In recent months, a lot of attention has been paid to the question of whether Congress, as part of a larger financial overhaul, will change the taxation of carried-interest income for managers of investment funds that are organized as partnerships.  In other words, Congress is poised to change the face of private equity and venture capital as we know it.

We know an overhaul is in the works – House and Senate bills are being debated, Elizabeth Warren is talking tough to NPR and ads for Fox News are asking whether America is broke.  We here at Brightleaf don’t presume to know the future (and we can’t seem to find a crystal ball on eBay), but we’re pretty sure we’re in for the biggest set of financial reforms since the 33’ and 34’ Acts were passed.     

Further, we bet that whatever reform measure is passed will include an increase in an important tax rate tied to long-term investment.  Congress has been trying, with limited success until now, to change the tax treatment of carried-interest income, which is the share of profits that private equity, venture capital and real estate fund managers receive as part of their compensation.  The problem, according to Senate Finance Committee Chairman Max Baucus (D., Mont.) and House Ways and Means Committee Chairman Sander Levin (D., Mich.), is that carried-interest is treated as capital gains (and taxed at a rate of 15%), when it should be considered ordinary income (and taxed at rates up to 38.5%).  Their argument?  That the managers running these funds have been paying capital gains rates on money that should be treated as wages because they earn this money for managing other people’s money (i.e. working).  Indeed, many proponents of the change argue investment managers should be thankful the U.S. isn’t proposing a U.K.-style excise tax of 50% on managers’ incomes.

So what’s wrong with that argument?  There are two important things to note: 1) fund managers take on a lot of risk when they make investments and 2) lots of people benefit when fund managers take these risks.  The first point boils down to this – fund managers don’t make money just by going to work, as the rest of us do.  Carried-interest, in the context of private equity and venture capital funds, is earned years after an initial investment is made.  Further, as Douglas Lowenstein, president of the Private Equity Council, points out, “earning carried-interest involves taking risks . .  . and exposing yourself to the possibility that you’ll have to return your earnings if things don’t work out.”  The rest of us simply don’t face consequences like this in our professional lives.

Second, saying that keeping carried-interest rates low provides an unfair advantage to fund managers is remarkably shortsighted.  When we begin orienting our tax policy around people, and not activities, we set a dangerous precedent.  Do fund managers sometimes make lots of money?  Yes.  But in the process, they provide essential funding to companies that in turn hire U.S. workers (indeed, emerging companies were the only ones to add jobs in 2009).  The Private Equity Council’s report on the proposed rate change states that the hike could prevent between 36,600 and 127,800 jobs from being created through private equity investments.  Taxing carried-interest at lower rates encourages capital formation, construction activity, and job creation, all of which are in short supply these days.  Can we really afford to discourage those activities at this point in history? 

We here at Brightleaf are inclined to say no.  In fact, we’ve spent the past few years growing and hiring talented workers thanks to the support of a venture capital firm.  While other companies were struggling, we were bringing in additional talent to respond to the demands of a changing legal industry.  We were advising law firms and corporate legal departments on ways they can incorporate document automation into their plans for the future.  And we will continue to do more of this.  Whether other companies will be as fortunate as we have been, we’re not so sure.

And, for those of you who want a re-cap of the first round, you can listen to our Dave Curran and Foley’s Gabor Garai right here.

Jordan’s post earlier this week, How to Compete on Price, is superb.   He begins with the often-heard truisms that law firms can’t compete on price–that it provides a fast path to commoditization and that it is ill-suited for the specialized, knowledge-based nature of legal services.

But then Jordan shifts gears, saying in effect that the more he considers the subject, the more that he realizes that lawyers will have to compete on price.    ”Whether we like it or not, price will become a significant competitive factor, and it will be dangerous to run our businesses pretending otherwise.”

Fortunately, Jordan also offers a solution:  law firms can compete on price by competing on cost.  By lowering costs, they can price more competitely (or flexibly) while maintaining or even growing margins.  While this may seem obvious, it isn’t.  Law firms (epsecially larger ones) have famously been cost-oblivious.  They compete to pay higher and higher salaries to incoming associate classes.  And they traditionally occupy the most expensive real-estate in their respective cities (Side note:  I was at a meeting in Boston last week with several GC’s and large-firm partners when one of the GC’s blurted out, “Why are you guys all in the Back Bay or the Financial District?  When is a firm going to locate its offices in Woburn?  Because THAT’S the firm I want to hire!) .

