Sooner or later a startup lawyer will hear the suggestion that payment be postponed or waived in exchange for equity. What is the lawyer to do when the client cannot (or would rather not) pay and offers stock instead?
On its face, taking equity looks like a practical solution. The client preserves cash, the lawyer gains a chance at upside and both parties deepen their relationship. But when lawyers consider investing in a client’s business they step into an area filled with potential conflicts of interest, fiduciary duty complications and regulatory scrutiny. What begins as an informal conversation can quickly become a professional minefield if not handled with precision.
The Psychological Appeal: Why Lawyers Say Yes
The allure of equity arrangements extends beyond mere financial calculation. For many lawyers, particularly those working in the high-energy startup ecosystem, equity represents more than compensation. It symbolizes partnership, innovation and the chance to be part of something transformative. This psychological dimension cannot be understated when evaluating why lawyers repeatedly find themselves drawn to these arrangements despite their inherent complexity.
The startup narrative is compelling: young entrepreneurs with revolutionary ideas, limited resources but unlimited potential, seeking legal counsel to navigate the path to success. When these clients cannot pay traditional rates, the equity proposition feels like a natural evolution of the relationship from service provider to strategic partner. This emotional appeal, however, can cloud professional judgment and lead lawyers to underestimate the risks involved.
Moreover, the fear of missing out (FOMO) plays a significant role. Stories of lawyers who became millionaires through early equity stakes in companies like Google, Facebook or Uber create powerful motivational narratives. These success stories, while real, represent a tiny fraction of equity-for-fees arrangements, most of which result in worthless paper certificates.
Ethical Framework
The central rule is Model Rule of Professional Conduct 1.8(a), which governs business dealings between lawyers and their clients. It reflects the profession’s recognition that the attorney-client relationship is not one of equals and that clients deserve extra protection. The rule demands that terms be fair and reasonable when judged against market standards, that the lawyer disclose the terms in writing and that the client have the chance to seek independent legal advice. The rule is written broadly because regulators understand how tempting and how dangerous these deals can be.
The “Fair and Reasonable” Standard
The requirement that terms be “fair and reasonable” creates immediate challenges for valuation. How does one value legal services against equity in a company with no revenue, uncertain prospects and volatile market conditions? Traditional billing methods provide clear benchmarks: hourly rates, success fees or fixed project costs. Equity valuation, by contrast, depends on subjective assessments of business potential, market size, competitive advantages and execution capability.
Courts have struggled with this standard, often applying hindsight analysis that seems unfair to lawyers who made reasonable judgments based on information available at the time. The safest approach requires lawyers to err on the side of conservatism, accepting equity stakes that undervalue their services rather than risk claims of overreaching.
State-by-State Variations
Compliance is not uniform across jurisdictions. Some states impose cooling-off periods to give clients time to reflect. Others prohibit specific investment structures or require mandatory consultation with ethics counsel. A lawyer who assumes that the Model Rule is the only standard risks discipline. The safest approach is to check both the state rules and any bar opinions on lawyer investment in client businesses before proceeding.
California, for instance, has developed extensive case law around these arrangements, often focusing on whether lawyers adequately disclosed risks and alternatives. New York emphasizes the prohibition on lawyers acquiring proprietary interests in their clients’ affairs. Texas requires specific disclosures about the illiquid nature of startup equity. These variations mean that lawyers practicing across multiple jurisdictions face a complex compliance matrix.
Securities Law Overlays
Beyond ethics rules, securities laws may apply. A lawyer who accepts stock is not just a service provider anymore but also an investor. That shift can trigger disclosure obligations, fiduciary duties under securities regulations and even registration requirements in extreme cases. Anti-fraud rules apply to every conversation that touches on the investment. If the lawyer paints too rosy a picture of the company’s prospects, even informally, that optimism may be scrutinized later as a misleading statement to an investor.
Anti-Fraud Provisions
Section 10(b) of the Securities Exchange Act and Rule 10b-5 apply to all securities transactions, including equity-for-services arrangements. These provisions prohibit material misstatements or omissions in connection with securities purchases or sales. For lawyers, this creates a delicate balance between zealous advocacy for their clients and honest disclosure of risks as potential investors.
State Blue Sky Laws
State securities regulations add another layer of complexity. These “blue sky” laws often have their own exemption requirements, filing obligations and anti-fraud provisions. A lawyer accepting equity must ensure compliance with securities laws in every state where the company operates or has investors, creating a compliance burden that can exceed the value of the legal services provided.
Potential Benefits: The Strategic Partnership Model
Despite these hurdles, the potential upside is real. Equity aligns lawyer and client interests. A lawyer with stock is more likely to think like a business partner than a mere service provider. That perspective can help the client because legal advice is given in a broader strategic context. It can also open doors. Lawyers may introduce the client to investors, potential hires or strategic partners, knowing that both sides stand to gain from the company’s success. For startups with limited cash, this can be invaluable.
Long-term Relationship Building
Equity arrangements create multi-year relationships that can span multiple rounds of financing, strategic transactions and business pivots. These deep relationships often result in better legal outcomes because lawyers develop intimate knowledge of the business, industry and management team. This continuity can be particularly valuable in complex industries where legal and business considerations are tightly intertwined.
Cash Flow Management for Startups
For early-stage companies, equity-for-services arrangements provide crucial cash flow relief during the most vulnerable business phases. This preserved cash can be deployed for product development, market expansion or team building, activities that directly impact company valuation and success probability. The implicit bet that equity will ultimately provide greater value than cash fees can be a winning proposition for both parties.
