Fewer Firms Dining on Equity Stakes
October 6, 2003

By Renee Deger, The Recorder
Originally published in Law.com's The Recorder.

Silicon Valley law firms fattened up on equity stakes during the Internet boom, but attorneys aren't finding investments in clients so tasty these days.

The still-ailing market for initial public offerings, flagging lawyer interest in investing and resistance by clients to handing over stock have combined to drastically reduce investment spending and returns.

Consider the portfolio of one the most aggressive dot-com-era investors -- Wilson Sonsini Goodrich & Rosati. During the boom, Wilson pumped as much as $30 million a year in firm profits into its investment pool. These days, that amount is down to $6 million a year.

A separate pool open to individual partners has suffered a similar drop in popularity -- one-third of the partners who invested in the fund last year have opted out this year, said Mario Rosati, one of the two Wilson partners who manages the firm's investment activity.

The reason for the decline is simple, Rosati said: "It's the market." With so few opportunities to make money selling stock, "we've reined in our investment activity."

The market for initial public offerings -- the fastest way to turn equity investments into cold hard cash -- has been discouraging. In the past 15 months, Wilson Sonsini partners owned shares in just two clients that staged an initial public offering. The equity stakes -- in Kyphon Inc. and Netflix Inc. -- were worth a total of $5.4 million as of Wednesday.

That may seem like a nice chunk of change. But compare it with the firm's equity take in 2000, and the portfolio begins to look much more anemic. In 2000, the firm held stock in 31 companies that went public, and at the end of the year the shares were worth $45.25 million.

The disinterest among lawyers is showing up in other places aside from a drop in dollars they're willing to put into firm funds. Mark Tuft, for example, is feeling it in his practice. The Cooper, White & Cooper partner did a brisk business counseling lawyers on how to ethically structure their investment programs.

"It was really a hot topic in the halcyon days of the Valley," Tuft said. "It wasn't a question of could you, but how could you."

Nowadays, when a lawyer contacts Tuft with investment-related questions, it's usually because the lawyers want advice on how best to get rid of their equity stakes. What they're finding, he said, is "divesting yourself of stock in a client is as hard as getting it."

And firms that once touted their ability to give new lawyers a shot at investment riches have backed off those claims. McDermott, Will & Emery, for example, created an investment partnership so associates could invest in clients. But the stock market tanked before the firm had a chance to put it into action, Anthony de Alcuaz, managing partner of the firm's Palo Alto office, said.

Of course, the clients aren't willing to give their lawyers much equity anyway -- and now they don't have to. During the boom years, corporate lawyers were in such demand that executives were willing to give bucketfuls of stock to seasoned Valley attorneys in exchange for representation.

The equity favored at the time was so-called founder's stock, which could be bought for pennies a share.

Now, founder's stock is essentially off the table, said Ron Bernal, managing director of Sutter Hill Ventures, a venture capital firm in Palo Alto.

In some cases, it's pure backlash. Entrepreneurs resented ever-increasing lawyer demands for options, Bernal said. "Some of the firms, which shall remain nameless, viewed it as a take it or leave it deal," Bernal said. "You got the feeling that it was being forced down your throat before you had a relationship."

One of the most visible examples of how the enthusiasm for lawyers taking equity in clients has dwindled in the Valley is the pending merger of Venture Law Group. VLG announced earlier this month its plan to merge into Heller Ehrman White & McAuliffe on Oct. 1.

VLG was founded in 1993 as a hybrid -- part law firm, part venture capital firm -- so that its attorneys could share in the successes of their clients by taking equity stakes, preferably in the form of founder's stock.

The firm enforced a policy of demanding stock in varying degrees throughout the 1990s. But since the stock market went bust in 2000, VLG abandoned its strict policy, said Donald Keller Jr., a partner.

"It's a competitive world out there," Keller said. "In most situations in which we got hired, [the client] is interviewing two or three firms."

Still, Silicon Valley law firms aren't ready to give up entirely on the practice of investing in clients. Gray Cary Ware & Freidenrich, for example, is pushing ahead with its investment plans -- though it admits that enthusiasm among partners has waned.

About one-third of the partners are still willing to participate in client investments, said John Howard Clowes, the managing partner of Gray Cary's transactions practice.

That's down from half the partners who were willing to invest during the boom, said Clowes.

"We're still, as a firm, interested," Clowes said, but he added that the frenzied investment pace during the boom "was a weird aberration -- it existed once and it will never exist again."

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