Don’t Rush a Term Sheet

TL;DR: No matter how many blog posts and books are out there (many of which I recommend) attempting to explain the mechanics of VC term sheets in simple terms, the reality is that VC term sheets are complicated, both in terms of how their math works and in how the various control-related provisions will impact a founder team over time. Take time to understand them, and don’t rush to sign, even if investors make you feel like you have to.

Background Reading:

Similar to the ‘automation delusion’ that I’ve written about in Legal Technical Debt, which has led some very confused founders to think that most of what startup lawyers do is getting eaten (as opposed to supplemented) by software, there’s a sentiment among parts of the founder community that VC deals have become so standardized that the only kind of analysis needed before signing a term sheet should look something like:

“$X on a $Y Pre?”

“5-person Board, with 2 common, 2 Preferred, and 1 Independent?”

“Great, here’s my signature.”

Take this approach, and you are going to get a lot of ice cold water splashed on your face very quickly, and not at all in a good way. I’ve seen it many times where founders run through a VC deal, so excited about how awesome their terms were, only to realize (sometimes at closing, sometimes years later when things have finally played out) that there were all kinds of “Gotcha’s” in the terms that they failed to fully appreciate. Having solid, independent, trustworthy advisors to walk you through terms before signing is extremely important, and it needs to be people whose advice you take seriously. See: Why Founders Don’t Trust Startup Lawyers and Your Best Advisors: Experienced Founders. 

Some simple principles to follow before signing a term sheet are:

A. Fabricated Deadlines Should be Pushed Back On – It is very common for a term sheet to end with something like “this term sheet will expire on [date that is 48 hours away].” That deadline is very rarely real. It’s just there to let you know that the VC expects you to move quickly.

It is unreasonable to sit on a VC’s term sheet for weeks without good reason. By the time they’ve offered you a term sheet, they’ve likely put in some real time diligencing your company, and the last thing they want is for you to take their term sheet and then “shop” it around to their competitor firms to create a bidding war.  Doing so is not how the relationship works, and will almost certainly burn your deal. So expecting you to move somewhat quickly in negotiating and then signing is fair, but if a VC is pressuring you with anything remotely like “this needs to be signed in 24/48 hours, or the deal’s gone,” what you have there is a clear picture of the kind of power politics this VC is going to play in your long-term relationship.

Move quickly and be respectful, but make sure you’re given enough time to consult with your advisors to fully grasp what you are getting into. It should be in everyone’s interest to avoid surprises long-term.

B. Model The Entire Round – VC Lawyers are usually the best people to handle this because they see dozens of deals a year and will be the most familiar with the ins-and-outs of your existing capitalization, but having multiple people running independent models is always a good idea, to catch glitches. You want to know exactly what % of the Company your lead VC expects for their money, before agreeing to a deal.

I have seen many situations where founders get distracted by a ‘high’ valuation, but when everyone is forced to agree on hard numbers they realize that the VC’s definitions were very different from what the founder team was thinking.  This is absolutely the most crucial when you have convertible notes or SAFEs on your cap table, because how they are treated in the round will significantly influence dilution. The math is not simple. At all.

C. Understand The Exclusivity Provision – Most term sheets will have a no-shop/exclusivity provision “locking you up” for 45-60 days, the amount of time it typically takes to close a deal after signing a term sheet. This is reasonable, assuming it’s not longer than that, to protect the VC from having their terms shopped around. But it also means that if you are talking to other potential VCs, the moment one term sheet arrives, everyone else should be told (without disclosing the identity or terms of the TS you have in hand) that it’s time to put forth their terms, or end discussions. Because once signed, your job is to close the signed term sheet.

D. Focus on Long-Term Control/Influence Over Decision-Making – Thinking through the various voting thresholds, board composition, and consent requirements is extremely important. Will the board be balanced, with an ‘independent’ being the tie breaker? Then being extremely clear on who the independent is, and how they’ll be chosen, is crucial. Will one of the common directors have to be the CEO at all times? Then understanding exactly how a successor CEO will be chosen is crucial, because usually at some point it’s not a founder.

If X% of the Preferred Stock is required to approve something, then you need to know (i) what %s of the Preferred will each of your investors hold, and (ii) who will the other investors be? Usually the Company gets discretion as to what money gets added to the round apart from the lead’s money, ensuring there are multiple independent voices even within the investor base, but some VCs will throw in a provision requiring that only their own connections fund the round. That heavily influences power dynamics.

