Contracts v. Might Makes Right

TL;DR: When a first-time entrepreneur is navigating an environment full of entrenched players who all know and depend on each other, the difference between a balanced decision process and a shake down can come down to a contract. Take contracts, and the independence of the lawyers who help negotiate them, seriously.

Background reading:

A background theme of many SHL posts is the following: entrepreneurs enter their startup ecosystems, from the beginning, at a massive structural disadvantage relative to the various market players they are going to be negotiating with. Everyone else knows each other, has worked with each other over the years, and has already made their money. And then you show up.

Now assume that environment as the background, and then imagine you start striking deals with these people: for a financing, a partnership, participation in a program, etc., but assume there are no contracts or lawyers involved. What do you think will eventually happen? Here’s how it will play out: as long as you continue to deliver exactly what everyone wants from you, very little will happen. When everyone’s expectations and preferences are 100% aligned in the short term, the absence of contracts means very little. They’ll “let” you stay in the spot you’re in. 

Until things (inevitably) go sideways. A market shift suddenly means a change in strategy might be necessary, but there’s disagreement on how and when. A quarter comes in under projections, and there’s disagreement as to what that means. A potential outside investor expresses interest in making an investment, and there’s internal disagreement as to whether it should be pursued.

I focus here on the word disagreement, because in many situations on high-level strategic issues, the right answer isn’t always clear cut. The goal (grow the company, improve economics) may be clear, but the right execution strategy is far harder to see.  People will disagree, and where they stand on an issue often rests on where they sit. For example, “portfolio” players (institutional investors) will often be far more comfortable, and even insistent, on taking higher risk (but much higher reward) growth strategies than entrepreneurs and employees, who have only “one shot.”  See Common Stock v. Preferred Stock for a more in-depth discussion on the substantial misalignment between “one shot” players (entrepreneurs, employees), who usually hold common stock, v. portfolio/repeat players (investors), who usually hold preferred stock.

The core point of this post is this: in an environment of substantial disagreement, and where everyone other than the entrepreneur is a repeat player that knows and has economic ties to each other, the first-time entrepreneur (who speaks for the early common stockholders generally) will lose every timeunless contracts in place say otherwise. 

In the absence of laws and contracts, the law of the market is “might makes right,” and established, repeat players have all the might.  

Here is a scenario that I’ve encountered far too often (although increasingly less so as awareness has increased) that is almost comical when viewed objectively:

  • A financing has closed, putting in place a “balanced” Board of 2 VC directors, 2 common directors (one of which is a new CEO, the other a founder), and an “independent” director.
  • In attendance at the meeting are 6 people: the Board and company counsel.
  • The 2 VCs regularly syndicate deals with each other and have known each other for a decade.
  • The new CEO is a well-known professional CEO who has worked in several portfolio co’s of one of the VCs, and was “recommended” by that VC for the position.
  • The “independent” director is an executive well-known in the local market who also has worked with the VCs at the table for over a decade, both of whom recommended her for the position.
  • “Company counsel” represents 6 portfolio companies of the VCs at the table, and has represented them as investor counsel on as many deals, and is actually currently doing so for other deals. In fact, company counsel became company counsel because he came “highly recommended” by the VCs when they were first negotiating the deal with the entrepreneur.

So let’s summarize: there are 6 people at the meeting, and 5 of them have all worked with each other for over a decade, regularly send deals to each other, and in some cases (at least with respect to the lawyer and a VC) are currently working with each other on other deals not related to this company. And then there’s the entrepreneur.

Wow, now there’s one “balanced” Board, don’t you think? I’ve encountered entrepreneurs (whose companies are not clients) in this situation before. I let them know that, whatever they think their position at the company is or will be, they are simply leasing that position until their investors, who hold virtually all the cards and relationships, decide otherwise; and regardless of what the common stockholders think. It’s possible things turn out fine, as long as all goes as planned. It’s also very possible they won’t.  But what’s absolutely clear is who decides, in the end.

