E is for e-commerce and ethics

It's tempting for law firms to invest in dot.com clients. But could there be a conflict of interests?
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Linklaters & Alliance hit the news last year when it admitted that it had invested in 16 different internet concerns instead of charging for legal advice. The firm recently acted on the flotations of Lastminute.com and Freeserve. com, but Rupert Pearce, the firm's head of internet and e-commerce, stresses that in neither case did the firm take equity instead of fees.

The view is that with an initial public offering (IPO), the company usually has little difficulty finding investors, or indeed paying its legal advisers.

Instead, Linklaters takes equity in through-the-door start-ups (about 30 to date) - what may be the Lastminute.coms of tomorrow, and which are mainly business-to-business companies. Since the initial press coverage, he admits "there was a rush of inquiries, including one or two which I thought might just be spoofs. But the basic criteria for taking equity are conservative ones - it is based 75 per cent on the management team and 25 per cent on the proposition, and Linklaters also has its own technology due diligence team to check out the technical side".

Mr Pearce says the firm has turned down 10 propositions for every one it has accepted. The plus side for the client is that with a law firm on board, it is more likely to make the investment banks more confident in the company. The shareholdings that Linklaters has taken in any start-up is in the low single percentage figures, so that the potential risk is quite low, and the upside obviously is that even if few of the companies are successful, that will subsidise the losses.

This is a rapidly changing area for lawyers and their clients. One of the start-ups which the firm recently took on involved two 20-year-olds who had never written a business plan before or even run a business but within three months, they have got the first round of set-up costs for their software business, and are now about to get the second round.

E-commerce lawyers may have relaxed their dress code for start-up clients, but what else have they relaxed? For lawyers who take equity in clients, should the "e" stand for ethical as well? The Law Society of England and Wales is producing new guidelines on the ethical implications of law firms investing in clients.

Mr Pearce says that Linklaters checked with the Law Society before proceeding. "It is critical that lawyers recognise that they don't just have to satisfy the Law Society, it is almost more important to satisfy the client, and make the client comfortable about the issue of a lawyer being both an adviser and an owner."

Inevitably the model for taking shares comes from the US, where 1999 was a boom year - an analysis in the American Bar Association Journal found that lawyers held stock in a third of the over 500 companies that went public last year.

One of the most frenzied concerned a company that had not made any profits and did not expect to but that did not stop the stock price rocketing to a 698 per cent gain, and set a new record as the biggest first-day initial public offering. It may sound vaguely familiar, in view of the press coverage about Lastminute.com - the company was in fact VA Linux.

As with many areas, the US is ahead - there are only a handful of lawyer-investors who have become "double commas" - in computer speak for millionaires - the majority have seen respectable gains.

And the fact that law firms in Silicon Valley have taken shares instead of fees in so many IPOs has already raised concerns about conflicts of interest. The main firms who do this shield themselves from conflicts by using outside partnerships to handle those investments. The profession's rules warn against taking interests that may be adverse to a client, but do not prohibit it.

One solution to bypass any conflict, is to give up law and set up your own dot.com, which also raises the chances of becoming a double comma.

Simon Olswang, who founded Olswang nearly 20 years ago, moved into new territory by heading up an internet company called Amaze. Now he is leading a bunch of net-heads who design websites. Would it float? "Not today," he said.

The firm he founded has occasionally taken equity in a client, but Olswang's chief executive Jonathan Goldstein says: "Some firms do it all the time. We have done it - not very often - but only where the business case was right and where it does not affect our impartiality. The question is: who is making that investment decision - and are lawyers the best people to do that?"

Rupert Pearce has announced that he will be joining venture development company Cognition Ventures as executive director and head of mergers and acquisitions