Legal Technical Debt

Siri, please amend my charter to authorize a Series AA round, prep me an offer letter for a CTO, issue options to 3 recent hires… oh and review/execute that stock purchase agreement with my accelerator. Keep the fees under $500.”  — Not too far off from how a (confused delusional) segment of the startup community thinks startup/vc law should work.

Imagine if advisors told startup founders that, in order to conserve cash, they should aim to spend as little as possible on developers. Find cheap ones. If the non-technical CEO can code something himself to get by, do so.  Just get it done. Don’t overpay.  In fact, if we can automate our development process, do it. Keep cash spend on ‘the business.’

Anyone with an ounce of experience in building successful tech companies would recognize this advice as absurd and dangerous, as if quality and accuracy are irrelevant. Yet every so often I hear about advisors giving this exact advice to founders, about legal spend. And while fewer may acknowledge it, such advice is equally as absurd.

Of course you’d say that, Jose. You’re a startup lawyer.

Well, maybe. But let’s process it a bit.

Why would minimizing your spend on software development (like legal services) be stupid and dangerous?

It can be explained in part with the term ‘technical debt.’ via Wikipedia:

“Technical debt… is a recent metaphor referring to the eventual consequences of any system design, software architecture or software development within a codebase. The debt can be thought of as work that needs to be done before a particular job can be considered complete or proper. If the debt is not repaid, then it will keep on accumulating interest, making it hard to implement changes later on. Unaddressed technical debt increases software entropy.”

While I’m not a developer, my general understanding of the term is that bad coding becomes more expensive to fix over time, in an almost compounding way. And there are even circumstances in which it is so bad that nothing short of a complete re-write will make it scalable and useable. In other words, going cheap on developers just means you are compounding your cleanup cost and headaches for the future, and even threatening a complete shut-down of the product.

Minimizing legal spend works exactly in this way, but magnified 10x.  I frequently write on SHL about the many parallels between complex contract drafting/VC law and top software developers. Both groups involve highly skilled people capable of analyzing, managing, and manipulating large amounts of complexity. Both implement changes for which the stakes on a company are very high. Both expect to be compensated well for their skill set.

Software developers produce the code base on which your product runs. Lawyers produce the code base on which your company, including its relationships with investors, board members, executives, and employees, runs. 

A crucial difference between software code and legal code is that bugs are far easier to find and fix in the former than in the latter. Software code is constantly being revised, with thousands or millions of users revealing bugs on a regular basis. Legal code (contracts) are executed and then put away, often to be reviewed only at high-stakes moments, when fixing them is extremely expensive or even impossible.

Unlike software code, you can’t unilaterally issue ‘updates’ to executed contracts. Any experienced lawyer has seen a deal cost 6-figures more than it should have, or even completely die, because of legal mistakes made earlier in the company’s history. So think of contract drafting for a scaled startup as high-stakes software development for which virtually any material bug is completely unacceptable once the code is shipped. Still want to ‘minimize’ legal spend?

Law is Code; Not Product.

In my experience dealing with many many sets of founders, a part of the startup community carries the very deep misconception that startup/vc law has been, or even can be, completely productized. Want to ‘just’ issue some stock, grant some options, close a seed round, etc? It’s been done hundreds of times before, so it must be all ‘standard’ by now. Just click a few buttons, fill in some names and numbers, and you’re done.

This is the attitude of someone using a product for which clean, standard, predictable, pre-defined features are already in place. “Just” issuing a service provider some stock should be like ‘just’ moving some files around on Dropbox, right? There’s a serious flaw in this thinking. The clean, standard, predictable company and contract history simply does not exist, and hence full automation is pure fiction. 