The difference between a well-advised entrepreneur and the one in the above scenario is this: the former will have real protections in place to ensure the common stock are treated fairly, and have their voice on key company matters. The latter may feel protected, but ultimately their position is at the discretion of their investors; and protection that is contingent on the whims of people on the other side isn’t protection at all.

Well-drafted contracts are, when negotiated in a transparent manner, a key mechanism for controlling the power of sophisticated repeat players who, absent those contracts, can simply force through whatever they want because of their political / economic leverage. What else might this reality tell us about negotiation dynamics in startup ecosystems?

Rushing through negotiations / contract drafting favors established players.

If the default market position gives power to established players, and contracts are a mechanism for controlling that power, the inevitable result is that those established players (at least the most aggressive ones) will try to get entrepreneurs to rush through contract negotiations.

“Let’s just go with what’s standard.”

“It’s all boilerplate.”

“Let’s save legal fees and put them toward building the business.”

“Time kills deals. Let’s get this closed.”

If someone is telling you that what the documents say doesn’t really matter, or that you should just stick to a template, it’s because, outside of the contract, they’re in control.  That doesn’t mean you should burn endless amounts of time negotiating every point, but take the material provisions seriously.

A market ethos of “relax, we’re all friends here” is designed to favor power players.

Old-school business folks know very well how large amounts of alcohol have often been used to seal business deals. In the startup world, alcohol may still be used, but just as effective is fabricating an environment suggesting to first-time entrepreneurs that everyone is just holding hands and singing kumbaya, and being independently well-advised isn’t necessary.

I’m all for having very friendly relations with your business partners. Life is too short to work with people you don’t get along with well.  But any time someone extends that thinking to the point of telling entrepreneurs that “everyone is aligned” and they should let go of the skepticism to focus on “more important things,” I call bullshit. Alcohol and kool-aid; stay sober in business.

“Billion or bust” growth trajectories mean contracts matter less. Outside of those scenarios, they matter more. 

Among emerging company (startup) lawyers, it’s always been well-known that the Silicon Valley ecosystem as a whole takes standardization, automated templates, and rapid angel/VC closings to an extreme relative to the rest of the country/world. I’ve pondered why that’s the case, and in discussing with various market players, concluded that it has a lot to do with the kinds of companies that Silicon Valley tends to target: billion or bust is a good way to summarize it. I wrote about this in Not Building a Unicorn. 

If the mindset of an ecosystem is significantly “power law” oriented in the sense that “winners” are billion-dollar companies, and everyone else will just crash and burn trying to be one of those billion-dollar companies, I can see why the finer details of deal negotiation may be seen as an afterthought. That environment, which is very unusual when compared to most of the business world, leaves a lot less room for the “middle” scenarios – things aren’t going terribly, and we’re clearly building a solid business. but neither is this a rocket ship, and there are hard questions to be decided – where the deep details of who has what contractual rights really matter.

In a heavily binary “unicorn” world, you’re either knocking it out of the park, in which case no one even reads the contracts and just lets you do your thing, or you’re crashing and burning, in which case the docs are just useless paper. As a law firm headquartered in Austin and structured for non-unicorns, we don’t work in that world, and actually avoid it.

For true “balance,” pay close attention to relationships.

In my opinion and experience, the best outcomes result when the power structure of a company (both contractual and political) doesn’t give any single group on the cap table the ability to force through their preferences, but instead requires some hard conversations and real “across the aisle” coalition building to make a major change.

Balanced boards are, on top of other contractual mechanics, a fantastic way of achieving this, when they are in fact balanced. The above-described scenario where everyone except for the entrepreneur knows and has strong economies ties to each other, including a company counsel “captive” to the VCs, is a joke; and sadly, a joke played on too many startups.

