On the West Coast of America, the birthplace of the burgeoningnumber of Internet start-up companies, a large number of firms,from niche boutiques to the biggest practices, regularly investin their clients. Some have been doing so for 20 years.

The trend first spread across the US, partly following therise of high-tech centres around Washington and Boston, and isnow starting to take a hold in the European market. Late lastyear, UK firm Linklaters & Alliance announced its intentionto join a growing band of UK law firms prepared to accept sharesin lieu of fees from Internet start-up clients. One of theworld's largest firms, Clifford Chance, is also activelyinvestigating the advantages and disadvantages, as isFreshfields.

The temptations are obvious. At the very least, a firm couldmake a lot of money as dot-com company stock rockets in value. Inthe US the market is alive with stories of overnightmillionaires. Silicon Valley firm Wilson Sonsini Goodrich &Rosati, a pioneer in this area, hit the headlines in January whenthe pricing of its shares in a computer hardware company, VALinux Systems, soared from US$30 (EUR30) to US$239.25 (EUR237)per share, valuing its holding at US$25.66 million (EUR25.4million). For many of the US firms investing in their clients,1999 has been very lucrative, with many making their biggestgains to date. And the firms are investing more and more. In 1998Brobeck Phleger & Harrison invested in 40 companies. In 1999that number rose to in excess of 70. The average investment inindividual companies was US$25-50,000 (EUR25-50,000). Six havealready gone public, increasing in value between 50 to 150 timesthe amount invested. None have so far failed.

Today the technology industry is a major force in the USmarket as many high-tech companies, not least Cisco Systems andYahoo, have quickly evolved into substantial internationalcompanies. The law firms that helped them on their way arereaping two major dividends: a loyal international client basewith names that rival those of any Wall Street firm and equityinvestment funds that are sometimes worth 10's of millions.

Although investing in clients can be risky, the potentialrewards can be hard to resist. "Over the years, I doubt thefailure rate has changed but if they do make it, it can be huge",says Wilson Sonsini's Don Bradley. Client demand is a key impetussays Neal Millard, a partner in the Los Angeles office of White& Case, a firm that has just started down this route becauseit received so many enquiries from clients. "Giving up stock isnot as painful from a client's perspective", he says. Clientsfeel they are getting a more committed service from theirlawyers. It is also the only way that most of them can ever hopeto launch themselves.

The approach to taking equity has become very sophisticated.Many firms start out by allowing ad hoc investments thatbecome assets of the firm. The majority soon establish separateinvestment funds to hold the assets. Millard says his firm talkedto a number of other firms with experience before it gave theconcept the go ahead. In most cases White & Case takes acombination of shares and fees in cash, "In some cases we agreeup front to take a fixed 1% in shares. In other cases we pick avalue that enables the client to maximise its cash receipts".

On the West Coast, it has got to the point where somepartners, and associates, refuse to work for a client unless theyget equity, on top of their fees. The market allows them todemand both as there is an acute shortage of lawyers in privatepractice with experience in the field. This is partly because somany associates are tempted to have a go at launching a start-upand are often headhunted by clients. It seems that everyone knowssomeone who has become an overnight multi-millionaire, and theyoung lawyers know that their firms will welcome them back withopen arms if the venture fails.

Tower Snow Jr, managing partner of Brobeck Phleger &Harrison, tells the story of one of his firm's associates who gota job offer from a start-up dot-com company. The lawyer signedthe package, including the stock options, and was working out hisnotice at the firm when the dot-com was sold. His stock optionsaccelerated and he made around US$52 million (EUR51.5 million)without ever having worked a day for the company. "The reactionin the firm was interesting" says Snow, with half of his lawyerssaying well done and trying to work out how they could do it,while the other half were left writhing in jealousy.

To try and make sure that the younger lawyers feel that theyare participating in the dot-com gold rush, without having torisk joining a start-up, many of the firms now let theirassociates share in the success of their clients. At WilsonSonsini a trust holds funds for its associates, and, saysBradley, "They have made a great deal of money in a shorttime".

