What is a legal opinion and why are my investors asking me for one?

A legal opinion is often one of the closing conditions for a venture financing of a US company. Founders of these companies will often ask us, “what is a legal opinion?” and “why do investors need one?” Below are brief answers to these and other commonly asked questions about legal opinions.

What is a legal opinion?

A legal opinion is a formal letter from your company’s corporate counsel to the investors containing counsel’s conclusions about various legal matters relevant to the company and the transaction, based on counsel’s review of a defined body of documents and information.

Legal opinions may include, e.g., the company’s valid existence, the valid issuance of shares to the investors under the applicable corporate law, compliance with certain laws in connection with the transaction, enforceability of the transaction agreements and, in some cases, the company’s existing capitalization. Legal opinions do not give an opinion on every aspect of the company and its business, but rather focus on a specific set of corporate and securities items.

Why do some investors ask for legal opinions?

An opinion from company counsel is intended to give the investors additional comfort as to the legal matters covered by the opinion, but they are not a substitute for “due diligence” to be performed by the investors and their counsel.

Are legal opinions given in every deal?  Are they the same every time?

No to each question.  Legal opinions are not given in every US venture capital financing, and they are much less common in the major non-US venture capital jurisdictions.  Even in transactions where they are given, the contents are negotiated between counsel to the investors and counsel to the company and vary somewhat from transaction to transaction.  Whether or not an opinion is given, and the contents of the opinion, must take into account the particulars of the company, the transaction and sometimes the investor.

Pros and cons of your counsel giving a legal opinion to your investors

Are legal opinions worth it? While the cost-benefit analysis varies from deal to deal, here are a few basic principles to keep in mind.

Costs

Most sophisticated law firms have a detailed process for the backup research and internal approval for giving legal opinions, which will increase the company’s transaction expenses. Companies may not wish to incur costs on legal opinions, because those funds could otherwise be used to grow the business.  Generally speaking, the smaller the amount being raised in a financing, the less likely that an opinion is appropriate. 

Another cost to the company is that of time – not just in the sense of lawyers’ hourly rates, but the fact that the drafting, diligence and (in some cases) negotiation associated with the legal opinion adds to the process of getting the deal closed. This can be a challenge for companies that need to close a deal on a very tight timeline.

Benefits

While the opinion is given for the investors’ sake, there can be benefits for the company as well. The opinion process can surface historical shortcomings in important corporate formalities that are in the company’s interest to address. Further, the fact that the company has delivered legal opinions in earlier deals can give comfort not only to the current investors, but can make the process easier in future financings; this is because if a company asked to provide a legal opinion in a later financing round, the backup work that counsel must perform typically only needs to cover the period since the last legal opinion was rendered by the same law firm.