  • What state are you located in? Laws vary, even if you’re a standard DE corp.
  • Are you a C-corp? S-corp?
  • Are there protective provisions that need to be complied with?
  • Any anti-dilution protection?
  • Enough authorized shares in the charter?
  • Enough reserved equity in the equity plan?
  • A well-documented value of the equity?
  • Is there a written agreement explaining the consideration and complying with securities laws?
  • Is the recipient an individual or an entity?
  • Board approval?
    • Are we confident the composition of the Board is well-documented?
  • Is stockholder approval necessary?
    • Any specific thresholds?
  • Vesting?
    • 83b?
  • Acceleration? What kind?
  • Any other special provisions/requirements implemented by past investors?
  • etc. etc. etc.

Virtually every VC, angel group, accelerator, large company, etc. has its unique variances in the contracts it executes/negotiates. States have different requirements. Laws change. Reality: people are not standardized.  They have their idiosyncrasies, and people determine what does and doesn’t get signed; what gets added to the code base.

Even if companies share 90% of the same legal DNA, the 10% variance is a massive wrench that makes automation, or even any kind of significant simplification, impossible without taking on enormous legal technical debt. That statement is not coming from a luddite lawyer who hates technology, but from the CTO of a startup/vc law practice that I am 100% certain is on the cutting edge of legal technology (the kind that actually works) adoption.

Telling a VC lawyer that you ‘just’ want to issue some stock is not equivalent to ‘just’ using a pre-coded feature in a product. It is far more like telling a software developer that you ‘just’ want to add a feature to your existing, non-standard, unique code base.  Imagine telling that developer to do it as quickly and cheaply as possible. Imagine hiring the cheapest developer you can find to implement that feature.

The contract that actually issues the stock may be 99.8% standard, but it has to be implemented into the historical set of contracts/context without blowing anything up. Contracts and laws do not sit in little, isolated modules without any impact on the other. They’re all inter-connected, with a change in one potentially resulting in a cascade of effects in others. Hence the code base analogy.  The larger, more complex the code base (set of contracts, number of jurisdictions, people involved), the greater the skill and experience required to work with it safely. And having a well thought-out, well-designed architecture implemented from Day 1 dramatically impacts the scalability and resilience of that code base.

So when a client says they ‘just’ want to issue some stock, all they might think about is opening a word document, filling some names, and signing. Of course that can be automated.  What often isn’t considered is the lengthy, complicated list of steps and analysis needed to fit that template document within the Company’s existing legal history. That, not the template stock purchase agreement, is what lawyers do, and software cannot do.

De-Valuing Law, like De-velopers, is De-lusional.

Anyone who sells a product or service into a market learns that not every buyer is willing to pay the cost necessary to deliver that product or service in an efficient manner, within the bounds of physics/reality.  Some buyers simply can’t afford it. But many others just don’t value the product or service enough to pay even the lowest possible price. As a lawyer, I learned very early on in my career that this is the case with founders looking to engage lawyers.

If I’ve been sold the lie that startup/vc law is a completely commoditized, standard product, I am going to shop for lawyers, and assess cost, the way I would for any other commoditized, standard product. I “just” want to issue some stock. Like I “just” want some toilet paper. There are founders (a minority, but many) who understand very quickly why they need to pay good compensation for software developers, and yet will question every single invoice from lawyers.

While I’m always more than happy to walk through an invoice when it makes sense, MEMN’s client intake process has been deliberately designed to filter out clients who, for whatever reason, de-value lawyers in this way.  Our website’s home page says “World Class Counsel, Brought Down to Earth.” Translation: top lawyers who are more efficient, responsive, and accessible than the large firms where they’ve historically been found. We compete with other firms who provide top-tier legal counsel to scaling tech companies; not with the unrealistic price expectations of people who, through inexperience or delusion, want Teslas at Kia prices.

The seed-stage period is the toughest time for startup legal budgeting. Things are starting to get more complex, but with only a few hundred thousand raised (let’s put aside California ‘seed’ rounds), every dollar paid hurts. Fixed fees, flexible payment arrangements, deferrals (but be careful), and good old-fashioned budgeting are the key to getting through that period with your lawyers. Any experienced set of startup/vc lawyers will know how to be flexible for seed-stage companies. Just always remember that flexibility (and efficiency) does not mean defying the laws of physics to get things as cheap as you’d like them to be. 

