Wednesday, February 25, 2009

Lawyers and Risk

For those running businesses, here’s a little secret about lawyers: Many of us aren’t very good when it comes to risk.

Sure, we can find risk – most lawyers can identify risks all day long. That’s what law school trains our already-skeptical minds to do. Spot the issues; identify any ways risk arises in a course of action. But balancing those risks against opportunity? Not so good.

Successful businesspeople know that you win by taking smart risks – risks that are outweighed by opportunities. These risks can be competitive, personal, financial, social or, yes, legal. The problem for most businesspeople is that the law is complex, and attorneys have done a good job making themselves its gatekeepers. How can the non-lawyer businessperson determine the size of the legal risk that lurks on the other side of an opportunity?

Your average business attorney will have little trouble assessing the potential for liability in almost any scenario. With some prodding, they will strive to give you the likelihood that liability will actually come into play. However, it can be like extracting teeth to get many attorneys to combine the element of likelihood of a risk with the likely consequences should that risk materialize.

Why is this important? Because – and I can’t emphasize this enough – legal risks are not created remotely equally. A legal risk may mean a vendor is likelier to send you a pissy letter. It may mean an increased likelihood of being sued. Or it may mean the feds raiding your office with a warrant for your arrest.

Obviously, you don’t want to take a major legal risk for a minor opportunity. Just as obviously, you shouldn’t let a little legal hand-wringing over minor risks slow down your plans. You also wouldn’t want to take those risks that are likely to result in criminal liability, bet-the-company litigation or other such unpleasantness under most any imaginable set of circumstances. Due to the gatekeeping function lawyers play, you must have input from your lawyers to tell which risk is which.

Are you getting this input? Just as potential risks are easy for attorneys to assess, the likely range of potential damages is difficult to come up with. Assessing this range requires not only understanding the worst-case outcome, but also discounting from this scenario to account for the uncertainty of the situation, the circumstances of your counterparties and the likelihood that liability will even emerge as an issue in the first place. All in all, a complex and messy process - and attorneys, being risk-adverse creatures, are often loath to wrong-set your expectations.

Much of this analysis is based on experience and judgment, not modeling or mathematical analysis (there are some exceptions I will write about down the road). If you’re lucky, you’ll work with attorneys who possess these qualities and are willing to fully deploy them for you. Ask yourself – are your attorneys walking you though this way of looking at your risks, or do you get the sense that they believe every risk needs to be eliminated? If the latter, and if getting new counsel isn’t an option, at least try the “worst case” test: Always ask your lawyer what the worst thing that could possibly happen is. You may be surprised by how often even the “worst case” is of little consequence next to the size of your opportunity.

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