Brobeck Phleger has partner, associate and staff funds. Itinvests US$2,500 (EUR2479) into the fund for each associate, forexample, which is then invested in clients. The fund vests 20%each year, and becomes fully vested in five years.

However, before a firm gets a severe case of gold fever, thereare several major drawbacks it needs to address.

First, according to Bradley, it is important to remember thatthe company may never make it out of the bedroom or garage. Inhis firm's experience, out of every 10 investments, one willprobably be successful and maybe two or three will return theinvestment.

Second, there are the ethical concerns. They includeeverything from maintaining independence and potentialmalpractice suits all the way to a temptation to indulge ininsider trading. These ethical stumbling blocks are the reasonsmost often advanced by firms for their reluctance to invest inclients. There is a thin line between being an objective legaladviser protecting your client's interests and being a biasedlegal adviser with a stake in the success of the client, whichmight blinker otherwise dispassionate advice and lead to a desireto encourage short term gain rather than long term growth.

Stephen Bent at Washington firm Foley Lardner says this ismore than an academic concern, "I encounter situations all thetime where I am aware that somebody I'm dealing with is somehowacting in a way that suggests their objectivity is beingcompromised". However, Bent's firm has accepted equity, althoughstrictly, he says, as a last resort, for example where a clientinsists that it will not get venture capital if it does not havethe firm's backing. Bent says his firm prefers to make otheraccommodations such as deferring or discounting fees with a bonusif the company achieves a certain milestone, "The ethicalconcerns are too significant and there are other things you cando which are virtually as good for the company and allows them todo what they have to do".

Paul Hastings Janofsky & Walker's Eric Joss says his firmis looking at the issue, but it is, "Concerned whether it isappropriate for the firm and it clients". In his view the issuesinclude professional responsibility, independent judgement andinsider trading. "We are aware of troubles and malpracticeissues", he adds. Skadden Arps Slate Meagher & Flom's JeromeCoben, based in the firm's Los Angeles office says "We have beenin the situation where clients offer equity but we prefer to helpin different ways". Whether or not to take equity is a continuingdebate within the firm, "The reality and perception is thatjudgement is impaired and investing in equity is not what lawyersare about. I have seen situations where the founders havescratched their heads and asked, 'Why is this happening'". JohnHartigan at Morgan Lewis & Bockius also queries whether theSecurities Exchange Commission will be happy accepting opinionsfrom stockholding firms.

Continental Europe. But if you move to theEuropean continent, the ethical concerns are proving to be amajor stumbling block to firms seeking to take this approach.While the Law Societies in England and Scotland accept that firmscan take equity in clients, the practice has yet to catch onacross the continent where the bar rules are much stricter.Although in some jurisdictions it is simply unclear what the barposition is.

In Sweden the bar raised the issue as a matter for debateafter two firms, Vinge and Delphi & Co, both publiclyannounced their intention to buy into their clients' businesses.A significant proportion of the bar membership said they thoughttaking equity in lieu of fees was against the rules. Vinge andDelphi & Co have been asked to comment on these findings. Inaddition the bar has set up a special committee to investigatethe issue further. In the meantime Vinge is reflecting on whatthe decision means for it and has publicly put a hold on itsplans to take equity. However, the firm is frustrated by thedelay, says Vinge partner Björn Gustavsson, "We need to be apart of the new economy and safeguard our competitiveness. Thedriving force behind this more than anything else is theclient".

In Germany, the bar rules do not appear to prohibit thepractice but very few firms have taken the plunge. Andreas Klein,the director of the German Bar's International Department, sayshe has not heard this issue being raised, "There is nothing likethis in Germany so far. It is not known to the public or to thebar, which doesn't mean it doesn't go on".