At the level of law that scaling companies require, technology will forever (or at least into the very distant future) remain a complement and not a replacement for lawyers. Yes, the legal industry as a whole is and will continue to undergo disruption as software eats up the more routine, commoditized parts of the profession. But VC-backed companies are not dealing with commoditized lawyers, and talented, creative VC lawyers are hardly, not even remotely, underemployed.  If anything, those of us who adopt new tools as they are developed have found our practices enhanced, not diminished, by technology.  It allows us to deliver more concentrated value with our time, which means a healthier attorney-client relationship overall.

If you engage your lawyers as the developers of an important foundation for your company – expecting effectiveness and efficiency, but staying realistic about the amount of complexity and value actually underlying their work, you’ll be surprised by the rewards.  For those who continue fantasizing about replacing lawyers entirely with apps, nothing will provide a better education than the moment the debt comes due.

VCs and Founder CEOs: Coaching v. Undermining

TL;DR Nutshell: For a first-time founder CEO, the process of acquiring the skills to run a successful, scaled company will inevitably involve mistakes, learning, refining, iterating, etc. The best VCs engage founder CEOs as coaches, constructively pointing out weaknesses and pushing them to become great leaders. The worst VCs go into an investment having already decided that the company needs a “real CEO” and will use every mistake, no matter how common, as a reason to reinforce their viewpoint.  Know how to distinguish between the two, or you’ll be sorry.

Background Reading:

One of the great things about being a VC lawyer is that you get to observe a volume and breadth of companies and founder teams that really isn’t accessible to most ecosystem players. Executives see only their own companies. Investors see only the ones they’ve invested in. But VC lawyers interact with teams that cross geographical, investor, industry, and all kinds of other boundaries.  More data points means more opportunities for pattern recognition, and I’ve noticed that the relationship dynamics between a first-time founder CEO and her lead investors – one of the most important relationships in the trajectory of a startup – often fall broadly into one of two categories:

  • Coaching – The functional category – The founder CEO understands, from Day 1, her role as the leader of the Company and that, cap tables and corporate governance issues notwithstanding, the Board and VCs are there to provide input, guidance, constructive criticism, and whatever else is needed to help the CEO exercise her judgment in leading the Company.  If the CEO makes a mistake – the budget was missed, some projections were off, a new hire turned out to be a dud, all mistakes that happen very often, especially in the very early days of a startup – everyone acknowledges the error, provides guidance on how to improve, and keeps moving. Investors offer suggestions, connections, and other resources all built around developing the CEOs personal skillset.
  • Undermining – The dysfunctional category – Because of the differences in experience, influence, and often age, an almost parent and child-like relationship develops between VCs and the founder CEO.  Very common mistakes like those described above don’t result in constructive advice for improvement, but in “this should NEVER happen” scoldings and early discussions about what kind of ‘talent’ is missing on the team. Communications become far more about what the founder CEO is doing wrong than about how she could start doing them right.

No one is born with the skillset needed to run a successful, scaling company. Founders know that, and experienced investors absolutely know it. Even more so, the early days of a startup are often so fast-moving and full of uncertainty that problems arise through no fault of the management team, but just because sh** happens. A lot.

A group of VCs who are committed to giving the founder CEO the necessary runway and resources to become a great leader is an invaluable asset to a founder team. But, unfortunately, in every ecosystem there are also investors whose routine playbook is to pretend that every hiccup, every miss, is just another reason why they need to pull out their rolodex and bring in some ‘adult supervision.’