Fortunately, Jordan offers several basic tenets of cost-competiton that firms should follow:

1. Initiate project management
2. Automate anything repetitive
3. Focus your high-value people on high-value work.  Offload everything else.
4. Use technology wherever possible
5. Think seriously about outsourcing
6. Adopt non-hourly billing and compensation

We often hear one or two of these tenets in our client meetings.  But it’s especially interesting to see someone list them all in once place in such a well-written posting. 

Nice work, Jordan.

Boulder is a fantastic place for emerging businesses.  A “what if/why not” energy permeates the whole city.  As the Times points out, Boulder’s outdoor lifestyle and countercultural past contribute to making the place feel less stultifying and corporate-ish than Rte. 128 and Silicon Valley do.  Because of this, people there just seem to think in less restricted and more collaborative ways.  That freedom of possibility fuels a large portion of the city’s tech boom.

Foundry fuels the rest.  As we tell anyone who will listen, they’re the perfect investors because they believe viscerally in what their portfolio companies are trying to do.  When other VC’s tell you that they support you, they basically mean, “I think you will make money, therefore I believe in your mission.”  When Foundry says they support you,  they’re really saying, “Because I believe in your mission, I think you will make money.”   That doesn’t mean they aren’t rigorously analytical (trust me, they are, in spades).  But it does mean that they’re willing to go further than other VC’s in helping their portfolio companies to win because winning means more to them.

If you’ve spent time in other VC offices, where everyone is wearing khakis and sky-blue button-down oxfords and sporting pretty much the exact same haircut, and then you walk into Foundry, you know instantly that it’s a different kind of place.  Much like the city around them.

For more on how Foundry invests, check out Brad Feld’s blog post on thematic investing here.

While this might seem like just another blip on the “how firms are dealing with the recession” radar, it’s actually huge news.  Here’s why:

When you discuss flat-fee  or value-based billing with large law firms, the most common and explicit objection they raise is that the nature of the work is inherently too volatile.  If the client makes last-minute changes or the counterparty stalls or tomorrow’s newspapers contain adverse news, then transactions and matters will drag on.  And protracted transactions tend to require more lawyer output, so a $100,000 project can end up costing the firm $200,000.  Right or wrong, this concern at the top of the list of things you hear when you discuss flat-fees with lawyers.

If you’re talking to very senior partners at these firms, and you prod them a bit, you will also hear this objection:  the firm profitability model depends inextricably on the ability to bill on a time basis for lawyer output.  Firms recruit incoming classes and promote associates and reward partners and retain rainmakers with the stream of time-based money. Even as clients vociferously demand  a move away from time-based billing, firms worry that a broad or drastic shift might have adverse consequences for their whole model. 

Together, these two objections translate to:

1. Because of the nature of our work, it is difficult to predict at the beginning how much law firm output will be required to complete a given transaction or matter. 
2. Our existing model means that it costs our firm a lot of money to produce law firm output.
3. Additionally, the way we measure law firm output and the streams of revenue we derive from it are critically important to how we get, promote, and retain our people.
4. Unless we can get, promote, and retain our people, we don’t have a firm.

[Quick aside:  It's not like hourly billing is evil.  It roughly correlates to the amount of work done; it's easy to track and account for, and it creates an incentive for thoroughness.  But for a variety of reasons, clients are increasingly unhappy with it and are insisting on alternatives to it].

By starting to de-couple associate compensation from associate hours, Clifford Chance is loosening the link  between cost and production so that every extra chunk of work done doesn’t automatically cost the firm more.   To borrow an economic term, they’re injecting elasticity into their Cost of Goods Sold model.  And increased cost flexibility should theoretically allow the firm greater pricing flexibility.

Also, you have this:  if one associate spends 50 hours on a deal that makes his client unhappy while another associate spends 40 hours on a deal that makes her client ecstatic, who should be rewarded more?  At least now, Clifford Chance has the opportunity to decide.

Well it happened!  Gabor and I had a great first conversation during the launch of the Entrepreneurship Talks™ Program. (Click Here to download the recorded event) The time went by so quickly.  We got a bunch of questions but were only able to answer  a few of them.  The Program seems to have hit a nerve.  There are lots of people (more than 300 people signed up for the Program) in the Entrepreneurial ecosystem who are looking for plain talk about common and often bewildering issues – particularly core legal issues.  Interestingly, it’s not just business people.  Sometimes  advisors and mentors themselves find this area somewhat of thicket and will try to answer questions – not in their domain – so that the entrepreneurs keep moving. I’ve met many a lawyer will answer a question about marketing with a preface like “I’m not a marketing expert, but have you tried the following…”  This can sometimes be counterproductive and confusing to someone who’s got a great business idea but not necessarily deep experience in a particular area or market.

