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STRATEGY

When Is a Law Firm Not a Law Firm?
 

Craig Johnson, founder of Venture Law Group, redefined what a law firm can do for a start-up by helping companies develop business plans, find financing, and recruit management.
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Venture Law Group has helped launch dozens of successful start-ups by coaching founders, recruiting high-profile management talent, and brokering financing deals. Hard to tell if its partners are lawyers or venture capitalists. And that's just the way they like it

When William Sharpe and his colleague Joseph Grundfest first called on Craig Johnson, in April 1996, they had only the vaguest glimmer of a business idea. Sharpe and Grundfest, both professors at Stanford University, envisioned marketing some instructional investment software and tools via the Web. Neither had ever run a company. But Johnson, founder of Venture Law Group (VLG), in Menlo Park, Calif., immediately saw in the academic duo the elements of a successful start-up.

Sharpe, a 1990 Nobel laureate for his theories on risk allocation in asset management, was at the time advising pension funds with assets of approximately $200 billion under management. And Grundfest, a former commissioner at the Securities and Exchange Commission, had proved himself a distinguished Netizen, promulgating cutting-edge strategies for regulating securities markets. What the two lacked--and what they had come to Johnson for--was a clear plan for packaging and selling their expertise, as well as a strategy for raising money to get the business off the ground.

"What we needed was somebody who could act as a coach and a team builder, who could bring to the table the right mix of people early on," comments Grundfest, who compares Johnson's role in Silicon Valley to that of a talent agent in Hollywood. "Craig Johnson is one of the elite group of people who understand the deal-making culture of the valley."

In several brainstorming sessions, Johnson worked for free--as a policy, VLG doesn't charge for the earliest stages of strategic business advice--to help his new clients refine their concept. Together they created the blueprint for Financial Engines, a company that would offer an electronic mode of aggressively managing the funds that American workers have socked away in retirement accounts, which now total $1 trillion.

Culling from a mountain of contacts he's developed during 24 years of Silicon Valley deal making, Johnson, 51, acted as a matchmaker, bringing the professors together with a software developer and with one of the valley's most respected venture capitalists, C. Richard Kramlich of Menlo Park's New Enterprise Associates. "Craig is very well regarded in Silicon Valley and has a lot of stature," says Kramlich. Indeed, Johnson's faith in the fledgling start-up alone was enough to pique Kramlich's interest.

Johnson went on to help recruit Financial Engines' president and CEO. Over a $3.95 plate of pancakes, Johnson persuaded 29-year-old Jeff Maggioncalda to forfeit a position with McKinsey & Co.'s prestigious high-technology practice and run the professors' new company instead. In January 1997, Johnson also helped raise $4.5 million in venture financing for Financial Engines, more than its principals had at first hoped for. "Craig has really helped develop the whole venture-financing protocol, and so he knew whom we should talk to," notes Maggioncalda, explaining that he decided to join Financial Engines largely because he trusted Johnson's gut instinct about the company. "He knew the strategies to get people interested, what sort of terms we should be shooting for, and what we should be willing to give up in the process."

For Johnson, who has served as midwife for hundreds of new companies, the birth of Financial Engines followed a familiar course. "It's a great example of how, with the vaguest of business concepts, we can help modify and develop what might become a successful $100-million company," he says matter-of-factly.

Johnson has positioned his Venture Law Group front and center in what has emerged as the Silicon Valley standard for setting up new businesses. Entrepreneurs have learned that they can bring their ideas to life by tapping into the skills of a wide range of people. VLG--situated in the heart of the valley's venture-capital community at the top of Menlo Park's Sand Hill Road--acts as a go-between. "Think of us as a McKinsey or a Boston Consulting Group for start-ups, with the added value that we can actually do the deals," he says.

Five years out of the gate, VLG, which according to Johnson generated $31 million in revenues in 1997, has emerged as a favorite adviser to Silicon Valley entrepreneurs and has offered strategic business, financial, and legal consulting to successful start-ups such as Internet search company Yahoo! Inc., E-mail service HotMail, Web auditing service I/PRO, and ultra-high-capacity-disk-drive maker TeraStor Corp., to name just a few. "We see ourselves as somewhere between a traditional law firm and a venture-capital firm," Johnson explains. In fact, the story of VLG is that of a successful Silicon Valley start-up--one that just happens to be a law firm.

