Lessons from Elon Musk (Mistakes) for Startup Governance

Thou shalt have no other gods before Me.” – The 1st Commandment

This post is going to discuss certain high-stakes financial happenings with one of the great heroes of the Startup / Tech Ecosystem of recent decades, and indeed someone I deeply admire for his technical acumen (political opinions are more hit and miss): Elon Musk. Depending on your orientation, I might even be called a “fanboi” at times. I am particularly a big fan of his achievements at Tesla and SpaceX, as well as his efforts (however imperfect and ham-fisted) to reorient X fka Twitter toward a more free speech philosophy.

Elon Musk had his hand slapped big time by Delaware courts, having his >$50 billion Tesla compensation package annulled for lack of appropriate Board governance and process. He is now very angry and campaigning to have Delaware dethroned as the international destination of choice for corporate law. His view is that Delaware has treated him unfairly by overriding the choices Tesla’s Board, clearly controlled by him, chose with respect to determining Elon’s compensation package.

On numerous occasions I’ve heard Elon referred to, particularly among startup players, as a “god.” That is understandable, because his technical and business talents certainly get close to once-in-a-generation ultra ultra elite level. An apex Navy Seal of an entrepreneur.

For that reason, I included the 1st commandment above. Completely putting aside actual religious theology, the more intellectualized interpretation of the 1st commandment goes something like this: do not deify – in the sense of treating as infallible and therefore worthy of worship, even absolute power – something or someone that doesn’t deserve it; which is to say no one and nothing deserves complete worship like “God.” Everything and everyone, no matter how good in a particular context or domain, has limits and points beyond which they need to be constrained, lest very bad things begin to happen. Inarguably (I think) good advice.

As someone who’s worked for over a decade in various startup ecosystems, watching numerous companies rise and fall (for all kinds of reasons) either up close or from various distances, I’ve come to analogize entrepreneurial energy to something like uranium, gasoline, or the sun. All highly concentrated, tremendously powerful sources of energy. The core drivers of the economy. Immensely valuable and important.

And yet, used in the wrong way, without appropriate processes, checks and balances, they kill and destroy: explosions, cancer, apocalyptic painful fire. It takes an appropriate system to channel that energy into something productive and valuable. Our sources of entrepreneurial energy deserve tremendous respect and freedom – something which American culture is uniquely good at, but they’re not gods. They too need constraints, or they’ll kill us.

Notice the word system in the term startup ecosystem. What has turned the world of American venture-backed startups into an economic powerhouse that is envied by the world is not, and never has been, simply bowing to entrepreneurs wholesale, giving them 100% unconstrained power to build whatever and however they see fit. The actual startup ecosystem has never deified genius entrepreneurs. Instead, it has placed their energy and talent within a dynamic, evolving system of independent forces, each with their own guiding principles and incentives, that shapes and channels that energy into world-changing enterprises.

Professional venture capitalists – not the unbundled dumb money funds swirling the ecosystem in recent years but actual professionals with deep networks and expertise about startup and growth playbooks – are one example of a countervailing force on entrepreneurs. You will hear propaganda in the market suggesting that all VCs are useless and just waste time beyond their willingness to write checks, but this is patently and obviously false from even a half-hearted review of the history. Numerous household names in tech were deeply shaped by elite VCs coaching, guiding, and even constraining entrepreneurs when experienced judgment suggested doing so was necessary to keep the energy flowing in a productive direction.

That is not to overstate the role elite VCs have played in the ecosystem. They too are not gods, and absolutely need their own constraints and monitoring to avoid excesses. But they are a valuable and necessary part of the system that shapes entrepreneurial energy into our elite economy.

Other not-quite revered but still important forces in the ecosystem include lawyers – representatives of the democratic and court-determined legal system for protecting and aligning interests in a high-stakes economy of diverse players – and accountants (auditors) also play an important role. Employees as well. Accelerators, despite their overall decline, are also worth mentioning even if fundamentally they are just VCs of a particular flavor.

The startup ecosystem as we know it is built by setting these players – these forces – to interact, engage, and when appropriate constrain each other. Imagine a weather system with different forces constantly swirling around and engaging, pushing and pulling, mixing and unmixing. That’s kind of how an entrepreneurial ecosystem works. No single force – yes, not even ultra elite entrepreneurs – is so universally good and important that it should completely override all the other forces that have proven themselves time and time again as essential toward channeling all the energy toward a constructive, durable outcome.

Over centralizing such a dynamic ecosystem, allowing one set of forces to take over another, weakening the checks and balances, is usually bad for the market as a whole. One example of this would be venture capitalists controlling the lawyers who advise companies, biasing their advice on conflicted high-stakes issues. I’ve written about this quite a bit. Another example would be businesses hiring sycophants as legal advisors or accountants to misinterpret or misstate laws or financials, denying the open market the transparency and protections that the system has evolved to provide. We see this quite often as well.

The fact of the matter is that Elon had a kind of kangaroo Board of Directors, including his own divorce lawyer, his brother, and supposed “independent” directors who in fact owed much of their wealth to Elon and even vacationed with him; something which may seem innocuous in smaller cases but is material when the executive in question is one of the world’s wealthiest people and can fund some really nice vacations.

Thus when Elon’s compensation package and the process for determining it were reviewed, it was a joke. Amateur hour of the highest order, inappropriate for a Series B startup let alone a public company like Tesla. There was not even a feigned attempt at a professional process. Elon thought himself a god who didn’t need to listen to the legal system or lawyers. The Delaware Chancery Court, a global force in corporate law with tremendous gravitation pull, just gave him a reality check.

