Author Archives →

Negotiation is Relationship Building

TL;DR: Aggressive investors, especially early-stage ones, hate it when you negotiate with them; but they’ll often mask their frustration by accusing you (and your lawyers) of nit-picking and not staying (air quotes) “standard.” It shouldn’t take a ton of explaining as to why that’s the case, but the truth is that there are very few ways to get to know your investors better than through negotiation of a financing or a difficult Board-level issue. People can say any number of nice-sounding things over beers, or in casual conversation, but the truth comes out when you ask someone to commit to it on paper.

As I’ve written in several prior posts, including Relationships and Power in Startup Ecosystems, the world of startups is quite unique given the high inequality of experience and power between the business parties involved. In most business contexts, you’ve got relatively seasoned executives on both sides negotiating with each other. But in the startup context, you often have highly-networked, experienced, wealthy, and influential investors negotiating with a first-time entrepreneur who is ‘unequal’ in experience to the investor in every category. Obviously, investors enjoy this environment. It gives them a significant amount of control, and offers numerous opportunities to push things in the direction that they prefer… unless of course when annoying negotiations, or experienced outside advisors, get in the way.

But then again, many startup investors are constrained in the ways that they can express frustration when they don’t get what they want. Because many of them have come to rely on public marketing personas – via blogs, social media, etc. – of “friendliness,” if they pound the table and simply tell a founder to shut up and sign the docs, word will get around; hurting their brand and pipeline. It’s too visible, and too easy for the entrepreneur to quickly react to. So they need to be smarter and more subtle about how they can constrain negotiations, and keep the playing field slanted in their favor, but in a way that’s more difficult to detect.

In the early stages of a startup, there are very few advisors that a set of entrepreneurs will encounter with deeper negotiation experience, and ability to level the playing field between startups and their investors, than a seasoned startup lawyer who is independent from the money. They often see dozens of financings a year, across numerous geographies and industries, and have also observed the full playbook of power games that aggressive investors can play on Boards, deals, and cap tables. This makes them important “equalizers” in the founder-VC dynamic, and it’s precisely why you constantly see the investor community engaging in strategies to gain influence over, or otherwise silence, the legal community.

Behind the well-spun rhetoric about “saving” founders legal fees, and helping “streamline” things for startups, is in many cases a strategy by influential investors to remove independent counsel from the negotiation table, because in doing so investors can fully enjoy the advantages of how much more experienced and influential they are than first-time founders & employees. Lawyers heavily dependent on the investor community for referrals have been more than happy to collude with the money in this scheme, at the expense of common stockholders who, as a result, are deprived of real strategic counsel.

Imagine for a second that Apple and Google – two equally powerful companies with equally seasoned executives – are negotiating a high-stakes deal with each other. Now imagine if someone at Google suddenly tried to tell Apple what lawyers they should be using to negotiate the deal. You would immediately expect a response along the lines of, “You must be joking, right?” What if Apple tried to tell Google how much they should spend on their advisors in negotiating/structuring the deal? Again, same reaction, which you would expect in the vast majority of business contexts and industries. Seasoned business executives have a very keen understanding of incentives, and don’t react lightly to someone reaching across the table out of some pretense of being “helpful.”

And yet this sort of behavior is extremely common in startup ecosystems. Why? The stated reason from the investor community – the “spin” if you will – is that they’re looking out for the entrepreneur. Can’t let those loudmouth, over-billing lawyers take advantage of founders, right? It’s much better if investors, surely out of good will and generosity, reach across the table and ensure things are being done “properly.” While in almost any other business context this would be seen as obviously self-interested and patronizing infantilization, the experience and power inequality that is unique to startup ecosystems enables investors to take on a paternalistic “this is how things should work” stance in high-stakes discussions with common stockholders. Few things irritate those investors more than hearing an experienced lawyer respond unapologetically, “here is how things actually work.”