As I wrote in Optionality: Always have a Plan B, build diversity of relationships into your Board and cap table. Feel free to let “the money” recommend people, because their rolodexes are valuable, and are often part of the reason why you’ve engaged with them. But you should be deeply skeptical of any suggestion that the preferred stockholders should, alone, decide who the CEO is, who company counsel is, who the independent director is, etc. etc. Letting them do that certainly may get your deals and decisions closed faster, but unless you are successful in delivering a true rocket ship, you will ultimately regret it.

The common stock, including the founding team and early employees, need a strong voice at the table, especially given the power imbalance with repeat players. Well-negotiated contracts and independent, trustworthy company counsel are the way to ensure they have that voice.

How LLC Startups Raise Money

TL;DR: Very similarly to how “classic” C-Corp startups do, with a few important caveats.

Background Reading:

As I’ve written a few times before, the trend of entrepreneurs (somewhat) mindlessly accepting the advice – that forming their companies and raising investment should always be as standardized as clicking a few buttons – appears to be reversing, at least outside of Silicon Valley. This trend is very much related to all the public stories from experienced founders emphasizing the downsides of following a “standard” path, taking on “standard” VC investment with very high-growth expectations, and how it can cut off a lot of more nuanced/appropriate growth and fundraising strategies. For more on that, see: Not Building a Unicorn. 

As entrepreneurs are spending more time exploring all their options, LLCs are increasingly popping up. I’ve written before about when an LLC may make sense for a startup (C-Corps are still by far the dominant structure). It generally boils down to whether the founder team thinks there’s a possibility that, instead of constantly reinvesting earnings for growth and looking for an exit, they’ll decide to let the business become profitable and distribute dividends to investors. C-Corps are very tax inefficient for those kinds of companies.

So naturally as LLCs become part of the discussion, the next question is how LLC startups can raise investment. Some founders have been incorrectly advised that LLC startups simply don’t raise investment at all. They think that C-Corp = investment, and LLC = run on revenue. That’s far from the case. While true that institutional tech VCs very often won’t invest in LLCs (although that too is changing), the pool of investors interested in early-stage tech companies is much more diverse now than it was even five years ago. Lots of strategic investors, angels, and investors from other industries looking at tech are quite comfortable investing in LLCs, and do so all the time.

LLC startup fundraising looks, at a high level, a lot like C-Corp fundraising.

Capital Interests – Units, Membership Interests, Capital Interests. These are all synonyms for the LLC equivalent of stock. The documentation for these types of investments looks very different from a C-Corp preferred stock financing only because the underlying organizational docs of LLCs are different: you don’t have a “Certificate of Incorporation,” as an example, you have an LLC Operating Agreement.  But the core rights/provisions often end up very similar. A liquidation preference giving the investors a right to get their money back before the common – often see “Common Units” for founders/inside people and “Preferred Units” for investors. Voting provisions re: who gets to elect the Board of Managers (LLC equivalent of a Board of Directors), and other similar rights.

Convertible Notes – These look 95% like C-Corp convertible notes, including with discounts/valuation caps to reward early-stage risk, just drafted a bit more flexibly to account for whether the notes convert into LLC equity or C-Corp equity (if the company decides to become a C-Corp).

SAFEs – Yes, there are LLCs now doing SAFEs, although the SAFE instrument requires tweaking (like convertible notes) to make sense for an LLC. Even for C-Corps, we still see SAFEs being used only in a limited number of cases (again, because we serve companies outside of California, where SAFEs dominate). That’s because they are about as company favorable (and investor unfavorable) as you can get, and many investors balk at what they see as an imbalance. LLC SAFEs are even rarer than C-Corp SAFEs, but they do come up.

LLCs are known for their flexibility, and given that LLC companies tend to be more “cash cow” oriented than C-Corps, even more alternative financing structures are popping up: royalty-based investment is one example, where investors take a % of revenue as a way to earn their return, instead of expecting it in the form of a large exit or dividend. But those are still so uncommon (for now at least) that they’re not worth digging further into.