While Elon is understandably not happy about that, in the bigger picture it actually reinforces why the American business economy – and Delaware law specifically – is so respected internationally. Nothing says “rule of law” (music to the ears of high-stakes economic players entrusting enormous amounts of money to complex governance systems) like overriding the (in this case arrogant) wishes of the wealthiest person on earth to enforce the rules.

To be very clear, this is not to say that laws are all important. Sometimes laws should be changed, even fudged. Uber is a great example of a company that thoughtfully broke some laws in order to improve them. Incidentally, it’s also an example of an entrepreneur ultimately getting out of hand and smart VCs + lawyers playing a constructive role to get the business back on track.

Laws are, in many respects, like speed limits. We can always assume they’re going to be fudged on the margins, and yet where you set them still plays an important role for determining how far the fudging goes. Elon clearly went too far, pushing (metaphorically) 150mph in a 75 zone. However special of a person he may be, and however important his achievements, there is always a point at which the system simply cannot tolerate anyone setting such reckless behavior as an example.

The lessons here for startup governance are straightforward. Legal advisors should not be sycophants – they should not be beholden to the VCs or the entrepreneurs wholesale. The most aggressive players on either side of the table will very often try to hire gladhander advisors so desperate for the work that they’ll rubberstamp whatever, and yet somehow independent professionals with actual backbones need to be allowed into the room.

Founders sometimes misinterpret my writings about corporate governance and “independent” company counsel as suggesting that I’m going to just be a founder CEO’s lap dog. Being independent from the VC’s so that company counsel can properly represent the common stock as a constituency is not the exact same thing as working for a particular founder.

Independent directors should be meaningfully independent, not the CEO’s or the VC’s BFF. Credible processes for setting very high-stakes compensation matter. And no, simply getting a fragmented stockholder vote at the end to “cleanse” an otherwise horrible process is unlikely to be sufficient, particularly in cases fraught with time constraints, information asymmetries, and coordination problems among the stockholders.

This is also not to say that Elon did not deserve to be extremely handsomely rewarded for his spectacular performance as Tesla’s leader. I’m sure his compensation will still be very very juicy. It just means that even Elon should have respected the process – the system – in which he was operating. He chose not to, and the system pushed back in a language that, short of imprisonment, even someone like Elon can definitely read and learn to respect: lots and lots of money lost. That kind of pushback is exactly what ecosystems must do in order to stay durable, dynamic, and not beholden to any single fallible, imperfect, definitely not a god player.

Corporate governance isn’t everything, but it matters, requiring constant monitoring and calibration to prevent conflict, collusion, and corruption. It has proven itself to serve a very important function in the startup ecosystem. Take it seriously, even if you’re an aspiring Elon Musk.

The (Real) Problem with Carta for Startups

TL;DR: Carta has forever sold itself as friction-reducing “infrastructure” for the startup ecosystem. What this recent debacle around shady secondary sales pitches reveals is that “reducing friction” often comes at a cost of over-centralizing the market. We need to think more broadly about whether keeping the startup ecosystem a bit more decentralized, even if that may seem “inefficient,” is actually a net positive in terms of trust and security for startups.

Carta, the cap table tool and self-proclaimed “infrastructure” for startup ecosystems, was all over the news recently in startup circles, because of the following:

In short, it appears that sales people for Carta’s secondary liquidity platform (for selling early startup shares to interested later-stage investors) were accessing cap table data, including investor contact info, of startups using Carta and directly pitching investors as to liquidity opportunities – all without (importantly) the knowledge of CEOs or Boards. A clever (in a mercenary sense) revenue-building strategy, but a spectacular breach of trust. No CEO or Board wants to be worrying about potential huge shifts in their cap table because their cap table software is out trying to get their angels/seed investors to sell their shares.

After a lot of back-and-forth, including some peculiarly aggressive accusations by its CEO, Carta eventually decided to exit the secondary market entirely; a smart move in my opinion even if it’s criticized by some as too reactive. 

What I want to write about on this post is that this whole debacle reveals something concerning about Carta’s long-stated aspirations as it relates to the startup ecosystem. What does it really mean when Carta repeatedly states that it wants to become foundational “infrastructure” for startup equity, and that it seeks to reduce “friction” in startup equity markets? Being a great cap table tool – what Carta originally was – has always been an obvious positive for startups, even if Carta has repeatedly been criticized for being overpriced and too complicated and has since started receiving more heated competition from leaner alternatives; particularly Pulley.

But should founders, VCs, and other startup ecosystem players actually want a centralizing tool to maximally unify the ecosystem and reduce so-called “friction,” as Carta has repeatedly pursued, or is there something about the decentralized nature of the startup market that is actually good? Is it possible that some “friction” in how the startup ecosystem functions is desirable and positive for founders and startups?

Analogies to the decentralization philosophy of crypto, and perhaps also open source software, are appropriate here. Crypto gets lambasted for all the energy that is expended in maintaining blockchains, but the regular response is that “inefficiency” is worth the added security of not having any centralized node that market participants need to trust to behave “nicely.” Friction is a price that is sometimes worth paying in high-stakes situations where trust and security are paramount.

You see similar concerns when discussing proprietary v. open source approaches to various forms of software and hardware. Yes, there is some benefit in some contexts to relying on proprietary “infrastructure” – scale economies, data aggregation, etc. – but obviously concerns about monopolistic rent extraction loom large and very often push markets toward decentralized or even open source standards.