Hans-Jürgen Hellwig, Vice President of the German Bar,confirms that the practice is not barred and that the German Barwould probably take a pragmatic view, based on the size of theinvestment.

There are indications that it will soon become an issue.Heuking Kühn Lüer Heussen Wojtek has not taken fees inlieu of equity as yet, but has plans to do so in the future.Peter Brautigam at Nörr Stiefenhofer & Lutz also doesnot rule it out as a future possibility, "There is quite a bigmarket for venture capitalists and start-ups in Germany andclients are suggesting this to us all the time". According toAndré Turiaux at Heuking Kühn, taking equity is lessproblematic for smaller firms, "It is easier for them becausewhere one or two partners own the firm, the shares can be moreeasily attributed to the partners. In a bigger firm with 100partners sharing the equity it can be problematic from anorganisational point of view".

In Finland it seems that firms are precluded from takingequity. Rainer Hilli at Roschier Holmberg & Waselius says,"This is an issue the firm has recently had to give someconsideration to, following some client demand. The same isprobably true for most Finnish firms. The Bar rules are veryclear: an attorney cannot engage in any form of business otherthan that of an attorney".

In The Netherlands Frederik Hemskerk, general secretary of theDutch Bar, says, "Lawyers are not entitled to indulge in anycommitments which may jeopardise their independence". A firmbuying into one of its own clients could be interpreted asjeopardising this independence. He is not aware of this practicegoing on in The Netherlands.

Philippe Jadoul, a partner in the recently mergedDutch/Belgian firm Huysmans Trenité Van Doorne has discussedthe possibility with some of his clients but is not entirely surewhether the bar rules would permit it in Belgium, where firms areprohibited from accepting fees in kind. When approached by European Counsel, the Belgian bar was outraged at anysuggestion that a lawyer would take equity in lieu of fees. TheParis bar reacted in a similar way, although some lawyers havedipped a toe into this area. One lawyer in a small Paris firmsays, "The main issue is the way the share purchase isstructured. It can be illegal if not done in a certain way". Itis important that the lawyer taking equity is seen to be buyingthe shares rather than accepting them in lieu of regular fees. Hehas taken equity on two occasions. In one case he was approachedby an individual who wanted to set up a company but could notafford the legal fees to protect his intellectual property rightsagainst another's claims. The lawyer accepted one share aspayment. Five years later it is valued at US$80,000(EUR79,000).

Wilson Sonsini's Bradley, however, believes the ethical issueshave been overblown. He says, "Our investing in clients is donethrough a partnership which is a separate entity composed of allthe partners of the firm". He also claims that the investmentsare so small that they do not create situations where lawyersmight be tempted to compromise their objectivity. A lawyer at aUK firm which takes equity adds, "There must be nothing betweenus and the client. We take the equity and we put it into aprofessionally managed fund. That takes it off the table. Thepartners don't see it and we get the same deal as everybodyelse".

Jim McCulley from the Virginia Bar's ethics committee says hisbar, along with most state bars, has debated this point anddecided that lawyers may take stock/equity in lieu of fees, aslong as the client consents after full disclosure and thetransaction "is not unconscionable, unfair or inequitable whenmade".

The California Bar and The Law Society of England and Waleshave also issued guidance notes on this issue. Guidance thatCooley Godward follows. Managing partner Lee Benton says hisfirm, "Gets a waiver from the client and points them to othercounsel to set the terms on which the firm takes stock". Whileclients often do not get independent advice, it is important torecord in writing that they were encouraged to do so. AlistairMorris of Pagan Osborne in Scotland agrees that it is vital toget a clear agreement, and ensure that the firm gets the sharesat value, which may mean paying a higher price than thedirectors. (For further details of the California Bar and TheLaw Society of England and Wales guidance see www.plcinfo.com"European Counsel extra materials".)

