 or prospectus, like in our WeWork example.

Investing in initiatives to build out legal infrastructure can save countless man- and woman-hours, millions of dollars, and help ensure smooth sailing toward post-IPO or M&A celebrations.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Chris Young is general counsel at Ironclad. Prior, he spent three years at GoFundMe serving as their general counsel, and worked as a litigator at the San Francisco-based law firms Morrison Foerster and Keker, Van Nest & Peters. He also served as the deputy finance director for Obama for America (2008), spent time in the Sacramento mayor’s office as senior adviser and counsel, and worked in the Obama administration as associate director of intergovernmental affairs at the Department of Justice.