I’ve raised my own concerns about conflicts and interest in startup ecosystems, when self-interested players with broad brands pretend to be helping founders but are in fact using their market power to effectively extract rent from the market. For example, I wrote about how YC’s Post-Money SAFE is actually a horrible instrument (economically) for many startups, and many founders don’t get advised about how to make its terms more balanced. YC has made a ton of money from pushing the Post-Money SAFE as a “standard.”

But the selling point of YC’s templates has always been “efficiency” and “reducing friction.” Again, we see a trade-off: trusting a self-interested party (in this case an influential investor) to set so-called “standards” may in some sense reduce “friction,” but the cost of that friction reduction is significantly more dilution to startup founders. Friction reduction, and trusting a centralized party to provide it, is not a free lunch. We need to assess the full costs before determining that it’s actually a good idea.

I’ve advocated for a more open source approach to startup financing templates, where we don’t pretend anything is a “standard” that shouldn’t be negotiated, but still allow for a github-like repository of well-known starting points for negotiation. This allows for some measured benefit of standardization, while maintaining decentralized adversarial players who negotiate and ensure each deal truly makes sense for the context.

I’m also an advocate for open source cap table templates. I think automated cap table tools have over-sold themselves, particularly at the earliest stages, and founders would be wise to understand that Excel is perfectly fine (and free) until perhaps Series A, or at least post-Seed.

I’ve also written about the tendency for startup law firms to flout conflicts of interest with the VC community. They’ll build deep relationships with VCs, while parlaying those relationships into representing the companies those same VCs invest in. The founders are often told that these counsel<>investor ties will “help” them – it will reduce “friction” because the lawyers know the VCs well – but it’s complete nonsense and even contradictory to the entire point behind rules around conflicts of interest in law.

You simply can’t trust lawyers to advise you properly in negotiating with a VC if that same VC regularly sends work to those same lawyers. This is why we designed Optimal to be a company-focused firm, and we regularly turn down VCs who ask to work with us. That has a cost in terms of limiting our revenue opportunities, but not unlike Carta’s decision to exit secondaries, it’s about preserving client trust. It’s a bet that the market needs and wants a player, in our case a law firm, offering trusted advocacy above what more conflicted players can provide.

All of this suggests that friction, though sometimes spoken of exclusively in negative terms, often serves a purpose. Negotiation is friction. Diligence (including of a VC’s reputation) is friction. Competition and independent review (even if redundant) is friction. Having multiple sets of advisors representing different parties instead of everyone mindlessly trusting one conflicted group is friction. Assessed holistically, sometimes friction is worth it when interests are fundamentally misaligned. 

So my advice as a VC lawyer watching how this has all played out with Carta is: the outcome here is good. It’s good that the ecosystem spoke its voice, and Carta acknowledged a fundamental problem with its business model. But let’s not miss the much broader lesson here as it relates to the many other situations in which some influential ecosystem player will promise startups “less friction” in exchange for trusting them perhaps far more than they really deserve.

I like Carta as a cap table tool, even if I think it needs to simplify itself and lower costs. I am, and have been, much more deeply skeptical of Carta as centralized “infrastructure” for the entire startup ecosystem, promising all of these wonderful benefits so long as we trust it with enormous amounts of power and data. This most recent debacle (I think) shows why others should be a bit more skeptical too.

Why BigLaw Over-Automates Startup Law

TL;DR: BigLaw’s very high operating costs require it to charge 3-4x of what its typical lawyers actually earn. This makes rates often stratospherically high. While billion-dollar companies that use BigLaw can afford those rates, early-stage startups often cannot. BigLaw is responding at times by hyper-standardizing and hyper-automating early-stage work. This has significant downsides, as companies lose out on flexibility, advocacy, and strategic guidance for very high impact projects, like financings. Much of this standardization ends up favoring VCs over startup teams. Elite lean boutique law firms offer an alternative approach, in which lower overhead allows for lower costs without requiring substantial inflexibility. In the end, this trend toward over-automation is leading many clients and lawyers to balk, and alternative approaches for achieving efficiency (while remaining flexible) are rightfully emerging.

Lawyers are not cheap. Elite lawyers – the kind with very extensive top-tier training, experience, and ability to handle high-stakes complexity – are in fact quite expensive.

Then again, elite human talent of all sorts is quite expensive. Top doctors make over half a million a year. Top software developers can make into the millions, and their “bugs” are much more easily corrected than bugs in contracts; which by design often can’t be “fixed” once they are signed.

I candidly find it amusing when “tech people” criticize elite lawyers for the amounts they earn, given what similarly elite talent in other industries (tech included) makes. If you’re expecting an apology, it’s going to be a while.

That being said, criticizing what people earn is not the same thing as criticizing what firms charge. There are in fact quite a few firms in “BigLaw,” including those who work with startups, where a lawyer charging over $1,000 an hour is in fact earning only a small fraction of that, maybe $200 or $250. “The beast” (the bloated institution) absorbs the rest. That, in my opinion as a leader of an elite lean boutique firm precisely designed to address this problem, is a very valid criticism.

Traditional elite law firms in “BigLaw” have virtually all designed themselves, with minor variances, around a similar high-overhead business model. They charge 3-4x+ what their typical lawyers are actually earning. That overhead pays for extremely posh offices designed to signal “prestige,” armies of non-lawyer staff, lavish events and other programming, as well as a small cadre of equity partners who absorb millions, sometimes tens of millions, in profits every year per partner without doing much of the actual billing.