As I’ve repeated several times before, the big issue with LLCs and fundraising is you absolutely need a tax partner involved. By that, I mean a senior lawyer with deep experience in the tax implications of LLC structures and investment. This is not a “startup lawyer,” but a very different specialty. The flexibility of LLCs brings with it significant tax complexity at the entity and individual holder level, and even the brightest corporate lawyers are not qualified to handle that on their own. 

The majority of emerging tech companies still end up as C-Corps, simply because it still makes sense for the type of business they plan to build. But even with C-Corp land, founders are digging much deeper into how to structure and fundraise for their companies, and pushing back on the suggestion that they should just sign some templates and move on; as if what the templates say (and don’t say) doesn’t really matter.  That may still work for the “billion or bust” high growth mentality of unicorns, but entrepreneurs who feel they’re building something different want flexibility, and to understand the full scope of options.

Comparing Startup Accelerators

Background Reading:

Over the past several years, accelerators have emerged as a powerful filtering and signaling mechanism in early-stage startup ecosystems, allowing high-potential young startups to connect with investors, advisors, and other strategic partners far faster and more efficiently than before. While it definitely feels like the accelerator “bubble” has somewhat burst, and their numbers are normalizing, I’m still often asked by CEOs for advice on how to assess various programs. The below outlines how I would approach the decision:

Cash and Equity.

Very simply, what are you giving and what are you getting in return in terms of cash and equity for joining the program?

Re: cash, the more “unbundled” types of accelerators (less formalized) tend to not provide any cash upfront, but also typically “cost” less in equity, often just 1-2% of your fully diluted capitalization. More traditional and comprehensive programs often require 5-8% of common stock, but often provide between $20K and $100K up-front as well.

Anti-Dilution.

See: Startup Accelerator Anti-Dilution Provisions; The Fine Print.   Most accelerators, with a few exceptions, have much more aggressive anti-dilution provisions than a typical seed or VC investor would get, and the “fine print” can dramatically influence the total equity requirement depending on your circumstances and fundraising plans. This is something you should walk through with an experienced advisor, lawyer or otherwise, to prevent surprises.

Pro-Rata / Future Investment Rights.

See: The Many Flavors of Pro-Rata Rights. Some accelerators will require you to “make room” for them in future financings up to a certain amount. This is not necessarily a bad thing, and it’s very reasonable given that the ability to make follow-on investments in “winners” is virtually essential for very early-stage startup investors (angels, accelerators) to make good returns. However, for the most in-demand startups, over-committing on future participation rights can become a problem because it can require you to raise more money than you really need to.

Fundraising / general success of past companies.

See: Ask the users.  If fast-track access to investors is not at the top of your priority list, then this may not be as big of a deal for you. But 95% of founders I’ve worked with have viewed “cutting in line” to speak with investors as the main reason for entering an accelerator. And don’t rely solely on numbers reported by the accelerators themselves. There are lots of ways of fudging the figures, including by “annexing” already successful companies into the accelerator (in exchange for free help) and using their brand/fundraising numbers to puff up the accelerator; neglecting to mention that the accelerator had nothing to do with those numbers.

Entrepreneurs often celebrate faking it until you make it. Know that some accelerators do the same. When an accelerator says “our companies have raised an aggregate of $200 million,” they may be neglecting to mention that a huge chunk of that was raised before some of the companies (the top ones) ever “entered” the accelerator. 

Ask specific founders, off the record. Without a doubt, the overall “prestige” of the accelerator’s past cohorts will have a dramatic impact on the accelerator’s ability to deliver on its “benefits” to you. There’s a heavy snowball / power law type effect with accelerators where the best ones attract the best companies, which then attract lots of capital/great mentors, which then attracts more great companies, further improving the accelerator’s brand, and so on and so on. And the same is true in reverse: accelerators with poor reputations and bad averse selection (they are just getting the companies everyone else rejected) can actually make it harder to raise money, and are best avoided.