Coaching ≠ Entrenchment

To be crystal clear, founder CEOs sometimes do need to be replaced, particularly when the Company has reached a size/scale where it really isn’t a ‘startup’ anymore; think Series B/C+. A Board of Directors has a fiduciary duty to do what maximizes the value of the entire Company, and if it has become clear that, after repeated attempts at building the necessary skillset, a CEO simply doesn’t have what it takes, she should step aside or be removed.  If the ship is sinking, it’s unfair to let everyone drown when you could’ve replaced the captain. 

My experience is that great founders are often (but not always) quite good at acknowledging when they’ve reached their limit– they obviously want their ownership stake to produce a great exit just like everyone else’s, and if they feel like bringing in new management will get that done, they will move aside. But not until they’ve been given a real chance. Even if we all universally accept that no one who raises outside capital is entitled to run a company forever, the best investors and advisors should universally agree that, given the massive personal sacrifices that founders make to build their companies, every founder CEO deserves an opportunity to make mistakes, learn from them, and mature into her leadership role without being constantly undermined.

If it’s been 2 years post-investment, you’ve cycled through ideas suggested by your Board, done the reps, studied the books, met with the mentors, things still just aren’t clicking and your Board is throwing out some names, think hard about it. That is just the Board doing its job.

But if you haven’t even closed a decent A round, your VC has you on a “tight leash” because you missed last quarter’s projections, and names (from the VCs own network) are already being suggested for new management, that is bullsh**. What you have there is an investor who planned to replace you before the ink even dried on the check.

The Importance of Transparency and Competition in Ecosystems

When I work with founder CEOs who’ve found themselves in the unfortunate situation of having an “underminer” on their cap table, my first piece of advice is simple: whining will get you nowhere. If a VC has managed to build a decent personal brand all while maintaining a consistent playbook of undermining a CEO’s leadership role from the very beginning, then he’ll respond only to consequences, not complaints.

Scarcity and opacity are the mothers of bad behavior in almost any market. If a market participant has thrived while being an a**hole, it’s because the market mechanisms needed for punishing that behavior, transparency and competition, have been absent. If you want to change the behavior, you have to change the environment. That means:

A. Never stop meeting with outside investors, and avoid contractual provisions that lock you in, early on, to a particular group of investors. Founders do themselves, their companies, and (frankly) their ecosystems a massive disservice by deciding that, once they’ve found ‘their VC,’ it’s time to stop investor discussions and ‘focus on the business.’

This does not mean that you should spend all of your time in full pitch mode – of course not – but you better believe that an investor’s knowing that you may be taking meetings with deep-pocketed California or East Coast VCs (who are increasingly looking outside of their core markets) will make them think twice about their behavior on the Board. It should not surprise anyone that the country’s VCs with the best reputations for how they treat founders (in addition to financial returns) are predominantly located in ecosystems with much more capital (and hence competition among capital) than the rest of the country.

B. Find Truly Independent Perspectives for both the Board and the management team. See: How Founders Lost Control of Their Startups, Apart from Ownership. Your independent director(s) should be actually independent – not people whom your ‘underminer’ has picked for 4 other boards before yours.  And you should know that pushing executives from their personal network onto the management team is a common way that ‘underminer’ VCs slowly unhinge the existing leadership. People remember who really got them their job.

C. Talk to other founders. Every founder approaching a VC round should be talking to the companies who’ve already taken money from their prospective VCs.  And I don’t mean just the rocket ships your VC suggested you talk to.  Recruiters know that the real data on a recruit comes from the people she didn’t list as references. You want to know how a VC treated the companies that hit road bumps, and that means doing your own diligence.

And when future founders come to you for feedback on a particular VC, play your proper role in the ecosystem and be honest. I certainly will be.  The best VCs deserve your praise – every ecosystem needs more of them, and the underminers deserve to be called out.

In any ecosystem, the best way to increase the number of coaches and marginalize the underminers is to (i) bring in new, competitive outside capital, and (ii) be transparent and honest about the capital that is currently available. Don’t whine about the players. Change the game. 