When there’s no one on the other side of the table to push back on behalf of the inexperienced players (the common stock), with credible experience and expertise, the experienced money has an easy time pushing important discussions, negotiations, and many other important company matters in the direction that they want. The following are the most common strategies that aggressive (and smart) startup investors will use to minimize negotiation, and therefore get what they want, while still maintaining an appearance of non-aggression:

A. Get startups to use “captive” lawyers.

I’ve written extensively about this already. See How to avoid “captive” company counsel and When VCs “Own” Your Startup’s Lawyers.  By emphasizing how much money will be “saved” by using “familiar” lawyers, entrepreneurs are often pushed to use lawyers who ultimately are controlled by the money. Those lawyers have every reason to keep their mouth shut in negotiations, because the money has heavy influence over the lawyers’ client pipeline.

B. Shrink the legal budget, to get lawyers to stay quiet. 

Negotiation takes time. Because of their experience, VCs often know how to negotiate deals themselves, without much need for lawyer involvement; certainly term sheets and Board issues. But first-time entrepreneurs and startup employees (common stockholders) are in the opposite situation. They rely heavily on outside advisors to walk them through terms and negotiate, and that requires a budget.

As we’ve said above, aggressive VCs hate negotiation. They know what they want, and they’re accustomed to being able to pressure founders into getting it. Any extra time negotiating (supported by counsel) means shrinking the power inequality between the VC and the entrepreneurs, so a great way to shrink that time is to shrink the budget. To the common stockholders, the extra time may be totally worth it, given how high-stakes and permanent the terms being negotiated are. But by saying something like “this deal shouldn’t cost more than $X” in legal fees, the investor has found an indirect way to get the lawyer to shut up in negotiating against… whom? The investor himself.

Flat fees are also a great tool for VCs to get your lawyers to rush their work. Under a flat fee model, the less your lawyer negotiates/advises you, the more of the fee they pocket while being able to do work for someone else. Less work means more ROI. Watch incentives.

If investors have opinions about how much to spend on legal in negotiating with a third-party, that’s great. Founders can often get good info from other experienced entrepreneurs as well. But the fact that certain investors are dictating to startups how much they should spend in negotiating against them is a sad joke. When a VC with a prominent blog throws into a post that a financing shouldn’t cost more than $X, process the incentives behind the statement. I bet he also has a list of preferred firms who’d be more than happy to “fit” within the budget for you. By convincing founders to view the selection of legal counsel as simply about who can do it faster/cheaper, investors create a race to the bottom where the winner just stays quiet and does what the investor wants. When VCs try to “save” you fees on a financing or serious Board issue, what they’re really doing is saving themselves from having to negotiate.

Investors should acknowledge their conflict of interest, stop treating startup teams like children, and keep their opinions on the legal budget to themselves.

C. Scare founders into rushing negotiations, for fear of losing the deal. 

“Time kills deals.” “Don’t lose momentum.” “Close fast and get back to the business.” Who hasn’t heard this over and over again from the investor community?

Sure, taking too long could kill a deal. But signing a terrible deal, or wedding yourself to bad actors, kills companies, or common stockholders. The number of times I’ve seen a deal actually die because founders chose to slow down enough to understand the structure, and move it to a better place for the common stock, is near zero. Remember the title of this post. Negotiation is relationship building. The point of negotiation isn’t just to get better terms. It’s also to observe the reactions of your potential investors when you ask them for something; because those reactions will tell you far more about whom you’re really working with than blog posts and tweets will. 

When you push back (respectfully), you are signaling not only what you care about, but the level of backbone they can expect from you in the on-going relationship. You’re setting the “terms” not just of a deal, but the dynamics of the relationship itself. Are you easily intimidated? Can you handle a high-pressure discussion? CEOs need to be able to. Your behavior in interacting with your lead investors heavily influences their judgment of how effective you’ll be in other difficult discussions with employees, commercial partners, etc.

I can’t tell you how many times we’ve seen founders rush through deals, only to find that once the ink has dried, the person they are now in a long-term and permanent relationship with is very different from what was portrayed pre-signing.

D. Fabricate “standards” and exert political/social pressure on startups to use them. 

See: The Problem with “Standard” Term Sheets (including YCs). Standards can be great, when drafted and implemented in a way that allows all sides to voice their perspective. They can offer a common starting point for negotiations. The problem with so-called “standards” in startup ecosystems is that, given the above-discussed power inequality, investors are the ones unilaterally setting the standards; and they then use their political influence to spread them across a market, creating social pressure to use them.