But some lawyers are not convinced of the effectiveness ofthese safeguards. Even if the investment is small, the potentialvalue to the firm is huge and whether or not the fund isseparated from the firm is seen as irrelevant. Says one, "Theissue here is that if you're rendering counsel in matters thatwill affect the value of a company, your self interest willappear to be paramount even if it is not".

In addition, some firms are finding that start-up companiesare now reluctant to give them shares. Some companies believe itcould be a very expensive way for them to get legal advice. Acompany could be giving away 1% of its shares, which grow to beworth several millions, in return for US$20,000 of legaladvice.

In the UK the hi-tech sector has seen tremendous growth andLondon is home to a number of leading IT focused law firms whichhave, again, led the way in this area. Field Fisher Waterhousewas one of the first to accept equity. Partner Michael Chissicksays his firm quickly realised it needed to change the way itworked in order to stay ahead of the field, "We picked up on thefact that everyone works with share options in the e-commercefield. Everyone is incentivised by them, the employees, thedirectors, the partners".

Field Fisher took its cue from the US model, "We started totalk to the US law firms and then put our own package together".He says that a flexible approach is the key in this market,"We'll look at deferred payments, fixed fees, equity stakes,basically it's an open approach". Start-ups can benefit from aspecifically tailored package called "Incubator" which provides abundle of services relevant to getting a company of the ground ata fixed fee, often working with experienced non-partner lawyersat rates that work within their tight budgets. Equity is taken invery modest amounts, with 1% being the norm, "We're notfinanciers, we're not here to fund businesses, we're here todevelop partnerships with our clients".

Other UK firms that offer services to start-ups in return forstakes in the business include Tarlo Lyons, Taylor JoynsonGarrett, Osbome Clark, Bird & Bird and Mishcon de Reya. TarloLyons recently invested in its client Netcentric Systems and aspokesman for the client company was keen to express howimportant that investment is for his type of company, "Equityparticipation ensures that fledgling companies are nurturedduring their early growth phase when cash and resources are at apremium".

Rupert Pearce, the head of the Internet and e-commerce groupat Linklaters & Alliance, says that competitive forces aredriving firms in the UK to change the way they work. He says, "Wereally believe that we must invest in the clients of tomorroweven if we have a tremendously vibrant practice today". AtLinklaters a start-up can expect to receive a package of advicethat will get it up and running and through its first round offinancing free of charge. Any other fees will be deferred for aperiod up to one year. In return the firm will buy into theclient's business. "That's a very significant investment by us inthem. The goal is to build long-term relationships that aremutually productive", says Pearce.

Clifford Chance is taking a cautious approach and MichaelMathews, a senior partner at the firm, has been given the task ofidentifying the financial and ethical pitfalls to produce a paperfor the firm's management. He says if the firm decides it wantsto take equity it will probably be in, "Circumstances in which ifwe didn't take stakes, we wouldn't be retained at all".

The practice is also starting to take root in Scotland. PaganOsborne's Morris was convenor for the Scottish Law Society'sprofessional practice committee that reviewed whether lawyersshould be allowed to take shares in lieu a few years ago. Itdecided that so long as the level of shareholding was small, itwould not influence the lawyer or the firm, and as such it shouldbe allowed. Morris's own firm takes equity in lieu, "It keepscosts down, keeps a good adviser for the client and helps ourfirm cement its relationship with that client".

Brobeck Phegler's Snow concludes that, when all the dust hassettled, "It's a simple cultural issue. On the West Coast it's anon-issue. On the East Coast it is seen as inappropriate". Thelatter is a view that extends across the Atlantic, but seems tobe by-passing the UK market. However, as Snow argues, in reality,"Only half a dozen firms in the US have the client base to do it.Those with venture funds are those doing the work".

If you are one of those firms, he says, "Its stupid not to doit. We prefer to be paid our normal fees, but if the companylooks to be a good investment we will also ask to invest".Concludes Jim McCulley from the Virginia Bar, "What's wrong inhaving an interest in a company and wanting that company to dowell?"