Lawyers are Slow, But Firms Shouldn’t Be

TL;DR Nutshell: Don’t be fatalistic in assuming that working with good lawyers always means slow response times. But also don’t delude yourself into thinking that any particular lawyer, if she’s good, will be immediately available for your every need. Asking the right questions about responsiveness up-front will prevent a lot of frustration in your startup’s relationship with its lawyers.

In my discussions with founders re: what they look for in hiring lawyers for high-growth, investor-backed startups, I’ve found that everything usually boils down to 4 criteria (often in the following order from most important to least, but not always):

  • Quality – Top founders usually have a strong understanding that (i) decisions when the Company has $5K in the bank account can (and often will) have a material impact on the business when its hit $20MM ARR, and (ii) cleaning up legal mistakes is orders of magnitude more expensive than doing it correctly the first time.

Quality is typically the main reason that startups ‘upgrade’ from generalist lawyers. See: Startups Need Specialist Lawyers, But Not Big-Firm Lock-In

  • Trustworthiness/ Like-ability – Your lawyers will be (or should be) close advisors working with you on the most high-stakes, strategic decisions of your company’s lifecycle. That relationship will get dysfunctional quickly if you can’t trust them, or simply don’t like them as professionals.

Trustworthiness is typically the main reason startups switch lawyers/firms from those that their lead investors insisted they use. See: Why Founders Don’t Trust Startup Lawyers

  • Efficiency – Hiring good lawyers, like hiring good developers, will never be cheap. It’s a basic law of markets that top talent requires top compensation. That being said, there are a lot of ways that founders can ensure that their legal budget is paying for great lawyers and not for expenses/overhead that isn’t actually resulting in better value.

Efficiency is typically the main reason startups avoid, or stop using, very large firms with billing rates 4-5x of what top lawyers require in compensation. See: How Startups Burn Money on Startup Lawyers

  • Responsiveness – This usually comes last because many founders have, through frustrating past interactions with the legal profession, come to the conclusion that ‘dealing’ with lawyers inevitably involves long wait times. Sort of how I brace myself every time I have to enter a specialist doctor’s office, because I know a 9:30 appointment, which was scheduled weeks ahead of time, usually means actually being seen around 11.

Send your lawyer an e-mail and expect a response in 3-4 days, if he’s not too busy. That’s just what it takes to work with good lawyers when you’re a small startup with a modest legal budget, right? The big fish have their attention most of the time, so just get in line… It doesn’t really need to be this way. Understanding 3 concepts related to lawyer economics will help you avoid this scenario:

1. Appreciate institutional bandwidth – and why, for speed, firms > solos. 

If recruiting and motivating top lawyers requires competitive compensation, then with basic math you’ll see why great lawyers who work with early-stage startups must work with many startups, not just yours, to get paid. Good startup lawyers are busy people, because maintaining a strong portfolio of work allows a lawyer to get paid well without burdening any particular company with an excessively large bill.

However, while a solo lawyer who is very busy will have only one thing to tell her client when they need something done quickly – “wait” – lawyers in firms have institutional bandwidth. If I’m busy, and I often am, I have other lawyers (and staff) in my firm who can be assigned to keep work moving. Properly run law firms know how to manage bandwidth and ensure that work is “spread” throughout their roster, without a loss in quality. This allows great lawyers to stay busy (required for compensation), without burdening clients with ridiculous wait times.

This point is, however, related to a second important concept:

2. For your primary counsel, hire a firm, not a lawyer. But size of practice area matters more than the size of the whole firm. 

The old adage “hire lawyers, not firms” has a lot of truth in it, but that truth only applies with the right factual backdrop:

  • It’s usually said by in-house general counsel, who themselves maintain a roster of specific lawyers (at various firms) that they can task on projects to manage bandwidth. Founders do not have this, and trying to build it for them would be a waste of time.
  • It assumes that there is something very unique about a particular lawyer that you need that others in her firm cannot provide. If you are doing cutting edge niche legal work that is unique to your particular market – like perhaps a patent lawyer with a very deep understanding of your special technology that no one else on the market has, this may make sense. For general startup/vc law, this is flatly not true if the firm you’re working with maintains proper standards and training for its roster of lawyers.