One influential investor creates a so-called “standard” document, without input from lawyers who are independent from the investor community, and publishes it on their well-followed blog. Other investors with strong social media followings, liking the “standard” because of how it’s written for them, then start sharing, liking, re-tweeting, blogging, and adopting the “standard” on their deals; emphasizing how much money everyone will “save” from keeping it “standard.” Couple that with the leverage investors have worked to build over startup lawyers, who can be pressured into adopting those “standards,” and then have the investors squeeze the legal budget tight to minimize negotiation, and you can see how groups of coordinated, high-profile investors can indirectly force an ecosystem to use their biased “standards” without negotiation.

Think about all the most well-followed blogs, podcasts, etc. that founders go to for advice on funding. How many of them are not published by investors? What about the most followed twitter profiles? VCs are repeat players. They have the time and resources to build strong networks and distribution platforms for disseminating their preferences in ecosystems, maintaining heavy influence over the microphones and amplifying narratives that suit their interests. You really think they’re all doing it to save founders money? First-time entrepreneurs and early employees, who are heads-down building their companies (not blogging and tweeting about startup fundraising and governance) aren’t coordinated or influential enough to counterbalance the dynamic. And if they even tried to speak out, the investor community has more than enough ways to retaliate and silence them.

This is why the info you hear offline (and privately) in ecosystems is often starkly different from what you hear online.

Then when a first-time entrepreneur – a “one shot” player without much ecosystem leverage – is advised to question the standard, a VC can use the whole investor-dominated ecosystem backdrop to exert pressure. “What? This is “standard.” X, Y, and Z funds all use it. Why are you nit-picking? Time kills deals.”

There’s a very manipulative game in how aggressive investors apply this pressure, often playing on the entrepreneur’s self-image. Founders want to see themselves as bold risk-takers, and there’s often a level of insecurity in interacting with seasoned investors, who might be former (and successful) entrepreneurs themselves. By saying something like “This is nit-picking. Why are you wasting time?” the investor is subtly saying “I thought you were a real entrepreneur. A real entrepreneur would close this deal.” It’s an extremely clever way to use the imbalance in the relationship to get the startup to stay quiet, and hand the investor control; not that distant from the kind of social pressure-driven power games you might encounter in a middle school.

There is a “range” of acceptable negotiation. 

Imagine two lines on a negotiation table, with space in-between them. Move past the farther line, and you are over-negotiating, and really nit-picking over things that are unlikely to matter. If you really feel like the lawyer you are working with is pushing you in this direction, then your failure started in hiring the wrong lawyer. Very young, inexperienced lawyers may try to over-state their skillset, and impress you with endless comments. But experienced Partners with successful practices have neither the time nor the desire to play games with nonsense. You don’t build a strong client base by killing deals. Competition among reputable firms, and reputation among entrepreneurs, are constraints on startup lawyers who might want to run up a bill unnecessarily.

So beyond that farther line, you’re over-negotiating. But before the closer line, you are rushing the deal. You’re naively allowing a highly misaligned (economically) investor to muzzle negotiations and pressure you to just do what they want. And in doing so, you are solidifying relationship dynamics that will inform how that investor treats you going forward; knowing that with a little pressure, or clever rhetoric, they can make you dance. Your company’s lawyers are there to honestly advise the company on important issues of clear misalignment; not to overly ingratiate themselves to the money.

Within those two lines is a range of acceptable negotiation. Understand the incentives of both overly-aggressive lawyers and overly-aggressive investors to move you out of that range; and that highly experienced startup investors are very skilled at masking aggression with false “friendliness” and marketing. In the lawyer context, you should have plenty of time long before the negotiation to have done your diligence and ensured you’re working with a Partner whose judgment you truly respect. In the investor context, you should also have done some diligence on their reputation to better understand how they work.