We got lots of comments from entrepreneurs who have been intimidated or unhappy about their interactions with lawyers.  Let’s face it, most lawyers didn’t go to charm school on their way to law school.  They’re often brilliant subject matter experts, but have some gaps on the interpersonal skills side.  That’s why I really enjoy working with Gabor.  He’s extremely knowledgeable, but also knows how to relate the legal world to the student who’s working on a very cool software business, or the inventor who’s developed an innovative tech solution for a business problem.

I’m a recovering lawyer who’s run several technology businesses; and I’ve also helped buy dozens of founder-based companies and tried to integrate them into larger companies (that’s the subject for a future blog because it hasn’t always been pretty).  In future Programs, we plan to share some real world experiences.  I like to think of it as land mine avoidance techniques that have been distilled from years of experience.  The goal is to give you enough information so that you can move forward prudently with your business. 

Watch this space for answers to questions generated by the Program. 

In the meantime, we’re gearing up for the next session – date TBD – that will focus on Intellectual Property.  So, if you have questions about trademarks, copyrights, patents, trade secrets; how to create them, protect them, license them, etc., please send them to me to include in the Program.  We’ll have a guest who’s run businesses and has grappled with real world IP matters. 

Talk soon.

Dave

Which I guess is how I came to notice the sentence at the bottom of this post. Despite its relatively vanilla meaning, the sentence, from a Delaware corporation’s Amended and Revised Certificate of Incorporation, somehow managed to swell to include 10 commas, 23 references to existing defined terms, three newly defined terms, and a corpulent 274 words. 

 274. 

People…is this really necessary?

Now, I recognize that the language comprising a best practices charter document has built up by accretion over the years.  And I get that our profession’s reverence for precedent means that at bonus time your firm’s compensation committee won’t be parceling out Distributable Net Income based on terseness in drafting  (“Bravo, Smathers…wonderful show of concision this year. Keep slashing away at the thicket of multi-level qualifiers; you’ll make partner in no time!!!”).   Still though, the twin goals of drafting should be:

1. To cover content thoroughly and unambiguously, and

2. To ensure that you have covered that content in an efficient enough manner so that your intended readers can readily comprehend it in a consistent way and can then conform their actions accordingly. 

The 274-word sentence might technically satisfy criterium #1, but it’s a total architectural fail on #2.  At some point, as qualifiying subordinate clause piles onto qualifying subordinate clause, this swaying Jenga-tower constructions comes crashing down on its readers.  If you ask your clients what they think when you draft 274-word sentences, I’d bet a surprising number of them would accuse you of being needlessly (and perhaps, intentionally) arcane. 

Here’s what it’s like…Remember the first wine-tasting in the movie “Sideways,” where Paul Giamatti’s cranky connossieur character described one offering as tasting like strawberries  but also having ”just like the faintest soupçon of like asparagus and just a flutter of a…like a,…a…a nutty Edam cheese?”  Put aside for a moment how unappealing this combination of tastes might actually be (“Seriously? Strawberries, asparagus, and nutty, waxed Dutch cheese?  Together? In a drink? Yummers.  I’ll take two cases!”).  Here’s the lesson to take from this scene:  sometimes experts, in trying to express their expertise with exacting specificity, totally foresake comprehensibility and accessibility.  Your clients do not want to read 274-word sentences any more than they want to drink wine that taste like it has asparagus and cheese in it. Lawyers, like Giamatti’s connossieur, can get a little word-drunk on their own capacity for complexity. 

[My almost-totally facetious solution?  Let lawyers bill by the sentence.  Let them charge more if they can split their thoughts into smaller and more digestible pieces.  In no time you'll have a generation of AmLaw Hemingways dropping their lean, hard prose into charter and transaction documents everywhere. ]

Here it is:

“In the event of a Deemed Liquidation Event referred to in Subsection 2.3.1(a)(ii) or 2.3.1(b), if the Corporation does not effect a dissolution of the Corporation under the General Corporation Law within 90 days after such Deemed Liquidation Event, then (i) the Corporation shall send a written notice (the “Redemption Notice”) to each holder of Preferred Stock no later than the 90th day after the Deemed Liquidation Event advising such holders of their right (and the requirements to be met to secure such right) pursuant to the terms of the following clause (ii) to require the redemption of such shares of Preferred Stock, and (iii) if the holders of at least a majority of the then outstanding shares of Preferred Stock so request in a written instrument delivered to the Corporation not later than 120 days after such Deemed Liquidation Event, the Corporation shall use the consideration received by the Corporation for such Deemed Liquidation Event (net of any retained liabilities associated with the assets sold or technology licensed, as determined in good faith by the Board of Directors of the Corporation), together with any other assets of the Corporation available for distribution to its stockholders (the “Available Proceeds”), to the extent legally available therefor, on the 150th day after such Deemed Liquidation Event (the “Redemption Date”), to redeem all outstanding shares of Series B Preferred Stock at a price per share equal to the Series B Liquidation Amount, of Series A Preferred Stock at a price per share equal to the Series A Liquidation Amount and of Series A-1 Preferred Stock at a price per share equal to the Series A-1 Liquidation Amount.”