Time commitments and Geography.

Many accelerators involve a substantial time commitment (including travel time) in terms of going through the “program” of events, meetings, training, etc. Feedback (given privately) varies on the ROI of those obligations, depending on the accelerator, type of company, etc. Some entrepreneurs find it invaluable. Others find it a necessary cost to getting access to the accelerator’s network, which is what they’re really there for. In any case, travel and time commitments are a real cost, so take that into account.

Market Focus.

One of the most common complaints I’ve heard from entrepreneurs, after having gone through an accelerator, is that it wasn’t helpful for their “type” of business. Some accelerators are very up-front and overt about their market focus: biotech, energy tech, transportation, etc.  Others are more generalist, but if you dig deep you’ll realize that all or most of their cohort is slanted in one direction, which will mean the accelerator’s network of investors and mentors will be as well.

An example: a heavily hardware-focused startup may not find as much success in an accelerator where the vast majority of companies are SaaS based. The same goes for a health tech startup entering an accelerator full of consumer or B2B startups.

Culture.

In much the same way that entrepreneurs’ own personalities set the culture for their companies, the creators and managers of accelerators heavily influence both their “online” and “offline” culture. Personalities, ages, lifestyles, and values will vary. Some accelerators are well-known for being extremely friendly, generous, and community-oriented. Others are known for being more competitive and “eat what you kill” in their approach. I’ve seen more aggressive entrepreneurs feel that their particular accelerator was a bit too “kumbaya,” while those with opposite personalities felt right at home. 

Do your diligence before entering any accelerator, and make sure you assess its offerings in light of your company’s own priorities and needs. I’ve seen companies emerge with polar opposite opinions of the same accelerator, even within the same cohort.  In many cases, it’s less about the program being good or bad in an objective sense, and more about whether it was a good or bad “fit” for that particular startup. 

How Angels & Seed Funds compete with VCs

TL;DR: The emerging “seed ecosystem” of angel groups, seed funds, and accelerators now provides local startups a viable path to seed funding, and eventually “going national,” w/o having to prematurely commit to a Series A lead.  That has dramatically reduced the leverage that local institutional funds once had over their local ecosystems.

Background Reading:

Once upon a time, startup ecosystems (if they could even really be called that) outside of Silicon Valley had only a handful of local VC funds writing checks. Without AngelList, LinkedIn, Twitter, Accelerators, good videoconferencing, and the many other recent developments that have reduced geographic friction in startup capital flows, those funds effectively “owned” their cities, including most of the startup lawyers in those cities; which often resulted in harsh terms and aggressive behavior. For more on this, see: Local v. Out-of-State VCs.

Raising “angel” money in that era often meant needing close connections (family, friends, professional) to very high net worth individuals willing to make big bets on you until you were ready for one of the few local funds to take you under their wing. If you were one of those lucky few chosen, those local VC funds would then, once they were out of their own capital, show you off to one of their trusted out-of-state growth capital funds.

The pipeline was narrowly defined, and choice was minimal: local angels (or friends and family), then local VC, then out-of-state growth capital.

Times have changed.

Today, angel groups are much bigger, organized, and collaborative across city and state lines. Seed funds – which weren’t really even much of a concept a few years ago – will write checks of a few hundred thousand to a few million dollars for rounds that may have been called Series A 3-5 years ago, but are now “seed” rounds. Prominent accelerators have themselves joined the mix, writing their own 6-figure checks and serving as valuable filters / signaling mechanisms to reduce the search costs of investors.

This “seed ecosystem” of organized angels, flexible seed funds, and accelerators has not only increased the amount of “pre-VC” capital available to startups, but very importantly, it has significantly reduced the leverage that local VC funds have over their local startup ecosystems. 