The fact that BigLaw has entrenched itself in this way of doing legal business makes it very difficult, even impossible, to meaningfully address “efficiency” at an institutional level. It would require sacrificing too many sacred cows with political leverage in the firms’ bureaucracies. Thus when BigLaw does try to do something to become more efficient, or at least appear more efficient, its options are constrained. One option that is always on the table is adopting (often pricey) automation software, because it ostensibly allows charging less without actually having to do human legal work (contextual, flexible, strategic) any more efficiently.

Don’t deliver more efficient lawyers. Instead, make clients use dumbed-down, inflexible, and often quite clunky software. They can talk to professionals only once they can afford $900/hr for an associate and $1400/hr for a partner.

I’ve written about this issue before, such as in Vaporware Technology Won’t Hide Your Firm’s Business Model Problems (on Above the Law). Lean elite boutique law firms are about what I call substractive innovation. Finding efficiency by removing unnecessary (for clients) costs, and re-designing a firm’s operations around that leaner operating model. Yes, this does involve technology, but a particular kind of technology meant to replace unneeded overhead and traditional processes; not to simply layer on new software without otherwise changing much at all about the firm itself.

BigLaw, for the above reasons, is usually incapable of this kind of innovation. It virtually always leans more towards additive so-called “innovation” – buying more and more things that purportedly bring efficiency.

Tying this all together. BigLaw – which in 99.9% of cases works with billion-dollar multinational high-stakes projects for whom charging over $1,000 an hour is not a budget problem – has to charge a lot for its lawyers. 3-4x what those lawyers actually earn. The portion of BigLaw that actually touches early-stage startups – 0.1% of what BigLaw as a whole category really does – faces a problem. Early startups are not billion-dollar multi-national entities.

That’s a big constraint on what BigLaw as it relates to startups can really charge. Startups are constantly balking at what they are charged by BigLaw. The way some of BigLaw is addressing this is by removing their elite lawyers almost entirely from that segment of work. Automation – I would say over automation – combined with what is often called in industry circles “de-skilling” (delegating to lower-level staff).

BigLaw is thus heavily incentivized to over-automate Startup Law. As I’ve written before in many contexts, automation in law is not a free lunch. Not even close. It relies on heavy standardization and inflexibility for it to be workable at all. The problem is that a lot of what founders ask lawyers to do in early-stage Startup Law is extremely high-stakes from a financial perspective. Even minor tweaks to language in docs can have 8 to 10+ figure implications. We are not talking about parking tickets or coffee shops.

The extremely myopic way in which pockets of Silicon Valley have over-adopted YC’s Post-Money SAFE is a perfect example of this. Only now are many founders coming to realize how much of an “own goal” it was to let YC pretend their terms were founder friendly and “efficient.” In that article I show how literally adding a single sentence to the Post-Money SAFE can have tens of millions of dollars in improved economics for founders, and yet the vast majority of so-called “efficient” automated startup financing tools to do not allow for this tweak. People are pretending they are saving founders money. What they are really doing is “saving” a few hundred dollars (at most) in legal fees while letting VCs (including YC) take millions from startup teams.

There are countless ways in which over-standardization and over-automation in Startup Law are costing startups and founders enormous amounts of money. Every attempt to create a so-called “standard” term sheet for equity rounds ends up with VC-favorable economic and power terms that simply are in no way, shape, or form a universal “standard.” See also Standardization v. Flexibility in Startup Law.

Because VCs (and accelerators) are “repeat players,” whereas individual founding teams are not, they have the market leverage to heavily bias so-called “standards” in their favor. And the software companies intending to profit from all of this legal hyper-automation are happy to help them in the process. I wrote about the outsized leverage and influence that repeat players have in startup ecosystems, including over many law firms, in Relationships and Power in Startup Ecosystems.

These automated financing software companies – who need law to become hyper-standardized so that they can ever-so-generously step in to charge for the automation – are heavily incentivized to publish biased “data” about so-called “standards.” For example, they’ll build a software tool offering only 2 or 3 ways to do a seed funding, all heavily standardized and therefore inflexible. They’ll market this tool, and then publish data saying things like, “80% of seed deals are Post-Money SAFEs, and so it is a standard.” Actually (if you read the footnotes), 80% of seed deals on your half-baked automated platform are Post-Money SAFEs. Selection bias. That is not the same thing as saying 80% of all seed deals in the country or world are.

These tools are lying with so-called “data” to promote their own wares. For that, who can really blame them? Everyone’s got to make a buck. But let’s please stop pretending that they actually care about what’s best for startups, or their founders and employees. I don’t criticize people for talking their book. I criticize people for pretending to be far more benevolent and selfless than they really are.

Lawyers should be telling startups and their founders whenever they are facing these sorts of issues. They should be telling founders that the Post-Money SAFE is not a universal standard, and that many many deals end up customized, or even with entirely different structures, to make the economics better. They should be negotiating term sheets to better position the governance of their client, instead of letting some VC dictate what “standard” means. Instead, many of them are over-standardizing and over-automating. Why? Because they’re in BigLaw, and that’s what BigLaw does for startups.

Because of its institutional inability to actually do human legal work more efficiently (see above paragraphs), which involves assessing context, negotiating, tweaking, advising, etc., and the fact that Startups cannot pay over $1,000 per hour for extensive advisory, much of BigLaw is choosing to delegate the entirety of early-stage startup law to software. In my opinion, this is an abdication of the responsibility of lawyers to actually advise their clients as to what is best for them. If I were a paranoid BigLaw lawyer, I’d at least worry a little about the malpractice implications of practicing law this way.

On top of the fact that this is not actually in the best interests of startups or their stockholders, many lawyers are themselves starting to balk at the machine-like evolution of BigLaw’s way of operating. Boutique law firms, where the ratio of billed rates to lawyer earnings is more like 2x instead of BigLaw’s 3-4x (dramatic efficiency) are not just about lower rates. In many segments they are emerging as refuges for lawyers who want to step off the assembly line and actually think for their job.