High-integrity investors who view their investment as the building of a balanced, long-term relationship will respond respectfully to negotiation; and not try to infantilize you by questioning your judgment or that of your counsel. It doesn’t mean they’ll give you everything you want. But they’ll be honest and open about their perspective, and what they’ll be flexible on v. what is a sticking point, and give you an opportunity to do the same. No pressure tactics needed. If they instead respond with frustration over your desire to deviate from what they want, or nonsense about why you’re not sticking to their idea of “standard,” you now have some important data on how they approach things, and how they view the relationship.

When aggressive investors over-emphasize the importance of “minimizing friction” in funding, and not “losing momentum,” they sell it as being about saving you time and money. But behind the spin is the fact that they may view your company (and the employees and customers who depend on it) as a number in their portfolio, and would much prefer that you just shut up and make them rich, or die trying. Given you have 100x more skin in this one game than any “unicorn hunter” with a diversified portfolio, you have every reason to push back (again, respectfully) for a deal that works for this company.

No one’s perspective (not an investor, nor a lawyer helping you negotiate with an investor) deserves to be treated like gospel. As a leader, your job is to triangulate advice from many people, all with their own incentives and biases, and make the call based on what you see as the right move for your company’s unique context. Work with experienced advisors whose judgment you trust and can’t be discredited by outsiders trying to use your inexperience against you, and use their insights to work within the range of acceptable negotiation. But also understand that the purpose of negotiation isn’t just about the deal itself. By moving past conversation, into actions and real commitment, it’s a valuable opportunity to have your investors show (not tell) you who they really are.

What Partners in Startup Law Firms Do

TL;DR: True “Partners” in serious law firms deliver high-impact, high-complexity legal advisory safely, because of their years of experience and having gone through deep institutional vetting processes with very high standards. Apart from Partners, firms often have a roster of non-partners who can handle more routine and “de-skilled” work efficiently without the higher rates of Partners. But inexperienced entrepreneurs run into very expensive problems when they think that, just because some of their legal needs can be done more cheaply by de-skilled legal labor, they don’t need Partners at all.

Related Reading: Startup Lawyers – Explained 

First-time founders are often mystified by the organizational structure of law firms, because of how different it is from a product-oriented business. They often think they simply need “a lawyer,” without digging deeper into the important differences among lawyers.

The first thing to understand is lawyer specialization. See Why Startups Need Specialist Lawyers. While a typical “startup lawyer” is (or should be) in fact a corporate/securities lawyer with a heavy specialization in “emerging companies” work, there are many other kinds of lawyers that scaling startups eventually need: employment, tax, commercial/tech transactions, patent (sometimes), data privacy, etc.

Once you get past understanding the specialty of the particular lawyer, you start getting into differences among lawyers within a specialty. If you engage a typical law firm, either BigLaw or a decent sized boutique (like E/N), you’ll see titles like Junior Associate (in our firm juniors are called Fellows), Senior Associate, Counsel, and Partner. Those titles are very important in terms of signaling the skillset that a particular lawyer brings to the table.

Very broadly speaking, the title “Partner” refers to the most senior (in expertise) people within a law firm. In a law firm that recruits top-tier legal talent, just being hired by the firm requires being in the top 5-10% of the overall talent pool. After the initial “filter” of getting hired, a lawyer has to have at least 7-9 yrs of experience within a specialty before they’re even eligible to become a Partner. Achieving that level of experience is by no means an automatic ticket. A very small % of lawyers in the market are eligible to even be hired by a top-tier firm, and then an even smaller % of those lawyers will make Partner. On top of needing to have done the job for X number of years, serious law firms have strict criteria for vetting the work product and judgment that a lawyer has produced, from a quality, complexity, and client satisfaction standpoint, in order to determine whether they are, in a sense, worthy of the Partner title.

You can think of serious law firms as universities for specialized vetting and practical training of lawyers, and the Partner title as a PhD.  That obviously means that the legitimacy of the law firm’s brand matters wildly for whether the term Partner even means anything. Just like a PhD from Harvard or Stanford, or any institution highly regarded within a particular field, says a lot more than one from a school no one has ever heard of, anyone with minimal credentials can hang out a shingle and call themselves a “Partner” of their firm; in which case the title is meaningless.