Of course, your primary contact with a firm will be a specific lawyer. But if you want to avoid waiting days, or even weeks, for something as simple as a response to an e-mail, you need legal bandwidth, and that means a firm. Expecting a specific lawyer to handle everything you need is the fastest way to ensure you are going to wait a long time for that lawyer’s attention, unless you’ve got several hundred thousand dollars a year in your legal budget for him. That’s called “in house counsel.”

But take note: there are a lot of law firms with 500, 1000, even 2000 lawyers who are incredibly slow. Why? Because they don’t actually leverage institutional bandwidth. A lot of those lawyers inside these large firm are either (i) in completely unrelated practice areas and hence aren’t actually available to help your particular lawyer (useless to you), or (ii) working in silos (just sharing a brand) with no effective mechanism for collaborating with one another. There are deeper reasons behind this “silo” problem that span issues like technology and compensation structures, but that’s too deep for this post.

Keeping dozens of different specialties of lawyers under the same firm is massively inefficient – to use econ jargon, we can call it “diseconomies of scope.” But within a specific practice area, there are very large efficiencies – shared technology, training, templates, institutional knowledge, and access to client information  – that a focused firm has over a bunch of independent lawyers. That’s why the specialist ecosystem that MEMN leverages is made up predominantly of specialized boutique firms, not solo lawyers (although there are those as well), each with their own institutional bandwidth within their practice area. See: The Tech Law Ecosystem v. BigLaw. 

3. Don’t hire an M&A or IPO Lawyer who uses startups as lead gen. Hire a startup/vc lawyer.

There is a massive difference between a lawyer who focuses on M&A (large exit transitions) and simply pursues startup clients as lead gen for very large deals v. a lawyer whose focus is startups and venture capital. The technology law firms that have very good response times have segmented large exit transactions as a specialty that operates alongside, but separate from, emerging companies corporate work. On top of improving response times, this results in better startup/VC lawyers and better M&A lawyers.  Find one of those firms.

Compare these two lawyers:

  • Lawyer A is assisting this month on (i) a formation, (ii) two seed deals, (iii) a Series B and Series C financing, and (iv) a $500MM acquisition.
  • Lawyer B is assisting this month on (ii) a formation, (iii) three seed deals, (iii) 2 Series A financings, and (iv) a Series B and Series C financing.

If you’re a startup client w/ one of those seed deals or VC financings and have a question, or you’re just a client with a quick question on a new hire, who do you think is more likely to respond promptly to your e-mail? Lawyer A, because of the fundamental fact that large, high-stakes, fast-paced exit deals tend to consume lawyers’ attention (for understandable reasons, big fees at stake) is going to take a lot longer. Hire Lawyer B over Lawyer A, and just ensure that Lawyer B’s firm has M&A specialists for when you need them… or hire Lawyer A and take a number.

Recap: Startups move fast. It is extremely frustrating to founders when their lawyers can’t keep up.  That doesn’t mean you should expect McDonald’s like responsiveness – these are highly skilled, busy professionals managing a portfolio of clients, not your in-house assistants – but if it takes days to even get a response to your e-mail, there’s an underlying problem that should be dealt with. For primary corporate counsel, find a firm with lawyers who focus on early-stage/emerging tech work, and with institutional bandwidth within that specific practice area.

And if you want the truth on how responsive a group of lawyers are, there’s no better place to go than that firm’s client base.  Believe me, if a founder CEO is frustrated with the responsiveness of her lawyers, you’ll have zero trouble getting her to talk about it.

Why I (Still) Don’t Make Investor Intros

TL;DR Nutshell: If in today’s connected startup ecosystems, with today’s tools and resources, a founder CEO still needs his (paid) lawyer to introduce him to investors, there’s a very good chance he can’t build a company. And most investors know that.