As I wrote in Optionality: Always have a Plan B, sunk money has very different incentives from future money. A seed fund/angel that has mostly maxed out the amount of capital it can fund you with has every incentive to help you find a great Series A lead at a great valuation; they are quite aligned with the common stock. However, a VC fund that wrote you a small seed check but wants to lead your Series A has very different incentives. The “seed ecosystem” wants to maximize your Series A options, while a VC fund wants to minimize them, until it gets the deal it wants.

Foreign capital will usually require some heightened level of de-risking or credible signaling before it will cross state lines. It’s much less risky to rely on my local referral sources, and “monitor” my portfolio where I can drop in by the office whenever I need to. If I’m going to write a check a thousand miles away, I need a little more reason to do so. In that regard, it’s well-known that there is a “flipping” point beyond which the pool of capital available to a startup moves from being mostly local to much more national: that point is somewhere between $1M-$2MM ARR (it used to be higher). 

Historically, reaching that flipping point was almost impossible without local VC, and this effectively kept startup ecosystems captive to their local funds. The new seed ecosystem, with its ability to often fund 7-figure rounds all on its own, has changed that. Now, if a desirable startup wants to, it can often raise $1-2MM in seed capital without taking a single traditional VC check, then use that to hit the “flipping” point, after which the number of VCs it can talk to goes up considerably. 

Of course, this dynamic is not always so clean cut.  More progressive VCs have wisely developed symbiotic relationships with this seed ecosystem for the obvious reason that it can serve as a pipeline when startups are ready for bigger checks. That is a smart move. What we’ve also seen is that large VCs are playing much “nicer” in seed rounds than they used to, as an acknowledgement of their reduced control over the market. Years ago you much more often saw VCs condition a $250K or $500K check on a side letter giving them the right to lead your Series A. That is increasingly becoming an anachronism, and for good reason.

At the same time that AngelList, accelerators, LinkedIn networks, and other signaling / communication mechanisms for startups are giving foreign capital more “visibility” into other ecosystems, allowing it to invest earlier and more geographically dispersed, the emergent seed ecosystem is also increasingly allowing local startups to “go national” without having to commit themselves to a particular VC fund. The obvious winners in this new world are entrepreneurs and investors willing to be open and flexible with how they fund companies. The losers are the traditional investors who haven’t understood that the old game is gone, and it’s not coming back.

Optionality: Always have a Plan B

TL;DR: Always build some optionality into your startup’s financing strategy. Failing to do so will overly expose you to being squeezed by sophisticated players who can see how dependent you are on them.

Background reading:

The below is a fact pattern that we have seen happen with several of our clients. It will provide some context for why the point of this post is so important.

Company X has raised a decent-sized seed round, which includes several angels as well as a “lead” VC; though that VC is not on the Board. The Company knows that it will run out of funds in 3 months if it does not raise more money, and it has been in regular communication with the VC about that. The VC reassures the founders that they will “support” them with a new bridge round. A month passes, and the founders ask about the bridge. “Don’t worry, we’ll cover you” is the response. Then another month passes, with more reassurances, but no money. Then 2 weeks before their fume date (the date they’ll miss payroll), the VC drops a term sheet with very onerous terms, including a low valuation, and mandated changes to the executive team. The VC makes it clear that they won’t fund unless those terms are accepted. The founders panic. 

Before we dive in, there are a few important points worth making about this situation. First, it was clear every time that it has come up that the bait-and-switch dynamic was planned by the lead investor. They paid very close attention to the exact date that the Company would run out of funds, and timed the “switch” to deliver maximal pressure. Second, the regular “reassurances” provided to the founder team were calculated to discourage them from using their time to find other funding sources. Third, the best way to avoid investors who engage in this kind of “below the belt” behavior is to do your diligence before accepting their check; see: Ask the Users. 

Always have a Plan B.

A startup’s ability to avoid being burned by the above behavior depends on its level of strategic optionality.  Optionality means strategically avoiding a situation in which you have no choice but to depend on one investor/investor group for funding. This is very different from not committing to certain lead investors as your main funding sources. “Party rounds” are what you call financings where literally every investor is a small check. The end-result of a party round is that no one has enough skin in the game to really support the company when it hits a snag. You really are just an option to them. 