There will be many situations in the Company’s life cycle where everyone on the cap table doesn’t agree on what’s the best path for the company. Ensuring balance on all material decisions, and preventing the concentration of unilateral power, is important, and yet not simple to understand without processing terms carefully. 

E. Shorter Term Sheets are Not Better – There is debate within the VC/VC Lawyer community as to whether shorter, simpler term sheets are better than longer, more detailed ones. I fall squarely in the camp that says you should have clarity on all material terms before signing and locking yourself into exclusivity; not just the economic ones.  That means any sentences like “the Preferred Stock will have ‘customary’ protective provisions” (meaning they will have the right to block certain company actions) should be converted into an exact list of what those provisions will be. I can guarantee you your counsel’s perspective on what’s ‘customary’ is going to differ from their counsel’s.

The view among those who prefer shorter term sheets is that you should sign as soon as possible, to avoid ‘losing the deal’ (as if VC investment is that ephemeral). I don’t buy it. The moment you sign a term sheet, you are going to start racking up legal fees, and you are now bound by a no-shop/exclusivity. That means your leverage has gone down, and you are much more exposed to being pressured into unfavorable terms to simply ‘get the deal closed.’ Politely and respectfully negotiate a term sheet to make it clear what all of the core economic and control terms are. The alignment and lack of surprises on the back end is well-worth the extra time on the front end. 

In short, the core message here is know what you are signing. Make sure your VCs know that you are committed, and aren’t going to play games by shopping their terms. But also make sure you are talking to the right people to ensure that the deal you think you’re getting is in fact the one in your hands.

Why Your [Specialist] Lawyer Sucks

TL;DR Nutshell: A common complaint from startups about their law firms is that, while they like their corporate counsel, the ‘specialists’ (patent, employment, benefits, export, etc.) that they end up working with suck. The core reason for this usually has to do with the incentives of large, outdated law firms to cross-sell their poorly-fitted specialists, even when better suited alternatives can be found elsewhere.

Background Reading:

Here are some very common complaints I’ve heard from funded startup founders about their law firms:

  • The patent lawyer I got connected to knew nothing about the background technology of our product. I spent half a day explaining the basic tech/science, and frankly had to do all the legwork myself.
  • The benefits/ERISA lawyer I spoke with took me through all kinds of corner cases/issues that seem far more relevant to a large company than to my startup, when all I want is an off-the-shelf equity plan and to grant a basic employee option.
  • I e-mailed the employment law specialist they referred me to about a time-sensitive executive termination issue, and it took 5 days to get a response, and it ended up being a junior lawyer they ‘throw’ to companies at my stage.
  • My TOS needed to cover some touchy healthcare privacy issues because of the nature of our (med-tech) product, but the guy my lawyer sent me to could barely tell me the basics of HIPAA.

Specialists and Sub-Specialists

One of the most important concepts founders need to understand in interacting with lawyers is that lawyers, just like doctors, have specialties and even sub-specialties; at least the good ones do. Corporate law is a specialty. Startup/VC Law is a sub-specialty of corporate law. There are also energy-focused corporate lawyers, healthcare-focused corporate lawyers, etc. The sub-specialties available in a city mirror the types of industries that dominate the local economy. That’s why Houston startups often use Austin tech/vc lawyers, and Austin energy companies often use Houston energy lawyers.

If you work with a generalist lawyer who dabbles in a little real estate, corporate law, litigation, and maybe does a few tax returns on the side, you’re asking for a world of pain if you’re building a scale-seeking tech company. But even if you work with a general corporate lawyer, failing to work with one who focuses on technology and venture capital (sub-specialty), you will waste time and money.

In the end, it’s all about incentives. 

OK, so now you understand that depending on the issue, you need corporate, tax, patent, trademark, employment, etc. etc. specialist lawyers. The question then is: which one should you use? Large, traditional law firms (BigLaw) always have the same answer: “use ours!” Nevermind that the benefits lawyer I’m sending you to spends 95% of her time talking to billion-dollar companies and will take 10 days to respond to your itty-bitty (to her) issue. Nevermind that “my patent guy” has a BS in chemical engineering and still uses a Blackberry, and you’re trying to patent a piece of consumer hardware. Nevermind that the lawyer I just sent you to keeps (as compensation) only 20% of the $650/hr he charges you, and there are far smarter lawyers in his specialty at a boutique charging half his rate.