When lawyers are able to charge, say, $500 per hour instead of $1100, they have time to actually negotiate for their clients. On top of this being good for the client (See: Negotiation is Relationship Building), from an intellectual standpoint it’s legitimately more enjoyable. Many ECVC lawyers prefer this way of practice over acting as if every deal before Series B should just be a cookie-cutter template.

The elite boutique law ecosystem (of which Optimal is a part) is thus emerging as a win-win countertrend to BigLaw’s tendency to over-automate and over-standardize. Many elite lawyers are tired of half-baked over-technologized (air quotes) “efficiency” that isn’t really efficient at all because of what the client loses. In moving to boutiques, lawyers get to drop their rates substantially without actually earning less. Clients get to pay substantially lower rates, while getting an actual elite human professional to help them navigate complexities and protect themselves; which many prefer over clicking a few buttons on software without ever being told what their options really were.

To summarize: the traditional cost structures of BigLaw require charging 3-4x+ of what their typical lawyers actually earn. This makes their rates, including for startups, extraordinarily high. Above $1,000 per hour in many cases. Sometimes $2,000+ per hour. Startup clients, who do not fit the billion-dollar mold of BigLaw’s average client, obviously cannot afford stratospheric legal bills. BigLaw is responding by accepting hyper-standardization and hyper-automation for its earliest stage work. Clients spend more and more time interacting with junior professionals and software that operate only in very narrow, inflexible lanes; depriving clients of real advocacy or negotiation on high-stakes issues. As a result of all this, inexperienced startup teams are increasingly pushed into these myopic inflexible fundraising approaches that are costing them enormous amounts of money and governance leverage.

There are ways to avoid this problem. The one I’m obviously an advocate for is to move a lot of this legal work to leaner elite boutiques. Some of the top boutiques in ECVC can deliver real legal horse power, especially in earlier-stage deals (pre-unicorn), at half the rates of BigLaw.

There’s another option: if you absolutely are going to use BigLaw, let them charge you for what the work really takes. Why pay BigLaw at all if you’re not using the real legal talent it is designed to house? If you’re raising a $75 million equity round, yeah, you’re going to pay a few hundred thousand dollars in legal fees with BigLaw if you let them actually do their job. As a percentage of the actual raise, it’s really not that much (under 1%). The alternative – over-automation and over-standardization – will be far worse.

If that doesn’t work for a $5 million or $15 million round, then again I suggest looking into elite boutiques. Their lower rates, but still elite rosters, will produce lower legal bills without compromising on the quality of the actual advisory you’re getting. See How Much Seed Rounds Cost – Lowering Fees and Expenses Safely to understand why boutique law is an increasingly popular option among top startup teams for earlier financing rounds. Boutiques are not doing pre-seed deals all day. We have clients closing Series A, B, C, even later, and exiting at 8-9-figure valuations. As I often say, the B in BigLaw is for billions. There’s a lot that happens before billions.

Straw-man prevention disclaimer – Let me be very clear here. I am not just a Partner at Optimal. I am also its Chief Technology Officer. I work with a lot of legal tech startups. I love legal tech, and I even like targeted, thoughtful automation. I’m particularly interested in upcoming ways to integrate AI to enhance lawyers’ productivity.

Some people with very loud microphones like to pretend that the legal profession is full of nothing but luddites who want to milk the entire world for fully bespoke, terribly inefficient work product. In startup ecosystems, this attitude is most often peddled by (i) VCs who want your lawyers to shut up, because when lawyers shut up VCs get what they want, and (ii) software automation tools; because they want you to use their inflexible software instead of an actual human.

What I am advocating for here is a more balanced perspective on when automation really is in the best interests of legal clients, and really is streamlining things, relative to when it is hiding all sorts of biases and costs because the real driver isn’t what’s best for the client but some extraneous factor like institutional constraints. I’m a big fan of automating basic option grants, which no serious professional wants to waste their time on anyway. But raising millions or tens of millions of dollars, and setting permanent power & governance terms that will influence huge segments of the modern economy? Hold the F up.

As I wrote here, the “values” of the legal industry and the software industry are very different, and both serve a very important purpose in the economy. In legal, it’s expertise, context, flexibility, negotiation, leverage, compromise, trusted advocacy. It’s about having a perspective, and pushing for it, while the other side does the same.

There can be no single answer or “standard” in this value structure, because the decision-makers and process for setting it are suspect, as conflicts of interest and subjectivity abound. Companies are different. Investors are different. Goals, industries, values all vary organically across institutions and contexts. It’s contextual “truth” arrived at via a decentralized adversarial process, as opposed to a centralized proprietary one. This concept is not entirely alien to many engineers.

In software, it’s broadly about standardizing, automating, universalizing, cutting costs and centralizing data. It’s about scale and speed, reducing “friction.” In this worldview, customization and “verification” via independent review is seen as inefficient and pointless. But is it always? When the stakes are really high?

Analogies about making private startup equity operate like “frictionless” liquid public markets are spectacularly flawed. In the latter, the transactions are impacting small percentages of the company’s capitalization, and rarely altering their fundamental governance. What happens in a startup’s earliest days sets the stage for the company’s entire growth. The present dollar value may be small, but the derivative long-term impact is massive. Post-IPO, very little of what’s being negotiated fundamentally changes anything.