The Conan O’Brien-Jay Leno contretemps seems to have settled somewhat:  Leno’s off the air until after the Olympics; Conan’s off the air until…well. at least until his non-competition agreement expires in September.  So, what better time to look back at one of the many factual issues that the new media got wrong during this whole mess: namely, what if anything that Conan’s contract said about when “The Tonight Show’s” timeslot.

It was generally reported last month that NBC was able to push Conan out of TTS’s traditional 11:35 airing and past midnight because his contract didn’t specify that he was entitled to any particular timeslot.  This tidbit was reported over and over again and was basically accepted as gospel truth by all media outlets. While it might initially seem peripheral, this was actually a  critical inflection point for the outcome of this entire debacle:  if NBC was free to move Conan’s show, then Conan would have been in breach of his contract by failing to accede to any such move.  But if Conan had a contractual right to 11:35, then NBC would have been in breach if they forced one.  

So, when NBC basically had to pay out the entire value of the contract and only got a meaningless seven-month noncompete in return (meaningless in that it would take more than seven months to get a new show together, so the non-compete wouldn’t actually slow anything down at all), it probably should have served as a pretty strong signal to the press that Conan indeed had a contractual right to keep his timeslot.  Instead, the press all whiffed on this…

…until this article came out the other day.  Written by Matthew Belloni, legal correspondent for The Hollywood Reporter, it contains the first public screening of the actual contents of Conan’s contract (at least in so far as they pertain to the timeslow issue).  Here’s Matthew’s scoop:

 1956-present:    The Tonight Show airs immediately after the late local news. 

Pre-2002:             Conan’s contract  as host of the 12:35 “Late Night with Conan O’Brien” defines “Late Night” as “the second show” after the late local news (The Tonight Show being the first)

 2002:                     Conan signs an amendment to that contract, which promised that he’ll succeed Leno as host of the Tonight Show whenever Leno stepped down.  The amendment expressly defines “Tonight Show” as that thing that airs on NBC at “11:35 PM.”  So, Conan’s contract now contains two separate references that place TTS at 11:35.

2004:                     Conan signs another amendment saying that he’ll take over “The Tonight Show” in mid-2009.  This amendment doesn’t mention timeslot at all, leaving the existing references intact.

2010:                     NBC is forced to cancel ‘The Jay Leno Show’ (where they had parked Jay after Conan took over TTS) by an impending affiliate revolt.  But, Jay’s contract specifies a $150M liquidated damages payment if NBC doesn’t keep JLS on the air at least two years.  So, NBC has to pay him or appease him.   And for appeasement, Jay selects “I’ll go back to 11:35.”   (Do not get me started on his “I had nothing to do with this decision” act).  To accomodate this, NBC tells Conan that they’re moving himand TTS  past midnight.  Conan says that he’s less than wild about the idea.  NBC responds that because the 2004 amendment didn’t mention the timeslot subject at all, they are free to place TTS wherever they want. 

So, basically, NBC was arguing that that when a contractual amendment is silent on an issue, it somehow by that silence invalidates all previous definitions in that contract or any if that contracts earlier earlier amendments.  Also, the silence invalidates 16 years of custom-and-usage dealings between the parties and  54 years of widely-held general cultural understanding about when the Tonight Show aired. 

Legal drafting experts everywhere still haven’t stopped throwing up.   Course of dealing?  Gone.  Ambiguity construed against the drafter?  Gone?  Plain meaning?  You’re outta here.  Consensus ad item?  See ya’ later. 

NBC’s logical position translates to this:   the law of the land is that amendments to any base contract must restate all the defined terms within that contract and all defined terms within any earlier amendments or those defined terms will be invalid. 

As it turned out, their near-total capitulation during separation negotiations shows that this position was basically a (pretty lame) bluff. 

Wonder what happens next???

At any rate, it’s a nice little reminder that the law can become so ingrained in our everyday lives that we take it to be part of the metaphysical underpinnings by which our world works…unti we realize that that law ain’t necessarily the law everywhere.

So until Madrid comes to La Paz, Evo, keep the Cacacha y Coca-Colla flowing.

We’ll see you there!