Two law firm concepts: “origination credit” (I make money off of the lawyers in my firm that you use) and “cross-selling” (my firm expects you to use our firm’s specialists) are at the core of why so many startups end up wasting time, energy, and money dealing with specialist lawyers who (for startups) suck; because they are either over-kill, not responsive enough, or simply unnecessarily expensive.

Ecosystem v. BigLaw

You would think that, as a startup/VC lawyer at a boutique law firm, I would always tell companies that they should avoid BigLaw and choose focused boutiques instead (the “ecosystem” I write about). You’d be wrong. No matter how much disruption occurs in healthcare, pushing medicine out of hospitals and closer to the patient, you will always need the Mayo Clinics of the world. In that sense, BigLaw still “works” very well in a very specific context, and that context is very large, complex M&A transactions and IPOs.

We regularly tell clients that, while our senior partners have closed and managed $750MM, even billion-dollar deals as partners in BigLaw, boutique firms are institutionally not designed for fast, complex, very large transactions requiring armies of lawyers and other staff who can be rapidly deployed onto a large deal. That being said, the vast majority of startups, even successful ones, will never, not even in their exit transaction, need those kinds of resources. 

Right-Sized Lawyers. 

The “max out” size of boutique firms varies with their structure and the credentials of their attorneys (particularly partners, who manage the large deals). At MEMN, we say about $400MM is where our model usually stops making sense, and we’ll even assist a client in finding successor counsel to handle that size of deal. At that point, you’re probably not worried too much about your legal bill as a proportion of the overall transaction proceeds, and the players you’re working with (particularly I-Bankers in IPOs) will often require you to use a short list of brands simply for marketing and insurance purposes.

But a $100MM acquisition? $200MM? With the right boutique corporate partners running the deal (trust me, you want real partners running your exit; read bios), and the right specialists chosen for the project, wherever they are, that is not (and has not been) a problem. The newly emerging ecosystem of top-tier boutique law firms can easily thrive while still being totally honest about its limitations. It cannot represent Uber. Uber needs BigLaw. But there are plenty of successful tech companies who aren’t Uber but still need serious legal counsel.

If you have decided that you want and need BigLaw, my completely honest suggestion to you is that you go all-in and choose one of the very small number of Silicon Valley based brands that regularly represent the tech unicorns of the world. While you will still deal with several of the “poor fit” issues that plague young startups using over-sized law firms, those firms are the most likely to at least have specialists and sub-specialists who understand issues faced by technology companies, and they at least try to work well with startups.  You’re “locked in,” but at least you’re locked into a place with lawyers who can competently address your needs.

Choosing a BigLaw firm that is not one of the top tech brands will be like going on your once-in-a-lifetime luxury off-roading trip in the mountains, and buying a $200K Ferrari for the task. Your friends (who aren’t morons) will show up in souped-up Range Rovers. If you’re going big on bling, at least do it correctly.

For the rest of the world’s founders who need serious legal counsel, but honestly don’t see themselves needing the institutional resources of BigLaw any time soon, the emerging boutique ecosystem (which is thriving outside of Silicon Valley) offers a serious answer to the “my specialist lawyers suck” problem: well-compensated, top-tier, responsive lawyers at right-sized firms, chosen not because of background economic incentives, but because they are the right lawyers for the job. 

The Fiduciary Duties of Founders

TL;DR NutshellThe moment someone is added to a startup’s cap table, founders (as majority stockholders, directors, and officers) becomes fiduciaries of that stockholder. This means that, regardless of how much control founders may have over a company, corporate governance law draws a hard line on how that control can be used. Crossing that line can result in a lawsuit.

This is one of those “core concepts” posts that, to lawyers and professional investors, will seem laughably basic; and yet the topic is something that I regularly see first-time founders get very wrong. And like most SHL posts, I’m going to explain things without referencing statutes or complicated terms. Founders need to understand the concept of Fiduciary Duties. The details they can learn from their lawyers or on-the-job.

State Corporate Law

Most Angel/VC-backed startups are Delaware corps. If they are not Delaware corps, they are usually incorporated in their home state and will be required by institutional investors to become Delaware corps if/when they ever are offered a check.  Whether you are a Delaware corp or not, your state certainly has corporate governance rules giving founders (as directors and majority stockholders) varying degrees of fiduciary responsibility to minority holders in their company. The concept is the same.