I strongly support having true lead investors writing larger checks in your rounds, because they will usually provide far more support than just money. And if you’ve done your homework and have a little luck, they’ll never even think about engaging in the kind of behavior described above. But in all cases the best way to maximize the likelihood of good behavior is to ensure a right of exit if someone decides to cross a line. I always try to work with “good people.” But no good strategist builds their life or company around the full expectation that everyone will be good. 

Lead fundraising yourself.

CEOs sometimes believe that they are doing themselves a favor by letting a lead investor do their fundraising for them – coordinating intros, negotiating terms with outsiders, etc. – so they can “focus on the business.” It often backfires. Angels and seed funds whose money has been sunk into the company, and who aren’t planning on writing larger checks in the future, are usually quite aligned with the founders/common stock in helping raise a Series A or future round. They’re being diluted just like you are.

But a VC fund with plenty of dry powder and a desire for better future terms is significantly mis-aligned with everyone else. Watch incentives closely.  Founders/the lead common holders should maintain visibility and control in fundraising discussions, with trusted independent advisors close by. 

Start early, and don’t tolerate unnecessary obfuscation and delays. 

Do not wait until a few weeks from your fume date to start communicating with investors for new funds. If someone says they will support you, great: when, and what are the terms? You want to know them now, not later. “We will support you” means very little without knowing what the price will be.

Expecting things to happen in a few days is unrealistic, but a month or more of delays is usually a sign that someone is playing games, and it’s time to pull the plug. No serious fund worth working with is that busy.

Build “diversity” into your investor base.

The power dynamics in a company are very different when all the major investors have strong relationships/dependencies with each other, and communicate regularly, relative to when various players come from different “circles.” Geographic diversity – meaning taking money from various cities/states – is a good strategy to avoid unhealthy concentration of power among your investor base. Also, diversity of investor types – angels, seed funds, institutionals, strategics – will ensure that your investor base includes people with differing incentives/viewpoints, which reduces the likelihood of collusion. 

In the scenario where a bad actor has tried a “bait and switch” on a founder team, a group of angels willing to write quick checks for an emergency bridge, or a lender offering a credit line, can be enormously valuable to relieve pressure and build time to correct course.

Contracts matter. A lot. 

Every commitment you make to investors requiring their approval, or guaranteeing their participation, in future rounds can have material strategic implications for how much optionality you have. Protective provisions matter. Super pro rata rights and side letters matter.  When you see dozens of financings a year, you regularly see how commitments made at seed/pre-seed stage play out over years and seriously affect the course of fundraising.

Good lawyers well-versed in the ins and outs of startup financing will go much further than just plugging some numbers into a template, which software can do.  They’ll dig deep on how the specific terms you’re looking at will impact the company, in its specific context, and how much room there is to stay within “market” norms while still keeping flexible paths open for the future. That’s, of course, assuming they aren’t actually working for your investors.

Make money, and own your payroll.

The ultimate optionality is being able to run on revenue if you need to; being “default alive” in Paul Graham’s words. Yes, you may grow slower than you’d like, but growing more slowly is always lightyears better than being forced into a bad deal.

Every salaried employee on your payroll raises the revenue threshold needed for your company to be default alive. Ensure that every member of your roster is essential, and that there aren’t redundancies that could be addressed by asking someone to be more of a generalist. And don’t let an institutional investor pressure you into hiring a high-salaried professional executive unless you have a clear strategy for how you are going to afford them, because, yes, that is another way that they can add fundraising pressure.

Stay in control of your fundraising. Start discussions early, and don’t tolerate delays. Build diversity of geography and incentives into your investor base. Let your lawyers do their actual job. And finally, watch your payroll closely. Following those guidelines will minimize anyone’s ability to squeeze you, and your investors will then act accordingly.