Within the legal field, you’ll often see a single lawyer get preciously close to being fired by Law Firm A because of how low quality that lawyer’s work product is (not even meeting Firm A’s minimum standards), and yet end up a “Partner” at random Law Firm B that dishes titles out like candy, because their brand lacks real value. Law firms are not created equal. Not even close.

Why is all of this vetting even necessary? Specialization, even sub-specialization, and heavy quality filtering processes are unusual for many fields and industries. The answer relates to issues I’ve discussed in Legal Technical Debt. Unlike software and other product-oriented industries, mistakes in law, particularly high-stakes law, are often extremely expensive to fix, if they are even fixable at all. Not infrequently, they’re permanent. Once a contract is signed, or an action with potential legal liability is taken, there’s no v1.2 over-the-air fix that can be issued unilaterally if bugs (errors) arise. Contracts would be pointless if you could tweak important terms without the other side’s consent.

This is why applying software industry thinking like “move fast and break things” can be spectacularly disastrous when approaching legal issues, because that thinking only works when you can take an iterative approach to low-stakes bugs. To make matters even worse and harder, legal mistakes are rarely discovered immediately after they are committed. They often sit in the background for years until the full reality comes out, with “interest” having compounded on the “debt.” The “complexity” that top-tier firms are designed to safely manage isn’t something that they themselves fabricate out of thin air. As companies grow, the number of relevant (extremely smart) parties with competing/conflicting high-stakes interests grows, as do the number of legal issues they touch; and many of those issues weave into each other by necessity such that a move on one triggers cascading, unintuitive effects on others. The complexity (and cost of errors) is inherent and unavoidable, like a highly contextualized and fragmented code base of contracts, relationships, regulations, and complex formulas, but where the cost of a “bug” is 50x.

So within top-tier law firms with reputable brands and vetting processes, Partners represent the highest level of flexible expertise, quality control, and experienced judgment that a particular firm is able to offer for managing very high-stakes, very complex and strategic issues safely without producing expensive errors whose costs are borne by clients. And ensuring you have direct access to that expertise is important for your most complex, high-stakes legal advisory.  But that being said, not everything you need from a law firm requires such a high level of expertise; and that’s why law firms have lower-cost, well-trained people with other titles and levels of vetting, like associates and paralegals.

As you move from Partners to lower-level professionals, the process is often referred to in some circles as de-skilling. It basically means that the law firm as an institution has put in place the appropriate quality control mechanisms to allow people with less fully-vetted and more narrow skillsets to do a limited segment of work that is appropriate for their abilities, while still producing an end-product meeting the firm’s quality standards. Highly-detailed checklists, template forms, and software-supported systems of institutional knowledge are common ways that law firms de-skill legal work (make it easier to do by introducing training wheels and boundaries) and push it down to people who charge less but are also more available than Partners.

Partners, for example, don’t need to issue your random option grants. Non-lawyers with appropriate oversight can do that. A Partner also doesn’t need to review your random NDA.  But a high-stakes term sheet, M&A deal, or key hire? You don’t want a non-partner leading that, because it’s too high-impact and the right output depends too much on highly contextualized, subjective, and complex nuances (human judgment) as opposed to simplified rules that a lower-level professional can follow. The typical way a startup engages a law firm is to view one or two Partners as the quarterbacks and main contacts of the legal team, who can then delegate lower-level, de-skilled work to cheaper but still well-monitored professionals. This puts the most experienced and trusted legal advisors in charge of the highest leverage strategic issues, while integrating them with cheaper professionals who can also get more routine work done.

The spectrum of Partners for high-stakes, high-complexity work through de-skilled professionals like associates and paralegals helps explain a lot about the different kinds of legal service providers you’ll encounter in the market.

Some firms (often small niche boutiques) are all Partners. Not a single lower-level non-partner on the roster. That can make sense if the work being done is all extremely complex and bespoke, as might be the case in very cutting edge fields. But in most fields (including corporate/securities law) a Partner-only firm will just mean you’re overpaying for work that could be done safely by someone cheaper, and also probably be done faster because larger rosters of professionals with different skillsets prevent bottlenecks by allowing work to be triaged (like a hospital). See: When a Startup Lawyer Can’t Scale for a deep-dive into what happens when startups engage solo lawyers or Partners who don’t have real infrastructure for scalability and full service.

