Lawyers Taking Their Piece of the Pie: Equity For Legal Services
In the world of startups and early-stage ventures, it's common for founders to ask legal counsel to “take equity” instead of billing for traditional hourly fees. For lawyers, not just those representing tech startups or acting as outside general counsel, working for equity can seem like a savvy business move—aligning incentives and potentially yielding big returns. But this arrangement is fraught with ethical pitfalls and risk management challenges. Lawyers who take equity must tread carefully to comply with the Rules of Professional Conduct, avoid conflicts of interest, and protect both themselves and their clients.
Understanding the Practice: When and Why Lawyers Take Equity
Equity compensation usually comes in the form of stock, options, or convertible instruments in exchange for legal services, either as full payment or a partial offset to discounted cash fees. Clients may propose these arrangements due to limited cash flow, and lawyers may accept them as an investment in a promising venture. While this may create a sense of partnership and commitment, it also blurs the line between lawyer and investor, triggering ethical duties that require heightened vigilance.
Applicable Rules of Professional Conduct
ABA Model Rule 1.8(a), and state analogs, governs business transactions with clients. When a lawyer takes equity as payment, it constitutes a business transaction that must meet several strict requirements:
The terms must be fair and reasonable to the client.
The terms must be fully disclosed in writing, in a manner the client can understand.
The client must be advised in writing of the desirability of seeking independent legal counsel and given a reasonable opportunity to do so.
The client must give informed, written consent.
Failure to comply with these requirements can render the agreement unenforceable and potentially subject the lawyer to discipline.
Model Rule 1.7 (conflicts of interest) also comes into play. A lawyer’s personal financial interest in the client’s company may materially limit their professional judgment. For example, a lawyer might be tempted to push for aggressive growth or fast fundraising not because it’s in the client’s best interest, but because it would boost the lawyer’s stake. This type of divided loyalty can create a conflict, potentially an unwaivable conflict, if not carefully addressed.
Model Rule 1.5 (fees) still applies - so the overall fee, even if paid in equity, must be reasonable under the circumstances. An unusually large stake in a company for relatively modest legal services may be viewed as an excessive fee, particularly if the company ends up being worth a great deal later. Documenting how the amount was determined and connecting it to the legal services are absolutely key.
Model Rule 2.1 reminds lawyers to exercise independent professional judgment and render candid advice. That becomes harder when the lawyer’s own financial future is tied to the client’s operations and valuation.
Best Practices and Risk Management Tips
Put everything in writing. Every term of the equity arrangement—valuation, timing, vesting, dilution rights, board roles (if any), and what happens if the company dissolves—should be clearly set forth in a written engagement agreement or side letter, just like any other investor or owner. While they can reference each other, the agreement should be independent of the engagement agreement. Avoid ambiguity.
Comply strictly with Rule 1.8(a). Use separate documentation confirming full disclosure and client consent, including an explicit recommendation that the client consults independent counsel. Do not rely on boilerplate language.
Use conservative valuations and avoid 'over-equitizing.' If you’re accepting equity as partial compensation, be cautious not to accept an amount that could appear disproportionate to the value of the services provided. A cap or clawback provision tied to future value may be prudent.
Avoid becoming both lawyer and director. Serving on the client’s board of directors while also providing legal counsel complicates fiduciary duties and creates potential for non-waivable conflicts. It also increases the likelihood that privilege could be compromised if business and legal roles blur.
Periodically reassess the relationship. As the client grows and the legal work expands, lawyers should evaluate whether their financial interest continues to pose a conflict under Rule 1.7. If it does, withdrawal or conversion to a traditional fee arrangement may be necessary.
Consider malpractice insurance implications. Many professional liability carriers view equity arrangements as heightened risk. Some may exclude coverage for services provided to companies in which the lawyer holds a material ownership stake. Confirm coverage before agreeing to equity.
Be prepared for disclosure obligations. If the client later goes public, undergoes an acquisition, or has outside investors perform diligence, your ownership and role as counsel may need to be disclosed. This can trigger scrutiny of the relationship and its ethics compliance.
Equity-based fee arrangements are not inherently unethical, but they require lawyers to be especially mindful of their duties under the Rules of Professional Conduct. The temptation of a big payout can cloud judgment, and the dual role of investor and advisor can erode the independence that clients rely on and the Rules and law require. Lawyers who take equity must do so with caution, transparency, and strict adherence to ethical rules. In the end, the best risk management strategy is to never forget that the lawyer’s role is to protect the client’s interests.
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