Nowhere am I saying here that the legal industry’s values should take full precedence over those of the software industry. Again, I’m a big fan of productivity tools in legal. We just need to avoid myopia in letting the software industry’s values (automation, standardization) steamroll over legal’s as it relates to high-stakes legal work simply because clients think (wrongly) that they have to use BigLaw, and BigLaw can’t make its actual lawyers cheaper. Automation and standardization can be good. Automating and standardizing everything, because we won’t consider alternative possibilities for achieving efficiency, most certainly is not.

The Open Startup Pro-Forma Capitalization Model

TL;DR: In the earliest stages of a startup, paying for a proprietary cap table tool, or simply dealing with the hassle of a 3rd-party intermediary software layer for modeling your capitalization, is not really necessary. We’re publishing the Open Startup Model, an Excel-based “open source” cap table and pro-forma that startups and their lawyers or other experienced advisors (if they don’t already have their own tools) can use for free. It’s based on the pro-forma structure we’ve used for hundreds of deals, and is flexible, editable and auditable.

Background reading:

In the beginning, there was Microsoft Excel, and it was good (enough).

For decades, startup cap tables and pro-forma financing models were maintained on Excel. It wasn’t perfect (nothing is), but it worked well enough. Then as the ecosystem matured, we saw the emergence of specialized cap table software, like Carta (pricier incumbent) and Pulley (leaner alternative). These tools make a lot of sense at moderate (not low) levels of cap table complexity – based on our experience at Optimal, typically around Series A or post-Seed.

But somewhere along the way some founders got the impression that these tools might be needed as early as the incorporation of the company, when there are only a handful of people on the cap table. The argument, certainly made by the cap table software vendors themselves, is that Excel is too clunky, and too error-prone. There is also a land grab dynamic here, in that it isn’t necessarily profitable for these tools to have tons of very small companies on them, but they have to build super early-stage offerings to prevent their competitors from owning the pipeline. There’s no simple way for the tools to agree to leave young companies alone, so we get these silly value-destroying attempts to onboard everyone.

All of this is, candidly, nonsense. I’ve seen seed-stage companies spending thousands of dollars a year and getting absolutely nothing extra of value that they couldn’t get from a basic excel spreadsheet maintained by someone moderately competent.

What makes old-school Microsoft Excel a still-used tool in startup finance is its flexibility, auditability, simplicity, and affordability (free, essentially). It’s really only once you’ve crossed about 20 cap table stakeholders that in our experience, as counsel to hundreds of VC-backed companies, a third-party tool starts to make sense. Before then, I often see more mistakes when founders try to use an inflexible outside tool than when they simply collaborate with a sharp outside advisor to keep things clean and simple on a spreadsheet.

That being said, one thing that has happened is the complexity of seed funding instruments has grown over time. See the Seed Round Template Library and Seed Round Educational Articles.

In the really early days, before the entire seed ecosystem even existed, most financing was in equity rounds. But as the SaaS revolution got started, financings both shrunk in size and exploded in volume, with equity rounds no longer making sense in many cases. So we got seed-stage convertible notes. Then we got notes with pre-money valuation caps, discounts, or both. Then you got pre-money SAFEs. Then you got post-money SAFEs, and various flavors of them. Then you got post-money convertible notes. Time-based discounts and caps. Milestone-based caps. Don’t forget friends & family SAFEs, which are slightly different. Oh, and let’s not forget seed equity v. NVCA equity. Even within these categories there are various nuances and flavors.

It is not surprising to us at all that the ecosystem has resisted all attempts to hyper-standardize fundraising instruments, notwithstanding the valiant (even if self-interested) attempts by high-profile VCs or software tools to centralize all fundraising terms. This reflects the decentralized reality of the startup ecosystem. Startups are not uniform commodities, nor are their investors. In the latter category, think of bootstrapping, friends and family, angels, super angels, angel syndicates, pre-seed funds, seed funds, family offices, crowdfunding, accelerators, VCs with seed fund arms, strategic investors.

Couple that organic diversity on the investor side with the extremely diverse industries, business models, geographies, team compositions and cultures, risk tolerances, and exit expectations of startup companies. Do we really expect all of these sophisticated business people playing with millions and tens of millions of dollars, gunning for hundreds of millions to billions, to fit into one or two template financing structures because some VC, accelerator, or cap table software says they should? Because of some childish aversion to actually reading a contract and tweaking a few terms?

The only people misguidedly trying to hyper-standardize this complex ecosystem are (i) specific VCs who profit from controlling terms, with their preferred templates, and (ii) specific software companies (often funded by the aforementioned VCs) who want to build some centralized proprietary tool on which all startup financing would at some point become dependent (surely with juicy margins to them as a result). Neither of these types of rent-seeking gatekeepers are looking out for the ecosystem itself, and its diversity of preferences and priorities; certainly not for entrepreneurs. They’re looking out for themselves (for which, as market actors, I don’t fault them).

Many entrepreneurs and startup teams in particular have lost huge amounts of equity and money by being misled into signing inflexible contracts that they thought were “standard,” but really aren’t. The smallest bit of tweaking and negotiation can produce enormous differences in financial outcomes.

Given the diversity of businesses and investors in the startup ecosystem, which inevitably leads to a diversity of funding instruments, flexibility of any viable wide-reaching startup capitalization model is key. That’s why MS Excel still matters, because of how flexible it is. Flexible and transparently auditable in the way that open source code is flexible; and proprietary “no code” tools are not.