On the opposite end of the spectrum are so-called law firms that don’t have any true Partners, meaning no one whose fully led a client base into high-stakes 9 or 10-figure highly-complex transactions, and gone through the vetting process of already reputable firms and achieved the Partner title in a meaningful sense. Firms full of non-partners will heavily gravitate toward de-skilled work, which often means large amounts of standardization and therefore inflexibility. Their less-experienced lawyers and professionals aren’t capable of handling high levels of complexity safely, so they’ll necessarily attempt to standardize their offerings to make them easier and safer to deliver; with the value proposition being that they can also be cheaper, because they have no expensive Partners to pay.

This heavily de-skilled and standardized approach to legal can work for a certain kind of client needing certain kinds of lower-stakes work, but it will run into problems if they try to handle everything a growing client needs, including higher complexity, higher-stakes transactions that simply cannot be simplified or distilled into an algorithm or checklist for lower-level professionals to manage. While some non-partner firms still refer to themselves as law firms, others instead refer to themselves as “alternative legal services providers.” Ultimately what they call themselves matters less than the fact that their value proposition to clients is very different from a law firm with true Partners.

A real top-tier law firm offers a blend of high-complexity, high-stakes Partner-led flexible legal judgment with more routinized de-skilled work, while an alternative legal provider leans heavily on de-skilled, more routine low-stakes work that “tops out” on how much flexibility and complexity in can handle. Serious firms are designed like Partner-centric creative studios at the top of their hierarchy, because their core value proposition is extremely well-trained and specialized intellectual horsepower capable of addressing hundreds/thousands of unique and very high-impact circumstances effectively. Highly-vetted (and compensated) Partners are the only “full stack” experts capable of ensuring quality control of that kind of highly variable and complex service with extremely high error costs. Remove those Partners, and the whole thing collapses into a nuclear disaster of errors and poor judgment.

Alternative legal providers are, instead, structured more like factories or product-oriented companies, because their offering is by necessity limited and simplified through routinization and inflexibility. Eliminate Partners (with their unique and rare, and therefore expensive, skillset) from your cost structure, and you’ll certainly cut costs, but you’ve also set a hard ceiling on how much flexibility and complexity your operation can now handle without a blow-up. The core “service” of an alternative provider isn’t actually experienced, flexible human judgment, but rigid institutional processes with less-skilled (cheaper) people adding a light layer of variability.

It’s much riskier for a startup led by inexperienced entrepreneurs to engage a non-partner alternative legal provider (instead of a law firm) than it would be for, say, a large company with an in-house counsel. Why? Remember, true Partners serve as the highest-level quality control and strategic quarterbacks of a legal team. If you’re a large company with highly experienced in-house counsel, they (the in-house lawyer) can serve as your Partner of sorts; developing a unique strategy appropriate for the context, monitoring for errors, and coordinating different appropriately trained people to execute on the strategy. But early-stage startups don’t have highly experienced (and highly paid) in-house lawyers. They cost hundreds of thousands of dollars, and in some cases even millions, a year.

Because inexperienced entrepreneurs have no idea how to appropriately vet and triage high-stakes legal work, or how to develop a contextualized and flexible legal strategy, having them engage legal service providers full of nothing but non-partners capable of only managing a limited scope of “standardized” work starts off a very long-term game of legal russian roulette. Sure, your option grants will probably be done right, as will an NDA review. But eventually (pretty quickly, usually) a higher-stakes, higher-complexity situation arises, and cookie-cutter de-skilled offerings just won’t work. No serious company follows a fully “standard” (whatever that means) growth trajectory.

Real Partners are expensive, and you often need them only for your highest-stakes issues where a wrong decision can have million or even billion-dollar implications, but when you need them, you really need them.  These kinds of situations arise often and unpredictably in the early days of a fragile, chaotic startup where the overall trajectory of the entire business is still being sorted out, founders are negotiating with market players 100x as experienced as they are, and a single decision can produce permanent consequences that you’ll have to live with for years.