At the most fundamental level, to say that founders have fiduciary duties to their stockholders means that they cannot, without seriously risking a lawsuit, unfairly enrich themselves at the expense of other people on their cap table. They can certainly get rich by making everyone on the cap table rich; by growing the pie. But they can’t, without some kind of very credible case that it is necessary for the well-being of the entire business, improve their part of the pie at the expense of the rest of it. 

Hypothetical: Founders X and Y hired Employee A and gave her 5% of the Company that, because of some big contributions she made, was 40% fully vested on the date of issuance (meaning 2% of the Company’s equity, of her holdings, is fully vested). After a few months after the issuance, they have a big dispute and the founders fire Employee A, which they are certainly entitled to do. Under the Stock Issuance Agreement terms, 3% worth of the Company gets returned (because it wasn’t vested yet), and Employee A walks away with the 2% she had vested.

But Founders X and Y are pissed off that Employee A has that 2%. “She doesn’t deserve it. She totally ruined the product” they say. Then the light bulb switches on. “We control the Board and the stockholder vote! We’ll just dilute the hell out of her by issuing ourselves more shares!” they say.

Sorry, dudes. If it was that easy to screw minority stockholders, no one would ever invest in a company.

Delaware and other states have rules around Interested Party Transactions.”  Without getting in the weeds, Interested Party rules boil down to:

  • A Board of Directors has a duty (a fiduciary duty) to do what’s best for the company and all of its stockholders taken as a whole, without unfairly enriching its own members.
  • Any transaction in which the Board members themselves are specific beneficiaries – meaning they are getting something that others are not – is inherently suspect. It is an “Interested Party Transaction” and is open to claims by minority stockholders (the people who didn’t benefit from the transaction) that it was a fiduciary duty violation.
  • In order to “cleanse” (so-to-speak) the transaction and, in some cases, give it a safe harbor protection from lawsuits, extra steps must be followed to ensure the transaction really was fair. Those steps usually are (i) obtaining approval by the disinterested members of the Board (if any) and/or (ii) obtaining approval by the disinterested stockholders of the company. The disinterested people are the ones who aren’t getting the special benefits.

Put the above 3 bullets together, and it’s clear that Founders X and Y (i) are planning an Interested Party Transaction and (ii) without getting a “cleansing” vote of that transaction, are assuming a very serious risk of a lawsuit. If there were 5 people on the Board, and the planned dilutive issuance to X/Y was approved by the rest of the Board, then the risk profile of the transaction would be very different. Similarly, if there are other people on the cap table besides Founders X/Y and Employee A, then if their votes make up a majority of the stock not held by X/Y (the disinterested stockholders) and they approve the dilutive new stock, we’re again in much safer territory.

The key is that, in an interested party transaction, you need to get a majority of the people who aren’t getting the ‘special benefits’ to approve the deal. If you can’t, then you’re asking for pain. 

If the entire cap table is X, Y, and A, then X & Y are just asking for trouble and (frankly) deluding themselves by thinking that they can dilute A (without her consent) in a legally air-tight manner. I’ve seen founders throw out a phrase like “let’s just do a recap” (short for recapitalization) as if recaps are a magical get-out-of-fiduciary-duties card. I think that idea was spread by ‘The Social Network,’ but I’m not entirely sure. Recaps are complicated, and you still have to worry about fiduciary duties to get them done properly.

Corporate Governance is Real

The overarching umbrella of the rules, processes, etc. that govern how corporate directors and officers interact with stockholders is called ‘corporate governance.’ Founders sometimes think it’s all silliness reserved for when they go IPO, but it’s not. From Day 1, corporate governance matters. Yes, it becomes more formalized as you grow as a company and the stakes get higher, but it’s the same rules at Seed v. at Series D, just being applied differently. You better believe it matters the moment a VC is on your cap table.

Fiduciary duties do not mean that you always have to do what your minority stockholders want. That would be impossible. It just means that, as a director/officer, you have to do what’s best for the Company (the whole pie), and not just for yourself. If there’s a financing coming up that some of your stockholders don’t like, you should be safe if disinterested parties approve it as something that is the best move for the entire company. I say should, because the rules, the process, and even the language in your board resolutions matter. They can be (and often are) the difference between moving forward knowing that your decisions can’t be challenged v. handing disgruntled stockholders a loaded gun to use against you when you least want them to.

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.

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.