Contributed by Jeffrey A. Showalter
Most large venture deals require that the Company’s outside legal counsel issue a customary legal opinion, addressed to the investors in the financing, in order to give the investors comfort that the company’s legal affairs are in order. For companies that have been represented since formation by large regional or national counsel with venture capital experience, this requirement generally is not overly burdensome. However, where counsel has not represented the company since formation or is unfamiliar with VC deals, the legal opinion can become an expensive part of the process and a potential delay in the timing of the financing. Below is a short primer on why VCs require legal opinions and the process and cost typically required for a law firm to issue such an opinion.
Purpose—what is the purpose of a legal opinion?
As noted above, in a venture financing, the legal opinion is primarily intended to provide the investors with comfort that the records and procedures relating to the company’s formation, corporate governance and capitalization are in order and that the company has properly approved, and has the legal authority to enter into, the subject venture financing transaction without burdensome registration with the SEC. Although the company also makes representations and warranties to the investors with respect to these issues, unlike other representations and warranties made by the company that relate primarily to business issues (i.e., intellectual property, material contracts, employment matters, etc.), the company’s outside legal counsel is often in a better position than the company to provide reassurance on the matters covered by a legal opinion.
Process and Cost—what does it typically cost for a law firm to issue a legal opinion?
In order to provide a typical legal opinion, a law firm must review all of the company’s corporate and capitalization records since formation, the transaction documents and various other material contracts and relevant statutes. Where the law firm has represented a company since formation, this “review” has largely already taken place prior to the financing, by virtue of the firm having prepared the relevant corporate and capitalization records. However, where the law firm is new to representing the company, this review of records can require substantial investment of time (particularly if the company has been in existence for a long period of time and has a complicated capitalization table) and often results in the identification of issues that the company needs to remediate, or “clean-up,” in order for the law firm to issue a “clean” opinion. Given this variability in required work, the cost of rendering a legal opinion in a venture financing typically ranges from $5,000 to $20,000 or more. In understanding why these costs can become so large relative to the other legal costs of the deal, it is also important for companies to appreciate that a law firm’s professional liability insurance coverage is used to back-stop any inaccuracies in the firm’s legal opinions. Accordingly, when issuing legal opinions, law firms must implement conservative procedures to ensure absolute accuracy.