News. Two big issues have been floating around the startup law space lately. First, Yokum Taku introduced “convertible equity” in an attempt to address the potential downsides (for entrepreneurs) of convertible debt, which set off a debate that Antone Johnson spectacularly Storified. More interesting to me, however, was AngelList’s announcement that seed rounds can now be closed, soup-to-nuts, on their platform. The real news there, for lawyers at least, is that Wilson Sonsini will close those rounds for free. Yes, as in nothing.
Startup Law – Deflation Accelerating
Much has been written about the “deflationary economics” concerning startups and the web, with Mark Suster’s post probably being one of the best articulations that come to mind. Not as much has been written about the indirect effects that industries experiencing economic deflation can have on other sectors they interact with. Wilson Sonsini’s AngelList pronouncement is, in my opinion, the clearest sign that the portion of the legal sector working with technology startups is itself experiencing rapid deflation — and not because lawyers have suddenly shed their luddite tendencies and read ‘The Innovator’s Dilemma’ (though they should).
What’s happened, essentially, is that with literally every other service used by their clients becoming radically cheaper, and the resulting downsizing of investment rounds, startup lawyers simply couldn’t maintain their usual fees and keep a straight face. This deflation started out with what you might call Stage 1 deflation, with standardized docs emerging, fixed fee packages, etc. Startup Law was just efficient at this stage, especially compared to other areas of the law. But with free, dynamically generated documents from high-end firms available online, and now with one of the best firms in the country saying they will close seed rounds for free, I’d say its reached Stage 2, where commoditized is the more appropriate adjective. And I’d argue that this has some serious implications going forward.
How We Got Here
First, it’s worth reflecting on the different steps that startup law firms have been (or should be) taking in order to compete in this deflationary environment. I’d break those steps into 3 categories: contractual, technological, and operational. These steps could also serve as a model for other parts of the legal field that, while not as aggressively deflationary as startup law, will likely eventually follow a similar path.
- Standard Firm Docs – In order to make contract drafting more efficient, firms started modularizing the language of their own documents. If an investor gets a 1x participating liquidation preference with a 3x cap as opposed to the 1x non-participating currently in the document, ‘drafting’ involves mostly cutting and pasting bracketed language, with minimal tinkering. While this cut down on internal drafting, it still left room for bickering about language with the other side of the deal.
- Universal Standard Docs – Going one step further, standardized investor docs like the Series AA and the NVCA Model docs emerged, allowing for parties on both sides to have a common language framework to work from.
The contractual efficiencies developed in startup law still required the usual process of opening a word document, filling in blanks, moving around language in a very straight-line fashion, and then proofing to make sure everything is coherent. Closing required creating signature packets, then tracking signatures and assembling them back into fully executed copies. But then technology emerged to streamline a lot of this process.
- Proofing Software – A significant amount of time on a transaction used to be spent by junior attorneys flipping through pages to make sure names are properly spelled, commas are in the right place, and defined terms are properly in place. Software like Deal Proof emerged that can scan a document and generate a proofing list for an attorney, cutting down on that proofing time by anywhere from (my estimate) 50-75%.
- Document Automation – Companies like Brightleaf have emerged to turn the cut-paste-and-proof process of working with form docs into one of simply clicking certain options in a form. Want that 1x participating LP w/ 3X Cap? Just click the right box in your template, and the language will get filled-in automatically, and every other area of the document that is impacted will also be modified. No need to proof.
- Electronic Closing. – With multiple parties often signing dozens of documents, the usual closing process involved creating “signature packets” where you PDF’ed the signature pages of each contract, and created single files containing all the pages that each individual party had to sign. Without doing this, mistakes would be inevitable. With electronic signature software like Docusign, this process is largely removed. Put the ‘Sign Here’ tabs for each person in the appropriate places, and Docusign will (1) guide them to where they need to sign, and (2) generate fully executed documents.
One obvious end-result of the contractual and technological developments has been that drafting simply takes a lot less time, which naturally means less money billed. But what they’ve also done is made the drafting and closing process a lot simpler. To modify a vesting schedule or a liquidation preference, you don’t really need to understand the actual mechanics of the language. Just click the box. And to get a deal signed up, you don’t need to create complicated signature packets and coordinate signatures. Just drop the Docusign tags in the right place, and it’ll do the rest.