Significant Risks: Professional and Financial Hazards
The risks, however, are profound. A lawyer’s professional judgment may be compromised when personal financial interests pull in one direction and professional duties in another. A settlement that preserves cash may look attractive from an investor’s perspective but shortchange the client’s long-term interests. Even when motives are pure, the appearance of divided loyalty can undermine trust and lead to malpractice claims.
Practical safeguards can make these arrangements safer, though never risk-free. The first is mindset. A lawyer should approach the investment as if they were a venture capitalist, not a service provider doing a favor for a client. That means conducting due diligence, reviewing the capitalization table, understanding dilution risk and evaluating the management team. If you would not invest your own cash in the business, the equity-for-fees trade is a red flag.
Insurance is another critical consideration. Many malpractice policies exclude claims tied to business ventures with clients. Review coverage carefully, disclose the arrangement to your carrier and obtain supplemental coverage if needed.
Protecting the Client: Fiduciary Responsibility in Dual Roles
On the client side, always encourage independent legal advice. Even if waived, the recommendation demonstrates respect for the rules and the client’s autonomy. Keep disclosures current and update them as circumstances change. Consider requiring separate counsel for major financing rounds or high-stakes litigation decisions where your equity interest could influence judgment.
Exit Strategies: Planning for Liquidity Events
Finally, think ahead to the exit. Equity in startups is illiquid. If the only realistic path to liquidity is an IPO or acquisition years away, be prepared to hold indefinitely. Whenever possible, negotiate exit options at the outset so that you have clarity on how and when you may convert the investment into cash.
IPO Considerations
- Lock-up Periods: Public offerings typically include 180-day lock-up periods during which early shareholders cannot sell their stock. Lawyers should understand these restrictions and plan accordingly for their financial needs.
- Registration Rights: Lawyers should negotiate registration rights that allow them to include their shares in future public offerings or registration statements. These rights provide potential liquidity even if the company doesn’t go public immediately.
- Market Conditions: IPO markets are cyclical and unpredictable. Companies may delay public offerings for years due to market conditions, requiring lawyers to maintain illiquid positions longer than anticipated.
Acquisition Scenarios
- Merger Consideration: Different types of acquisition consideration—cash, stock or combinations—affect lawyer returns differently. Cash transactions provide immediate liquidity while stock deals may extend illiquidity periods.
- Earnout Provisions: Many acquisitions include earnout provisions that tie portions of the purchase price to future performance. Lawyers should understand how these provisions affect their returns and the additional risks they create.
- Drag-Along Rights: Companies may have drag-along provisions that require all shareholders to participate in approved transactions. While these provisions can force liquidity, they may also require lawyers to accept transaction terms they find unfavorable.
Secondary Market Opportunities
- Private Equity Secondary Markets: Growing secondary markets for private company shares may provide liquidity opportunities before traditional exit events. However, these markets often price shares at significant discounts to fair value.
- Company Buyback Programs: Some successful companies implement share buyback programs that provide liquidity to early shareholders. Lawyers should encourage clients to consider these programs as companies mature and generate cash flow.
- Strategic Buyer Interest: Industry consolidation may create acquisition opportunities that provide earlier exits than initially anticipated. Lawyers can help facilitate these opportunities through their industry networks and relationships.
Conclusion: Navigating the Decision with Professional Wisdom
The decision to accept equity instead of fees is tempting, especially in the startup world where cash is scarce and growth stories are compelling. But it carries risks that extend far beyond ordinary fee arrangements. The safest path is to approach the decision with the same rigor applied to a complex client matter, to respect both the letter and the spirit of the professional rules and to protect the trust at the core of the attorney-client relationship.
Success in equity-for-services arrangements requires lawyers to function effectively as both legal counselors and sophisticated investors. This dual competency is rare and difficult to develop, suggesting that lawyers should approach these opportunities with appropriate humility and extensive preparation.
The legal profession’s ethical framework provides important guidance, but it cannot eliminate the fundamental tensions inherent in serving two masters, professional obligation and personal financial interest. Lawyers who choose to navigate these waters must commit to extraordinary transparency, rigorous self-examination and unwavering dedication to client interests even when personal interests suggest different paths.
The potential rewards, both financial and professional, can be substantial for lawyers who approach equity arrangements with appropriate sophistication and safeguards. However, these rewards come with proportional risks that can threaten both professional reputation and personal financial security. The decision to accept equity compensation should never be made lightly or without comprehensive understanding of all implications.
Ultimately, the growth of equity-for-services arrangements reflects the evolving nature of professional service delivery in innovative industries. As these arrangements become more common, the legal profession must continue developing frameworks that protect both lawyers and clients while enabling the innovation and risk-taking that drives economic growth. This evolution requires ongoing dialogue between practitioners, regulators and clients to ensure that professional standards keep pace with market realities.
The lawyers who succeed in equity arrangements will be those who master the complex intersection of legal expertise, business judgment and ethical reasoning. This mastery cannot be assumed or developed quickly; it requires deliberate effort, extensive education and ongoing refinement. For lawyers willing to make this investment, equity arrangements can provide both financial opportunity and professional fulfillment. For those who lack the commitment or competency to navigate these complexities, traditional fee arrangements remain the safer and more appropriate choice.
The choice between equity and cash ultimately reflects each lawyer’s professional philosophy, risk tolerance and long-term career strategy. There is no universally correct answer, but there are professional standards and best practices that can guide decision-making and implementation. Lawyers who honor these standards while pursuing innovative compensation arrangements will help define the future of legal practice in the entrepreneurial economy.