So when entrepreneurs are diligencing firms to work with, they need to be thinking about a number of variables:

  • Does the firm have the right specialty of work I’m looking for, and access to other specialties I might need?
  • Does this firm have true Partners (with credible expertise and vetted backgrounds) that I can trust to handle non-routine and very high-stakes, high-complexity matters safely?
  • But do they also have the appropriate institutional infrastructure of lower-level professionals to get less high-stakes but still important work done on time and correctly (de-skilled work)?

Partners are necessary for high-stakes, high-complexity work that can’t fit within a template framework. Non-partners (and infrastructure) are necessary for speed and efficiency on day-to-day needs that are more predictable. When the “buyer” of legal services is an experienced in-house general counsel, they can often do without Partners. That’s why a lot of the most successful alternative legal service providers (who don’t have Partners) entering the market are targeting large companies with in-house counsel who can safely bypass Partners for specific segments of more routine, lower-stakes work, while correctly identifying higher-impact issues and applying Partner-level expertise to them.

But startups led by entrepreneurs engaging directly with a firm should understand that because no one on their internal roster has the expertise to credibly handle and triage the most high-impact, high-complexity legal issues that they’ll inevitably run into as they scale, Partners are essential, including for interacting with highly experienced and misaligned players on the other side of the negotiation table (like investors) who have their own Partners advising them. Focusing too much on routine, low-stakes things like how quickly or cheaply a firm can check off some boxes or fill in a template misses the much bigger picture of why the number of law firms taken seriously by the top players in the industry is much smaller than the total number of firms in the market.

People building a coffee shop or other small business (with very limited legal needs) might engage LegalZoom, or a productized de-skilled legal offering that looks like LegalZoom with paralegals and moderately-skilled attorneys added on top to add a narrow band of customization. And large companies with experienced in-house counsel will regularly engage alternative providers for narrow segments of lower-stakes work that doesn’t require Partner attention. But early-stage executives building highly complex enterprises facing extremely high-impact strategic legal decisions know that the issues they’re touching are much higher-stakes, and focus on the Partners of the firms they engage for that reason.

Some alternative legal providers are very open about their narrow capabilities, and how they’re very different from an actual law firm. They are serving a legitimate, unmet need by heavily productizing a narrow segment of high-volume, lower-margin work. Clerky is a great example of a reliable, productized startup legal offering that doesn’t pretend to replace law firms, and is open in its marketing about what it is and what it’s not; a tool for handling a very limited scope of work for very early-stage startups who can’t yet afford quality counsel, or have counsel but need extremely simple, standardized tasks done cheaply but safely (with software automation) because of their small budget.

But sometimes alternative providers like to mask their limitations, and market themselves as “full service” firms; and Partners at actual law firms then grab some popcorn and wait for the fireworks. While scaled enterprises with experienced in-house counsel are the most appropriate market for de-skilled legal “products,” those “buyers” are also far more scrutinizing of legal services because they have the experience and judgment to separate fact from fiction. Inexperienced entrepreneurs don’t know what they don’t know about legal, which makes them easier targets for bad actors peddling X or Y legal product as a comprehensive solution, when they actually carry enormous gaps and limitations that will only become obvious when it’s too late to fix them. First-time founders are also prime targets for misaligned but clever market players (investors, commercial partners, acquirers) across the table who might want a young, inexperienced startup to be disarmed with less capable advisors; allowing that player to then take advantage of the uneven playing field.

De-skilled legal labor enabled by technology and well-designed processes absolutely has its place in the market – and well-run firms take advantage of it; but it’s as a supplement to the high-stakes, high-complexity work that the smartest industry players trust top-tier firms and Partners to do, not as a replacement. Anyone suggesting otherwise is marketing a highly-polished time bomb as a solution. 

Ask a law firm the right questions about the scalability and credibility of their expertise, including their Partners, or the reality check delivered to you when the legal “technical debt” comes due will be ice cold.