Background Reading:

Certain law firms I come across love to use the following biz dev pitch: “our firm has close relationships with many investors, and we love helping make intros to them for our clients.” Some have even attempted to institutionalize this into an entire department within their firms.

Sounds great, doesn’t it? Lawyers are constantly interacting with investors, so they must be a great shortcut to getting intros, right? Not so fast.

A paid intro is generally worse than no intro, particularly in today’s ecosystems. 

I wrote Don’t Ask Your Startup Lawyer for Investor Intros about a year and a half ago, in which I made the following argument:

  • Early-stage investing is at least as much about betting on founders, particularly CEOs, as it is about betting on a particular business.
  • Because investors see 100-1000x more companies than they can fund, or even assess, they heavily rely on filters/signals to judge the quality of founding teams.
  • The way in which a CEO obtains an investor intro (and from whom) speaks volumes about that CEOs ability to network, persuade, and generally hustle; all of which are extremely important skills for a successful founder CEO.
  • There are far more ways, today, to get connected with investors and find true, authentic warm referrals – AngelList, LinkedIn, Twitter, Accelerators, etc. – than there were even 5-10 years ago.
  • Therefore, in a world in which there are 100s of possible paths to get introduced to an investor, the fact that your lawyer (someone you are paying) ends up making the intro can send an extremely negative message about the founding team – including that they can’t hustle, can’t convince anyone else in their ecosystem (that they aren’t paying) to introduce them, or both. Samir Kaji emphasizes this last point, about a weak intro making investors think negatively about the founders, in his post.

At the time I published that post, most people providing feedback on it agreed, but I had a few dissenters – generally lawyers arguing that they’ve made successful intros themselves. I don’t doubt that they’re telling the truth, but what was telling is that few could give examples of successful intros in recent years – and my point is very time-contextual. Even five years ago, relationships within startup communities were far more opaque than they are today, and an intro from a lawyer didn’t have nearly the level of negative signaling then that it does now.

But one pattern become obvious that relates to another point I’ve made before:

For a lawyer’s investor intro to not have a negative signal for a particular investor, the lawyer and investor must have a very close relationship, and that means you shouldn’t want that lawyer representing your company in a deal with that investor.

See: Why Founders Don’t Trust Startup Lawyers

There absolutely are particular lawyers who have very close relationships with particular investors, much more than other lawyers who simply run into those investors on deals and on boards (professional acquaintances). The issue is that those close relationships develop, nine times out of ten, from those lawyers working for those investors. And for reasons that should be obvious (but if they aren’t, read the above post), the last lawyer you want representing your company in a VC deal is the lawyer who is BFFs with the VCs you are negotiating with.

So maybe some lawyers can make a decent intro… but you shouldn’t work with them… which makes it significantly less likely that they’ll make the intro. Life is complicated.

Other founders, particularly well-respected ones and especially those who’ve been funded by an investor, are the best source of referrals. Other well-respected, non-service providers (advisors, accelerators, angels, etc.) are the second best. Anyone you are paying comes dead last.

Jeff Bussgang has a great post on how to ‘rank’ different potential paths to investors – Getting Introductions to Investors – The Ranking Algorithm. His hierarchy makes a lot of sense. And aside from other founders being the best source of referrals, they are absolutely the best source of intel on investors, when you’re diligencing them. If a group of VCs have provided you a term sheet and you aren’t actively (but discreetly) talking with their portfolio founders to understand what working with those VCs is actually like, you’re doing it wrong.

As ecosystems become more transparent, and prospecting tools become more sophisticated, investors may be relying less on referrals anyway.

I found the data reported by First Round Capital in their 10 year Project to be pretty interesting, including the data suggesting that First Round’s referred investments significantly underperformed relative to investments that First Round hunted on their own. Honestly, this isn’t that surprising.