Seizing a unique niche for itself, VLG was created to redefine what a law firm could do for a start-up. "They are geared to providing the kind of support that you need as a start-up," observes client Amyl Ahola, president of TeraStor. "The service we've gotten has been surprisingly, consistently positive."

At the outset of each relationship, VLG acts a lot like a venture-capital firm, picking and choosing as clients the start-ups in which it sees the greatest likelihood of long-term success. And while VLG does not actually finance the companies it jump-starts, it does routinely purchase small equity positions (typically less than 1%) through a venture fund called VLG Investments. As it did with Financial Engines, Johnson's outfit then helps assemble an external team of other advisers well suited to the clients' business needs. Along the way, VLG tries to become an integral player in refining its client companies' business plans and financing strategies--all with an eye toward building companies that will succeed and ultimately produce investment returns for VLG years down the road. The lawyering--and the bills--don't come until later.

It's a business model that's radically different from what traditional law firms have used. It initially relied heavily on Johnson's personal reputation. He had built up his "platinum Rolodex" while at Silicon Valley's top legal powerhouse, Wilson, Sonsini, Goodrich & Rosati, where he practiced for 18 years. As a partner there, Johnson attracted a strong following among early-stage companies and formed deep relationships with the venture-capital community. "He was really the number two person at Wilson, Sonsini," observes venture capitalist Kramlich. But by 1993, Johnson was consumed with the idea of creating a different kind of firm--one that would concentrate primarily on early-stage companies.

Johnson claims that the idea for VLG came to him in a dream in early 1993. For months he had been frustrated in his efforts to set up a Wilson, Sonsini satellite office on Sand Hill Road. He'd been worried, too, by turnover and growth at the firm, which in his time had expanded from 10 to roughly 250 lawyers. That growth--accompanied by expansion and maturation of the companies on Wilson, Sonsini's client roster--had diluted the firm's focus on the early-stage companies that were Johnson's passion. His dream seemed to spell out a clear solution to it all.

When he had been a computer programmer for Burroughs Corp. in Pasadena, Calif., in 1970, Johnson typically would not hammer out a single line of code until he had a clear picture of an entire program laid out in his mind. Now, he says, he awakened from a deep sleep with a complete vision for a new business in his head. Before any of the details faded, he got out of bed and, still in his pajamas, wrote down everything. By dawn he had filled 15 pages.

Within a few months of committing his plan to paper, Johnson quit Wilson, Sonsini. As commander of a 15-person group that concentrated on serving emerging companies, Johnson had long been an independent player. Still, he suspects that some of his colleagues thought he was nuts. He was, after all, forfeiting his post at one of the valley's most powerful and influential institutions, as well as a $1-million-plus annual pay package, to start something brand-new--under the logo of an acorn.

The dream seemed to have set in motion something Johnson could not turn back. "I went to sleep on a Friday evening with no idea of leaving the firm and woke with the reasons fully formed in my mind," he explained in his resignation. "I was skeptical at first, but the conclusion now seems inevitable."

Johnson designed for his new firm a brand-new business model, based on the framework of a venture-backed start-up. The name as much as said so. Rather than trumpeting the names of its founding partners, as the appellation of virtually every other law firm in the country does, the moniker Venture Law Group evoked the nature of the practice. "At first we weren't even sure if it was legal," Johnson recalls. (Since VLG's inception, more than a dozen firms have latched on to the VLG trend, among them Enterprise Law Group, Genesis Law Group, Commerce Law Group, and Technology Law Group.)

Johnson, who firmly believes that there is value in innovation simply for the sake of innovation, championed a marketing campaign that features frequent giveaways of coffee cups, tote bags, and fleeces emblazoned with the VLG logo--"√ la Hard Rock Cafe," he jokes. He has bucked law-business norms in more profound ways as well, giving everyone--from the most junior secretaries to the most senior partners--a slice of the firm's profits. In addition, VLG has flattened the traditional pyramidal law-firm model of staffing, in which a cadre of newer lawyers works under the supervision of a few senior ones. Instead, VLG promises its clients that its big-name senior partners--lawyers like Johnson and his partners Joshua Pickus and Jim Brock--will be deeply involved in servicing the business.