Firms have taken advantage of this simplicity by pushing work down to junior attorneys and even paralegals, who bill a lot less per hour. Where it might have previously required an experienced attorney to draft and close a seed financing, an innovative firm might have a paralegal do 95% of the work, with zero drop in quality. A partner or senior attorney might spend a few minutes discussing very high-level issues with the client, but that’s it.
The Next Step: Deal Platforms
I have zero doubt that Wilson Sonsini is taking advantage of all three of the above categories. But the key to really get the kind of deflation reflected in the free AngelList closings is the next step of legal technology: Deal Platforms. Rather than just the initial drafting of docs being automated, with negotiation over terms and language to follow, the automation becomes bilateral. If the investor wants a better liquidation preference, he simply fills in a field or checks a different box, and if the Company disagrees, they uncheck that box.
Contract language becomes completely secondary – commoditized – on a deal platform. One can easily envision a time in which the negotiation of a full venture deal, not just a convertible note financing, involves nothing more than checking boxes and filling in a few fields, with full documents automatically generated and then electronically signed. The chances of closing such a deal for free are practically zero, but all that automation could make a ~$10K legal bill for a full institutional venture capital financing a reality, which would be about a 50-80% cut on current rates.
Takehome: Nobody should be myopic enough to expect AngelList-like automation to stop at the seed deal stage. Again, The Innovator’s Dilemma, legal version. See below from AngelList’s Q&A.
Does Docs support Series A rounds?
No. Docs only supports seed rounds right now. (emphasis added)
Implications: Freemium Startup Law
There are a number of ways that this rapid deflation has and likely will impact the structure of startup law practices. One result of the already-occurring deflation has been the growth of boutique firms competing with BigLaw by offering similar, albeit more limited, services at lower billable rates. I wrote about this previously: ‘In Startup Law, Big Can Be Beautiful.‘
The economic advantage of a boutique practice is that firms can avoid the high billable rates necessary to sustain the breadth and overhead of large law firms, while still offering their experienced attorneys comfortable salaries. That works well in an environment where the demand is for cheaper seed financings and venture deals. But what happens when free or practically free becomes the dominant expectation?
Cross-subsidize. As Wilson Sonsini’s move has made absolutely clear, large firms have their own economic advantage with respect to legal fees: cross-subsidizing low-end work with profits from larger deals. Large firms don’t just handle formations, seed financings, and venture deals, they also handle cash cow M&A and IPO transactions that are not experiencing anywhere near the kind of deflation going on at the low end. Those deep pockets make offering free startup work a lot easier, provided enough of the loss-leaders generate big deals down the pipeline.
This model of offering a lot of stuff for free and profiting off of the high-end users should look very familiar to techies: it’s the freemium model, applied to law. And it distinctly favors large, brand-name firms. Boutique firms lack the institutional capacity to handle the large transactions that a larger firm can use to cross-subsidize free work. Without more radical change, their only hope is to make up for deflation with volume. But [insert large number] * free doesn’t pay the bills. Commoditized deal work favors the cross-subsidization of large firms over the lower labor costs of boutique practices.
Conclusion: Move Fast, Move Up, or Move Out
At this point (when deal platforms become ubiquitous), I see smaller startup law practices having to either (A) get used to operating at much lower margins, or (B) find a way to move up-market and take a piece of the larger deals. I wrote previously about the possibility of boutiques using technology to scale for large transactions here: The Ad-hoc Law Firm? Granted, I don’t have much visibility into how boutique practices are doing, though I’d love to hear from other attorneys or knowledgeable people on how they see the future panning out.
As for large firms operating in this space, the choice is much more straight-forward: either become radically efficient with your commoditized startup work in order to keep the pipeline flowing, or get out. I’ve seen firms here in Austin completely exit startup work for exactly this reason. Thankfully, we’re going with the other option.
Post-script (years later): AngelList’s experiment failed, and no “deal platforms” have emerged. Why? Flexibility and coordination. The diversity of options for even early-stage rounds, and their different appropriateness depending on context, makes full standardization and automation an impossibility. And the subjective preferences of various investors (and companies) also serves as significant resistance. Automation and flexibility are fundamental tradeoffs, and the market has chosen flexibility for high-stakes deals.