Led by a Partner colleague of mine, Jay Buchanan, we’ve published the Open Startup Model. Free, Excel-based, flexibly customizable and auditable, even “forkable” if others want to iterate on it. “Open Source” effectively. It’s based on the same model we’ve used hundreds of times at Optimal, with clients backed by elite VCs like a16z, Sequoia, Accel, Khosla etc. and dozens of “long tail” funds across the world as well. It works from the formation of the company through Series A (or a Series Seed equity round).

Jay will be writing periodically at OpenStartupModel.com, with info on how to take better advantage of it. Just like open source code isn’t intended to be handled by untrained end-users, this model is not intended to be entirely self-serve by founders. We are modeling very high-stakes and complex economics here. Rather, it’s meant to be a potential starting and focal point for various experienced market participants (including lawyers) to work with founders on.

Just as we are big believers in the thoughtful integration of elite legal industry values and lean tech values, we think an “open” startup ecosystem, with its enormous organic diversity of market players, is far healthier and more sustainable than misguided attempts to centralize everything behind a handful of rigid proprietary structures and tools. An open pro-forma model, together with our open-source contract templates that we’ve published here on SHL, is part of that vision.

In that vision, it’s not necessary that dozens of different actors come to agree on some “standard.” These templates and models will look extremely recognizable to all the serious law firms and other key players in the market. That alone saves time if startups or lawyers want to use them, and as institutions get more “reps,” efficiencies follow as institutional knowledge is gained.

We hope everyone – founders, lawyers, investors – will find this helpful, and welcome any feedback on improving it; particularly if “bugs” are found. As a final legal tech tip for lawyers, the ability to redline excel models, much like how you redline contracts, is super important and improves efficiency in reviewing model changes. Litera Compare is our favorite redlining tool for excel files.

As a separate tip for startup founders, if you need a 409A valuation, but don’t want to pay extra for a third-party cap table tool (because Excel is fine for now), Eqvista and Scalar have lean 409A-only (no extra software) offerings.  Some seed-stage companies go this route, combining Excel and a 409A valuation without the extra bells and whistles of the pricier cap table tools, until their cap table has grown more complex (typically post-Series A).

Finally, once you get to the point of needing to onboard to Carta or Pulley (if you’re successful, you will get there eventually), the following may be helpful for saving on their costs.

Legal Tech for Startup Lawyers: Deal Closing Software

TL;DR: Deal closing software for collecting and tracking signatures, then compiling closing sets, is a great legal tech category for law firms to streamline administrative tasks on deals, saving clients money and time. Based on my research of the available options in adopting legal tech for our own elite boutique firm (Optimal Counsel), Closing Folders and Litera Transact are the closing tools that other firms should take a look at. Bigger picture, law firms need to think deeply about the proper balance of legal industry values (flexibility, advocacy) v. tech industry values (speed, standardization) as new legal tech hits the market. There are potentially serious negative consequences for companies (clients) if we thoughtlessly let one industry’s values dominate the other.

After publishing How Much Seed Rounds Cost – Lowering Fees and Expenses Safely, which ended up getting way more traction than expected, a number of lawyers from other firms reached out to me politely asking for recommendations as to what tools we use at Optimal for streamlining administrative tasks on deals. I sometimes forget that, even though this blog is targeted toward founders, quite a few lawyers and firms in the industry follow SHL as well. I also occasionally hear from law schools planning their course curricula.

Given that our firm is built around a thoughtful balance of blending lean legal tech with elite lawyers, I can understand other players in the industry looking to us for recommendations. My view has always been that the “optimal” blend of legal and tech ensures that the core values of neither industry get shoved down the throats of clients; who ultimately should be the ones getting better served. Rather, it’s about balancing the positives of both, while counteracting their negative tendencies.

Balancing Legal and Tech Industry Values

Key values of the elite tier of the legal industry are flexibility and trusted advocacy for a client, and (in the case of startups) a client led by executives (founders) often at a substantial informational disadvantage relative to players they are negotiating with. See Negotiation is Relationship Building for a deep-dive on just how much founders and startup teams lose when trusted and experienced legal counsel is pushed out of the picture by misaligned market players who profit from displacing lawyers at the negotiation table.

Legal: Trusted, Flexible Strategic Advocacy with Professional Liability

Having a relationship with a highly experienced and trusted senior lawyer, without ties to your investors, is one of the best “equalizers” for founding teams navigating the fog of an opaque market full of much more experienced players. Unlike regular vendors of services and tools, lawyers have professional ethical obligations to their clients, as skilled fiduciaries advocating for their interests. Paying for counsel is not just paying for a neutral product or service, it’s paying for an experienced advocate reviewing terms and negotiating specifically for your team’s context and priorities.

The downside tendencies of the legal industry are, for some lawyers at least, to “overwork” projects; making unnecessary comments and mountains out of molehills. Reputational competition can put limits on this behavior, but it still occurs in some circles. Clients and Boards should be educated as to what terms are very high impact and high-risk – such as core economic terms, or governance terms influencing the power hierarchy of the business – while, especially on smaller projects, accepting “good enough” for the more marginal terms unlikely to be impactful other than in rare edge-cases.

This is why I’m a big fan of taking an open source” approach to legal templates for early-stage work, reflected in the Seed Round Template Library. Creating a common language framework as starting points can significantly reduce unnecessary negotiation over unimpactful issues, while preserving the flexible and trusted dynamics of each side having advocates looking out for their client’s interests. Independent counsel serve as the flexible “software developers” of this market (contract language is code), with open source templates serving as the transparent and modifiable “github” repository.