As an extension of that principle, VLG has elected to limit its lawyers to advising only 15 to 20 companies at a time (whereas at other law firms, individual partners may count 30 to 50 companies as clients). "We have far fewer companies per attorney than our competitors," Johnson acknowledges. "We prefer to concentrate on companies where we can provide business advice as well as legal advice. We like to be in the trenches."

It's not surprising, then, that VLG turns away as much work as it takes on. On a recent day, for example, Johnson rejected a video-postproduction business. "It didn't sound like it had enough new technology to have a lot of interest for us," he explains. "We want to brand VLG as the law firm you want to be with if you're the next Yahoo!"

Rather than taking on all of the work that comes through the door and growing to accommodate increased demand, VLG has instituted procedures for screening incoming assignments and is trying to resist expanding beyond 75 lawyers. The firm accepts only what it deems to be the most exciting, cutting-edge slice of the market. "We're like a cork floating along on top of a river of venture capital. Wherever the river goes, we go," Johnson explains. "When biotechnology companies are hot, we're biotech lawyers. Lately, telecommunications and software companies have been hot, so we're information-technology lawyers."

VLG partner Joshua Pickus jumped at the chance to represent WebTV Networks Inc.--which was acquired by Microsoft in 1997 for $425 million--even though WebTV was beyond the start-up stage when VLG came on board. When WebTV had approached VLG to handle the work, WebTV was already recognized as hot in Silicon Valley. The fact that WebTV had chosen to switch to VLG as new counsel said lots of good things to valley insiders. VLG's burgeoning reputation also played a role in developing the firm's ongoing relationships with Oracle and Intel.

Still, VLG has tailored its approach to appeal specifically to entrepreneurs who don't have a lot of cash to spend on fees. Fledgling ventures can count on VLG to devote substantial time--anywhere from a few weeks to a few months--to developing a business plan and a financing strategy, at no cost to the client until the client receives its financing. Yahoo! founder Jerry Yang points out that his company was not billed by VLG until after it had received its first round of venture funding. It was the same for Financial Engines. The upside for VLG comes as its lawyers help their clients through the ensuing barrage of deals and other transactions that typically accompany a vibrant start-up--work that VLG does charge up front for. The key, Johnson explains, is volume. Not volume of clients, but volume of work for a handful of clients who will come to rely heavily on VLG as their companies come to life.

"When we actually get down to doing substantive legal work as opposed to business counseling, then the meter goes on," Johnson explains. No matter how big or how small the company, VLG lawyers expect to be treated not as mere peripheral legal advisers but as true team players. "We want companies to treat us as real partners," Johnson says. "Real business partners in building up a business."

Reflecting that philosophy, VLG asks its start-up clients for the opportunity to buy into their businesses, purchasing common stock first and preferred stock after a company receives financing. All the firm's senior lawyers and partners contribute a pro rata share of their profits to VLG Investments, which in turn takes a small equity position in the firm's start-up clients. In addition, a partner responsible for bringing in a particular client also buys into the start-up personally. As a policy, VLG partners are required to take from 10% to 20% of the equity opportunity that VLG is offered in the client, with the remaining 80% to 90% reserved for the firm's fund.

"Because we're so involved early on in the business strategy as well as the legal strategy, we like to participate on a financial basis," explains Mark Silverman, one of three VLG partners in charge of running VLG's fund. "The ability to participate in the upside of the business for a client is very motivating."

From a pure investment perspective, Silverman concedes that the strategy is "very risky." Indeed, when compared with the most aggressive venture-capital firms--which typically back 10 to 20 new companies a year--VLG Investments seems downright wild. Since its inception, in 1993, Silverman says, the fund has invested in more than 200 companies.

The stakes typically are small--an average of just $11,000--for a current total investment of $3 million. As Silverman explains it, the investment goal of the fund is to produce a 20% to 30% yield compounded over a five-year period. Because the fund didn't really take off until 1995, Silverman says, he doesn't expect to see any measurable returns before the year 1999. "Although it's been hit-and-miss, it looks like it may bear fruit in the next few years," Johnson says of the investment strategy. "Our goal is to meet cash-compensation expectations for senior people while our equity investments mature."

