What is a Legal Opinion and Why Do VCs Require Them?

If you have ever presented in a fundraising meeting with a venture capitalist, chances are they have asked you to provide a legal opinion from a qualified attorney. Legal opinions are formal letters from counsel to the investment group summarizing the relevant legal matters after counsel has performed a formal due diligence of the company’s intellectual property assets and legal documents. Legal opinions are often one of the critical final milestones before closing venture funding, dealing making, and decision making on whether to invest in a new company.

What is a legal opinion and what is its purpose?

A legal opinion will generally provide potential investors with an itemized review of the legal issues that are germane to the particular investment opportunity, showing that the company was appropriately formed, that the appropriate documents and agreements regarding the structure and governance of the business are in place (e.g. shareholder agreements, preferred stock purchase agreements, bylaws, payment of fees to government agencies, filings of annual reports, etc.), that the business is not currently subject to or under imminent threat of litigation, or that the business is subject to a settlement or judgment against the business, among others.

The purpose of a legal opinion is to provide an objective and unbiased assessment of the overall legal situation surrounding a client based on an existing and/or hypothetical set of circumstances. In the context of venture capital and investments, legal opinions are usually requested by VC firms during the due diligence process to determine the potential legal benefits and liabilities of a prospective investment.

Why do venture capitalists require legal opinions?

There are several reasons why VCs require legal opinions before investing. Legal opinions provide a blanket of comfort to wary investors who find peace of mind knowing that a comprehensive review of the company has been conducted and its legal affairs do not carry significant liabilities to its funders.

Just as any prospective investor should rigorously research and understand their risks before investing in an investment, VCs understand there are no as assurances with any investment. Nevertheless, a legal opinion can provide some measure of relief.

There are a number of reasons why VC may want to formally retain an attorney to draft a legal opinion, but the two primary reasons are: first, to protect a VC’s own fiscal interests and assess the volatility of the investment against the potential for upside for large returns, and second, to ensure that the company the VC is considering investing in is not subject to current litigation or a likely future legal dispute.

Startups, particularly those in preeminent technology industries such as SaaS, blockchain, AI, electronics, semiconductors, energy, or others where venture capital funding is necessary to launch and scale, should be proactive and predict and plan for the inevitable legal opinion request. To best prepare your tech startup for funding and success, check our guide titled 5 Fundraising Secrets for Tech Startups.

How is a legal opinion structured?

Though legal opinions may vary based on factors such as technology, vertical, and the size of investment, most legal opinions include a detailed description of what the opinion covers, including all documents reviewed and the scope of due diligence provided. A legal opinion may further include a description of the legal counsel’s background and basis for opinion, any assumptions made during the opinion, and specific legal conclusions made along with the application of governing law.

What are some key components of a legal opinion?

Key components of a legal opinion vary and are dependent upon the type of transaction being reviewed. However, there are common elements that are included in many legal opinions. These common elements include:

• A confirmation that the business is properly organized or incorporated
• A confirmation that the business is in good standing
• A confirmation that all corporate formalities have been completed
• A determination of whether there is any likelihood of or existing litigation

Legal opinions often include:

• A scope of the legal opinion’s coverage including what documents were or are being reviewed and any applicable laws that govern
• A description of the stock or ownership records
• Analysis regarding the status and surrounding issues of any existing IP portfolio assets including validity, estimated value, pending application states, assignments, ownership, expirations, and strengths and weaknesses in comparison to competitors
• Potential liability analysis for claims of infringement of competitors’ IP rights
• Analysis of issues specific to the business being analyzed (e.g., a new technology such as a cryptocurrency platform will have vastly different issues and emerging rules and regulations than a consumer products manufacturer)

These elements are important because they provide VC firms with the information they need to make fully informed investment decisions. By understanding the legal risks involved and identifying any legal issues that need to be addressed regarding a potential investment, VC firms can avoid investing in companies that are not legally allowed to do business or are encumbered by potential or actual legal issues that render the investment unprofitable, unworkable, or illegal.

To see a sample legal opinion, follow this link to the American Bar Association’s website.

How much does a legal opinion cost?

Like so many other legal matters, the cost of a legal opinion depends on a variety of factors. Most law firms follow a tradition billable-hour model for their detailed and often layered legal opinion process. In most circumstance the decision to seek a legal opinion depends on the amount of funding being raised, with smaller transactions being less likely to require a robust opinion. A startup may elect to allocate their limited financial resources to narrow legal opinions. In general, the cost of a legal opinion for VC funding typically ranges from $5,000 to $20,000.

These costs will be based on a number of factors, including: (1) the time required to research and draft the opinion letter and (2) whether the lawyers or law firm conduct any negotiations beyond drafting the formal legal opinion letter that require additional time and resources. If the lawyers or law firm have been previously involved with the business from its inception, less time will be necessary for the initial researching and reviewing corporate documents, legal agreements, and intellectual property holdings.

However, retaining a new law firm who is not familiar with the business will necessitate additional time becoming familiar with the industry, vertical, and corporate formalities. Startups should pay close attention to the cost-benefit analysis of their funding before exploring a costly opinion.

How can you procure a legal opinion for your startup?

As many companies and entrepreneurs understand, acquiring venture capital funding for your business can be very challenging since your business is one of many in competition for a limited resource. However, one strategy will significantly increase your chances at acquiring funding: preparing early and conducting the necessary research to streamline the cost and time required to prepare a legal opinion. You can begin the process of procuring a legal opinion by scheduling a free consultation with the startup and business attorney specialists at The Rapacke Law Group.

The Rapacke Law Group is a fixed fee intellectual property law firm built for the speed of startups that employs attorneys experienced in the full spectrum of business and technology startup funding. The Rapacke Law Group does not engage in hourly building and requires no additional, unexpected fees for calls or emails. Contact us to schedule a free consultation with one of our attorneys.