A lot of studies on investor performance emphasize that, while many people get lucky with one or two home-runs, the people who consistently outperform the market are those who actively take a process, data-oriented approach, and try their best to counteract their biases. That doesn’t mean success in VC is about number crunching, but it does mean that if your personal relationships are the main way that you find companies, you’re going to have a lot more sources of bias in your decision-making than someone who takes a broader, but more calculated approach.

In short, we live in a very different world from the one in which VCs sat in their offices relying on proprietary, somewhat opaque deal flow sources. In that world, lawyers were a better source of investor intros. That world no longer exists. Investors fund hustlers, and (today) hustlers don’t need their lawyers to introduce them to investors.

Converting Your Startup to a Delaware Corporation, Correctly.

TL;DR Nutshell: If you’ve accepted that you need to convert your startup to a DE corp from a different entity type, then it’s also time to accept this: there is no off-the-shelf, “click a button and file” way to convert to a DE corp. It is highly contextual. The right lawyers can do it efficiently and correctly. The wrong ones will tell you it’s simple, screw it up, and require you to pay the right lawyers 5x more in the future to clean it all up.

Background Reading:

The purpose of this post is not to debate whether your startup should be a Delaware corporation. While we do work with a decent number of VC-ish backed Delaware LLCs (sometimes LLCs really do make sense), the vast majority of technology companies that raise venture capital either start or end up as Delaware corps. And the moment a lawyer starts playing contrarian with me, talking up why Delaware isn’t needed, or C-Corps are tax inefficient, I quickly end the exchange by asking how many VC-backed companies she’s actually worked with. We are talking about scaling tech companies and venture capital. Not small businesses or companies funded by local, non-institutional investors.

So for purposes of this post, we are going to take it as a given: you need to be a Delaware corporation, but you aren’t one right now. Converting is simple, right? Just file a form?

Converting from any kind of entity to a DE Corp is not “standard.” Ever. 

Properly forming a DE corp startup from scratch has, thanks to standardization and automation, become a relatively straightforward process.  The reason, of course, is that you’re starting from nothing, and nothing is the easiest condition to automate from; no messy context throwing a wrench in the system. Conversion, however, involves a history with any number of possible permutations, and that means all the shiny templates and technology must give way, partially, to human judgment.

  • What are your state’s rules around entity “conversions”; is a “statutory conversion” allowed, or will you need to do a merger or possibly even an asset sale? It depends. 
  • What approvals does your state’s rules require? It may be a majority of all equity, it may be 2/3, it may be unanimous. It depends.
  • What specific documentation (like a “Plan of Conversion”) and filings (often in both states, not just DE) do the rules require? It depends.
  • Are there any existing agreements in place that might require a separate consent to be obtained before the entity can convert? Ok you get the idea.
  • Does the company’s existing capital structure require a (hopefully quick) discussion with tax counsel regarding possible tax hits (phantom income) resulting from the conversion? This is a crucial issue to consider when converting an LLC to a Corp. 

Converting a Non-DE Corp to a DE Corp (Corp to Corp) is generally simpler than converting an LLC to a Corp. Converting any entity in a state that allows for statutory conversions (TX and CA do, NY does not) is generally simpler than having to do a statutory merger.  Whatever the context, you will screw it up trying to do it yourself. In fact, I’ve lost count of how many law firms have screwed it up, requiring founders to pay us 5-10x in cleanup costs than they would’ve paid if they had just hired competent counsel from Day 1.

The reason you will never just push a button to receive medical treatment is that every person is different, and tailoring high-stakes treatment to individual differences is precisely what professional judgment (supported by tech, of course) handles best.  Startup law is no different. Technology and tools absolutely cut down on waste, and yes there is a lot that is standardized even in conversions.  But in the end the institutional knowledge of the law firm you choose will determine whether it gets done efficiently and correctly, or whether you’re just deluding yourself into thinking that the guy promising a cheap, simple conversion actually knows what he’s doing.