By Adam J. Epstein | medium.com | September 20, 2017
After the 2008 financial crisis, micro- and small-cap companies, to reduce costs, broadly recast in-house counsel as a luxury, and despite the resiliency of the financial markets, many small, public companies never re-hired legal staff.
Savvy institutional investors have taken note and cautiously approach small public companies without in-house counsel because, even under ideal circumstances, they are risky investment propositions. When these companies attempt to navigate a labyrinth of unique commercial, regulatory, and capital markets’ legal issues without in-house lawyers, risks can rise beyond the thresholds of many fund managers.
Why small, public companies should consider hiring in-house counsel
The legal industry is in trouble. Large corporate clients have gotten wise to the billing inefficiencies of big law firms and have increasingly taken legal matters in-house. Large law firms have thinned their ranks dramatically and put the brakes on hiring new staff. The good news for public companies is that there is an unprecedented number of high-quality attorneys looking for jobs and charging lower rates.
They pay for themselves
Many small-caps without legal staff outsource everything from business development and employment agreements to quarterly and annual securities filings, proxy statements, and financings. Moreover, all of that outsourced work is being purchased by non-lawyers, a fact that benefits law firms a lot more than clients. The reduced fees from doing considerably more of this legal work in-house combined with the savings from having a lawyer purchasing outside legal services can pay for a quality in-house counsel pretty quickly—and then some.
Proactive risk management
These cost savings can pale in comparison to the value small, public companies can derive from avoiding trouble in the first place. No matter how great an outside law firm is, they don’t have visibility into day-to-day operations. Every aspect of daily business is replete with legal landmines, not to mention tasks such as reporting and communicating financial results, financings, and mergers and acquisitions. Managing those legal risks without any lawyers in the building is like trying to design a space shuttle without engineers.
In 2014, nearly 75 percent of shareholder-activism campaigns in the United States were waged against micro- and small-cap companies. Whereas small, public companies might have survived with less fulsome corporate governance in the past, those days are over. When public companies don’t have in-house counsel, the corporate secretary role is typically assigned to other Section 16 officers (often the CFO). While some undertake this double duty with aplomb, it’s often more advisable for in-house counsel to assume the corporate secretary role given the legal nuances of corporate governance.
For the majority of U.S. public companies, the line separating a going concern from liquidation is thin. Balance sheets at these companies are fragile, and cash flow is variable. Any small-cap institutional investor will tell you that they regularly see non-lawyers hiring the wrong lawyers to negotiate complex financings; non-lawyers trying to preside over sprawling internal investigations; and non-lawyers attempting to manage “bet-the-farm” litigation. Large-cap companies can often easily rebound from a substandard financing, from overpaying for legal services, and from losing lawsuits. Most small-cap companies can’t.
For better or worse, life as a small, public company is fraught with complex legal issues. Further, institutional investors know that, without in-house counsel, companies are less likely to spot issues in advance, and when problems arise they will materially overpay for help. Neither is good.
The author, Adam J. Epstein, is a former institutional investor, and now an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He speaks monthly at corporate governance and investor conferences and has appeared internationally more than 100 times since 2012. Mr. Epstein is a key contributor to Nasdaq’s new Amplify small-cap content initiative, and a distinguished National Association of Corporate Directors (NACD) Board Leadership Fellow, and faculty member. He is the small-cap contributing editor for Directorship magazine, author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw-Hill, 2012), and contributing author to The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not for Profit Board Members (New Jersey: Wiley, 2016). In June 2017, The Perfect Corporate Board was the #1 ranked corporate governance book on Amazon.com, and, in June 2016, The Handbook of Board Governance was the “#1 New Release” in corporate governance on Amazon.com. Connect with Adam on LinkedIn or learn more at https://adamjepstein.com/.