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Failed Tech Startups Fuel Insolvency Firms

The Recorder
July 25, 2015

Pachulski Stang Ziehl & Jones and Debra Grassgreen are mentioned in David Ruiz's The Recorder article "Failed Tech Startups Fuel Insolvency Firms."

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David Ruiz, The Recorder  

July 24, 2015  

SAN FRANCISCO — For every startup that succeeds in Silicon Valley, the common belief is that another nine fail. That can mean calamity for entrepreneurs and investors, but it's a boon to Bay Area bankruptcy lawyers who have a steady stream of work thanks to nearly constant wind-downs.

Despite its steady nature, working as an undertaker to failed startups is not particularly glamorous work in a business culture that practically worships overnight success. Founders often have to find new legal counsel to see them through a dissolution as the law firms that banked on their success face conflicts with creditors or shunt the foundering companies off to specialists in smaller practices.

Earlier this month San Francisco-based cleaning platform Homejoy Inc. announced that it would cease operations by July 31. The company, which emerged from the legendary Y Combinator, had secured $38 million in venture funding in late 2013 from prominent backers including Google Ventures, Redpoint Ventures and Max Levchin, PayPal Inc.'s former chief technology officer.

It's not clear who is advising the company, which as recently as March was looking to hire its first general counsel. Earlier this week, the company's litigation counsel at Paul Hastings filed a request to withdraw from the representation.

Homejoy did not respond to an email seeking comment and repeated phone calls to the company did not go through.

Patrick Costello, a bankruptcy specialist who runs San Jose's Vectis Law Group, said he sees a lot of referrals from large Valley firms. "If your law firm's business model is premised on growing companies, there are too many conflicts and not enough money in handling the downside," Costello said.

Robert Eisenbach, a bankruptcy lawyer at Cooley, said that, whenever possible, his firm will advise its clients through a wind-down.

But, Eisenbach added, "There are occasions where we can't do it. One of their senior secured creditors is a client and it poses a conflict for us that we can't overcome."

The saying "Fail fast, fail often" is something of a motivational slogan in tech circles. Still, some Silicon Valley firms conspicuously avoid referencing that particular "exit strategy." Though Cooley lists a bankruptcy and corporate restructuring practice group on its website, neither Fenwick & West nor Wilson Sonsini Goodrich & Rosati advertise that service.

Fenwick chairman Richard Dickson said that, while the firm has some attorneys with relevant experience, bankruptcy is not a practice it focuses on.

"That's largely because of our technology focus," Dickson said. "There are a limited number of technology companies that have pursued bankruptcy or reorganization."

Startups typically unwind using simpler legal mechanisms such as corporate dissolutions, and Dickson said the firm often advises clients through the process.

Partner Gordon Davidson raised another issue. "We do not practice bankruptcy law ourselves primarily because it is a very specialized practice and can create conflicts where one client could be an investor or creditor of another client," Davidson said, noting that Fenwick refers work to specialty firms including Friedman & Springwater, Vectis Law Group and Pachulski Stang Ziehl & Jones.

When a young company's go-to firm doesn't have the right lawyers for the work, specialists are generally called in, said Debra Grassgreen of Pachulski Stang. "That's why they come to us," she said. A corporate firm might have a transactional bankruptcy attorney, Grassgreen said, but not a whole team of lawyers that is required for larger Chapter 7 or 11 filings.

Big Law rates can also be an issue.

"Most board members who are familiar with startups and winding them down appreciate that their primary corporate counsel will not handle the windup and that it will be referred to special counsel that bills at a different rate and has the requisite focus," Costello said.

Choosing how to shutter a company is a critical decision. Few startups formally file for bankruptcy, which is a lengthy process that better suits large corporations with extensive obligations.

In some cases, the best path is an assignment for benefit of creditors, or ABC, where an "assignee" works much like a trustee, meeting with creditors and negotiating asset sales. That process can work best for a young company with valuable intellectual property, since the company can choose someone to properly represent their assets. However, assignees have an upfront fee and charge a percentage of the assets.

The quietest option is corporate dissolution, where assets are liquidated to pay off creditors.

Handling the dissolutions of technology startups has a different rhythm than bankruptcy work in other industries where the work tends to follow economic booms and busts, only in reverse. Startup wind-downs tend not to be countercyclical and even tick up in boom times, said Grassgreen.

"When that engine is really revving and there are tons and tons of startups, you're going to have more failures," she said.