VLG's desire to identify and attract Silicon Valley's best early-stage companies as clients and investment opportunities demands that the firm be aggressive and visible in a steady stream of deals. That gives its lawyers an up-to-the-minute perspective on the market--something that even the most seasoned corporate executive can lose while running a business. Says Financial Engines founder Grundfest, "They've got experience that most entrepreneurs lack, because they've seen so many more venture deals."

"They often leverage what they learn from one company onto another," adds client Ariel Poler, founder of I/PRO, which audits and measures the effectiveness of Web sites. "Their networking is very helpful." In several instances, Poler says, VLG lawyers have introduced him to another of their clients, opening doors to new business relationships. In December 1996, for example, VLG partner Jim Brock introduced Poler to executives at Silicon Investor, a Web site for investors, who were looking for an outside board member. He accepted the board seat.

The firm also plays a role in helping entrepreneurs maneuver through the most treacherous junctures of a start-up--when a venture will either crater or rise to the next level. Financial Engines CEO Maggioncalda credits Johnson with keeping all the players in the game when the time came to ante up seed money. After discussing the subject privately with each potential investor, Johnson then matter-of-factly broached the buy-in topic in a meeting with everyone, asking each person to state publicly the specific amount he or she would contribute to the new venture, and writing it all down.

"He was able to create things out of nothing," marvels Maggioncalda, likening Johnson's role in the formation of new companies to that of an alchemist. "In a very nonobvious way he set a rhythm and a tempo that made everything come together."

In some ways, VLG seems an odd moneymaker. While the firm counts fewer companies per lawyer than its closest competitors, it has so far managed to offer incoming lawyers a tidy $91,000 a year--near the top among valley law firms. Partners' earnings have begun to close in on those at Wilson, Sonsini. (Johnson says he personally clears the $1-million mark these days.) In part, VLG's financial health has resulted from the firm's ability to tack premium rates onto its normal hourly fees for certain creative deal work, and from a 98% bill-collection rate, Johnson boasts. But when compared with other players in Silicon Valley, such as major VC firms like the Mayfield Fund and Kleiner Perkins, VLG still lags behind the competition in earnings. The bulk of the VC firms' wealth typically comes from stock distributions. "We hope in the future to close the gap a little through our own investments," Johnson says.

For now, the closest analogue to VLG in terms of earnings is Silicon Valley's LECG, a cohort of Berkeley law and economics professors that is not a law firm but does offer strategic business consulting. That group, which Johnson points out went public in December 1997, mirrors VLG in terms of size, revenues, and profits, he says.

Determined to recruit and retain top-tier talent, Johnson has tried to mix the long-range upside potential of VLG's investment returns with a collegial culture. The firm has set out to attract young, energetic lawyers who are interested in taking their relationship with a client to a new level. Many have defected from top law firms, lured by the concept of being involved at the most exciting stage of a company's development. Like many of their entrepreneurial clients, they are also attracted to building something of their own from the ground up.

VLG's culture is reflected in everything from the office that features outdoorsy photos of lawyers with their families to the profit sharing that gives everyone a slice of the firm's success. Four times a year--at the end of each quarter--VLG tallies up its expenses and overhead, subtracts that amount from its receipts, and divides what's left among everyone from the file clerks to the senior lawyers.

Partners, who carry the greatest burden of bringing in the business, receive a much larger portion of their pay in profits than do junior lawyers and nonlegal staff. The final quarter of 1997 was VLG's most profitable ever, producing big bonuses all around. In 1993 a single profit point (the equivalent of a share in the firm) was worth nothing. "We felt lucky to be able to pay our salaries in our start-up year," Johnson notes. In the subsequent four years, the value of a point has increased from $1 in 1994 to $2.13 in 1997. "Given that our point total has more than doubled since we started, we are proud that our per-point value has continued to increase," Johnson says.

From the outset, Johnson hoped that VLG's culture combined with its earnings potential would lead to zero voluntary attrition among the firm's lawyers. So far, VLG has lost 10 lawyers. Holding on to good people is a problem for many firms in the area. "Turnover is our enemy," Johnson laments.

Another serious issue is whether the firm's cozy culture can survive the increase in personnel. In five years VLG has expanded from 14 to 75 lawyers and has added a Pacific Northwest branch, in Kirkland, Wash. "With their expanded growth, they do less and less for their employees, but they expect more," grumbles a former employee. "The bigger it's getting, the more it's becoming just like any other law firm."