This is better for clients and the market than a centralized and proprietary “no code” framework by which self-interested participants, like prominent investors or VC-backed software vendors, impose their inflexible and uneditable “code” (contract terms) onto the entire ecosystem, in part by pretending that something is a universal “standard.” A flexible “open source” approach to early-stage deal terms provides efficiency, without requiring an enormous diversity of market players to fit their businesses and investor theses within a handful of narrow structures.

Tech: Standardization, Scale, and Speed

Unlike the legal industry’s values, which heavily prioritize strategic advocacy and flexibility, the values of the software industry are efficiency, scale, and speed. These are absolutely important values that law firms need to integrate into their cultures to serve clients well, while also being very candid when these values are being exaggerated to dupe inexperienced teams. The negative side of hyper-automation is reduced optionality (inflexibility), and a tendency to gloss over nuances in order to make it easier to sell a software-based service. This downside can sometimes be astroturfed with an over-emphasis on mass-market “data,” when even data compilation and visualization requires significantly narrowing the scope of variables, quietly labeling impactful terms as “standard” or “boilerplate” when they absolutely are not.

A great example of how this plays out is the selection bias of automated tools. They’ll promote “data” suggesting that X or Y is some kind of “standard,” while glossing over the fact that X or Y are the primary options promoted by their tool, creating a self-motivated circularity. You can only choose X or Y if you use the tool, and the tool then uses its self-selected “data” to tell you that X or Y are the “standards.” Given it’s evidently all “standard boilerplate,” you’re told to just pay for their tool and avoid all that negotiation and review mumbo jumbo; even if some of said mumbo jumbo would significantly help a team.

This clever sleight-of-hand – using biased “data” to pretend that important terms are far more standardized than they really are – is looking out for the needs of a company profiting from selling simplistic software that can’t function without hyper-standardization; not the needs of the end-user (the client).

As I’ve said many times before, “don’t ask your lawyers about this” sounds very suspicious. “Let’s save you some legal fees” sounds much more benign, but the end-effect can be the exact same. A huge number of inexperienced teams get duped into signing bad terms, or taking counterproductive actions, but the smoke-and-mirrors strategy of minimizing legal fees (and thus not talking to a trusted independent advisor) provides misaligned actors plausible deniability for their (air quotes) “advice.”

Early-stage private companies building unique products and services, and gunning for 8-10 figure (or more) exits, are not standardized commodities, nor are the contracts they are signing at the foundation of their businesses. This is a total contrast to standardized shares of large public companies, which by their nature are highly liquid, have minimal governance authority, and are a part of diversified portfolios; in other words “low stakes.”

In contrast to liquid public equities, Founders’ and employees’ livelihoods, and often their entire life savings, rely on permanent deal terms tied to high-concentration illiquid assets with significant power over a company’s trajectory. Taking an inflexible, high-speed approach to the super high-stakes terms controlling a startups’ financing, ownership, and governance reflects far more the desires of market players who rely on scale and diversification – like spray-and-pray “dumb money” funds or mass-market software vendors – than on what is actually good and appropriate for each unique company with all or most of its eggs in one basket. This is exactly what happens when “tech values” are allowed to steamroll over legal’s.

Deal Closing Software

There are two broad types of work that law firms do for clients on financings: (i) actual “lawyer work” – assessing terms, educating and advising clients, negotiation, drafting and structuring – and (ii) administrative work like creating signature packets and tracking signatures or assembling closing sets. The former category is very difficult, indeed at times dangerous, to heavily outsource to third-party software because of how high-stakes and permanent it is – flexibility and trusted advocacy really matter here, but the latter category is always great to apply thoughtful technology to.

Closing Folders and Litera Transact are two deal closing tools that all corporate lawyers should review and consider adopting for their practices (one or the other). We’ve used tools like this for years, and I know a lot of ECVC “BigLaw” uses them as well. They use focused web-based interfaces for:

  • Organizing deal checklists and document sets
  • Auto-generating signature pages and packets
  • Auto-issuing e-signature requests through trusted e-signature tools like Docusign
  • Tracking real-time status of signatures, and
  • Compiling closing sets efficiently

What I love most about these tools is their focus and flexibility. If there’s one thing I’ve learned being a legal CTO for a decade, it’s to never trust sprawling “all in one” kinds of tools that show significant feature creep. The tendency for a software company to constantly expand into other features, and even industries, more often reflects a desire for monopolistic empire building than what is actually good for the end-user. They inevitably end up confusing, bloated, and over-priced.

Instead, use tools that do a focused set of tasks extremely well, with a simple interface, and customizability that integrates well into the varying needs of a law firm (the user here). Unlike signature collection features bolted onto other kinds of software, these tools are designed for lawyers and can work on an extremely diverse sets of transactions, including equity or debt financings, and M&A. The fact that no particular deal structure is imposed on them is super important so law firms can apply them to their clients’ varying needs.

Client Data Privacy and Security

While both tools started out as independent startups (Litera acquired Doxly and renamed it Transact, iManage acquired Closing Folders), they’re now owned by trusted legal software companies with robust and transparent policies around client data privacy and security. Lawyers should always be cautious about what software tools might be mining their clients’ data for other ends.

In the most egregious cases I’ve seen software companies market tools to lawyers, use those tools to mine those same lawyers’ client data, and then leverage that data by attempting to displace law firms with high-cost, high-margin legal “products” lacking the flexibility, contextual awareness, and ethical obligations of actual counsel. Sometimes that “data” is being sold directly to your clients’ market counterparties, to improve their negotiating posture.

If the tool is offered to you for “free,” then the payment is in data. What is that data going to be used for? I prefer paying directly for straightforward, well-designed and focused tools. My firm’s (and my clients’) data is not for sale.

Hopefully this is helpful. Good luck.