Johnson acknowledges that the firm's growth has begun to wear away the "warm and fuzzy" aspects of VLG's culture. But in order to fulfill the firm's goal of holding on to top-quality lawyers by providing them with a steady stream of fun and challenging work, growth has become a necessary evil, says Johnson. "Young attorneys want support as they become more senior--which means growth," he explains. "The only way to slow growth is to change the nature of what we do or how we perceive opportunity. This will gradually happen as our equity investments become more important. People will perceive growth as dilution."

Yet Johnson has already begun to tinker with the nature of VLG's practice, positioning the firm to be a big player in the upcoming Internet company Garage.com, which he's launching with former Apple Computer Inc. heavyweight Guy Kawasaki. (See "Anatomy of a VLG Start-up," below.) Johnson says he's also intrigued by the idea of building up some capital to expand VLG, rather than cashing out the business every quarter. "If there's money on the table, there's always pressure to distribute it," he says. "But I would love to be part of a business where we had $5 million in the business to build it the way we want it to be built."

And Johnson does have ambitious plans for expansion. VLG is now poised to pursue his dream even further. He has begun to ponder something controversial and potentially groundbreaking: making VLG the first law firm ever to go public. In fact, Johnson points out, VLG structured itself from the outset to allow for that possibility--although at the moment, many obstacles, including the lawyers' professional code of conduct, prevent law firms from going public. Johnson is reluctant to discuss any details of his plan, but the mere fact that he is thinking about it demonstrates the breadth of the firm's ambition and its skill at eschewing traditional labels and limitations. As Yahoo! founder Yang puts it, even in a community known for offbeat and groundbreaking ideas, VLG still manages to stand out as "a new kind of firm."

D. M. Osborne is a former senior reporter for The American Lawyer and is a contributor to the soon-to-be-launched magazine Content.


Anatomy of a VLG Start-up

Guy Kawasaki sat down for lunch with lawyer Craig Johnson last September, eager to talk about his latest brainstorm. Kawasaki, the former Apple Computer director of software product management, sketched out his vision for a series of snazzy Web sites about hot cities like Kuala Lumpur and London. But Johnson, who knew that Web sites supported by advertisers were notoriously iffy, was less than enamored with the concept.

Instead, Johnson steered his client in another direction. The lawyer started describing his idea for an alternative to the ad hoc, word-of-mouth network that most entrepreneurs rely on. Johnson envisioned a system that would work like an elite matchmaking agency. A venture like this needed a Silicon Valley celebrity at the helm, Johnson explained, and Kawasaki--who had made his name as one of Apple's more visible evangelists--would be ideal. By the end of lunch Kawasaki had changed plans.

Beginning this month, the 43-year-old Kawasaki will be headlining the two-part introduction of Garage.com, a Web-based venture that will introduce carefully screened entrepreneurs to venture capital. (The name refers to the humble birthplace of companies like Apple and Hewlett-Packard.) The main feature will be a password-protected area called "Heaven" (which will be on-line at the end of the summer), where investors can check out the business plans of Silicon Valley high-tech start-ups.

CEO Kawasaki says Johnson wielded his "platinum Rolodex" to attract the right people to the project. The lawyer helped recruit Web-site sponsors Silicon Valley Bank and Coopers & Lybrand, as well as some high-profile directors, including Silicon Valley Bank president John Dean. (Johnson will sit on the board, too.) Johnson also took steps to register the venture, which will start off with about a dozen employees, with the Securities and Exchange Commission as a broker-dealer.

A few Web sites, such as the Small Business Administration's Angel Capital Electronic Network, already expose entrepreneurs to potential investors. But Johnson claims that most of these sites simply act as bulletin boards and don't add much value.

"Garage.com will be quite selective," Johnson says, estimating that only a few dozen plans at a time will be on display in Heaven. Finalists will be chosen by professional screeners from Coopers & Lybrand, a few Garage.com staffers, and outside industry specialists. "If you want to interest serious angels, you can't have them wading through hundreds of plans," says Johnson.

How will Garage.com make money? Along with charging investors for access to the site, it will take a 3% to 4% cut of the financing it arranges. But the payoff lies in equity. Garage.com will take stock in each venture it helps finance. And in the VLG tradition, Johnson will participate in the action through his equity stake in Garage.com. -- Susan Beck


Last updated: May 1, 1998




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