Why Startups shouldn’t use YC’s Post-Money SAFE

TL;DR: If you’re going to use it, you should make some slight (but material) tweaks. It otherwise gives your seed investors a level of extreme anti-dilution protection that is virtually unheard of (circa 2019) in startup finance, making it worse than seed equity and conventional convertible notes (or pre-money SAFEs) in terms of economics for most seed stage companies; which is of course why investors love it. There are far better, more balanced ways to “clarify” ownership for seed investors without forcing founders and employees to absorb additional dilution risk. YC has done a “180” in moving from the pre-money SAFE (very company friendly) to the post-money SAFE (extremely seed investor friendly).

Post-Publishing Updates:

A regular underlying theme you’ll read on SHL is that key players in the startup community are incredibly talented at taking a viewpoint that is clearly (to experienced players) investor-biased, but spinning / marketing it as somehow “startup friendly.”  And lawyers captive to the interests of investors are always happy to play along, knowing that inexperienced teams can be easily duped.

One example is how “moving fast” in startup financing negotiations is always a good thing for entrepreneurs. Investors are diversified, wealthy, and 100x as experienced as founders in deal terms and economics, but it’s somehow in the founders’ interest to sign whatever template the investor puts on the table, instead of actually reviewing, negotiating, and processing the long-term implications? Right.

Y Combinator’s move to have its SAFEs convert on a post-money, instead of pre-money, basis is another great example. Their argument is that it helps “clarify” how the SAFEs will convert on the cap table. Clarity is great, right? Who can argue with clarity?

What’s not emphasized prominently enough is that the way they delivered that “clarity” is by implementing anti-dilution protection for SAFE investors (like themselves) that is more aggressive than anything remotely “standard” in the industry; and that wasn’t necessary at all to provide “clarity.” Under YC’s new SAFE, the common stock absorbs all dilution from any subsequent SAFE or convertible note rounds until an equity round, while SAFE holders are fully protected from that dilution. That is crazy. It’s the equivalent of “full ratchet” anti-dilution, which has become almost non-existent in startup finance because of how company unfriendly it is. In fact, it’s worse than full ratchet because in a typical anti-dilution context it only triggers if the valuation is lower. In this case, SAFE holders get fully protected for convertible dilution even if the valuation cap is higher. It’s a cap table grab that in a significant number of contexts won’t be made up for by other more minor changes to the SAFE (around pro-rata rights and option pool treatment) if a company ends up doing multiple convertible rounds.

When you’re raising your initial seed money, you have absolutely no idea what the future might hold. The notion that you can predict at your initial SAFE closing whether you’ll be able to raise an equity round as your next funding (in order to convert your SAFEs), or instead need another convertible round (in which case your SAFE holders are fully protected from dilution), is absurd. Honest advisors and investors will admit it. Given the dynamics of most seed stage startups, YC’s post-money SAFE therefore offers the worst economics (for companies) of all seed funding structures. Founders should instead opt for a structure that doesn’t penalize them, with dilution, for being unable to predict the future.

Yes, YC’s original (pre-money) SAFE has contributed to a problem for many SAFE investors, but that problem is the result of an imbalanced lack of accountability in the original SAFE structure; not a need to re-do conversion economics. As mentioned in the above TechCrunch article, the reason convertible notes are still the dominant convertible seed instrument across the country is that the maturity date in a convertible note serves as a valuable “accountability” mechanism in a seed financing. A 2-3 year maturity gives founders a sense of urgency to get to a conversion event, or at least stay in communication with investors about their financing plans. By eliminating maturity, SAFEs enabled a culture of runaway serial seed financings constantly delaying conversion, creating significant uncertainty for seed investors.

YC now wants to “fix” the problem they themselves enabled, but the “solution” goes too far in the opposite direction by requiring the common stock (founders and early employees) to absorb an inordinate amount of dilution risk. If “clarity” around conversion economics is really the concern of seed investors, there are already several far more balanced options for delivering that clarity:

Seed Equity – Series Seed templates already exist that are dramatically more streamlined than full Series A docs, but solidify ownership for seed investors on Day 1, with normal weighted average (not full ratchet) anti-dilution. 100% clarity on ownership. Closing a seed equity deal is usually a quarter to a third of the cost of a Series A, because the docs are simpler. Seed equity is an under-appreciated way to align the common stock and seed investors in terms of post-funding dilution. Yes, it takes a bit more time than just signing a template SAFE, but it’s an increasingly popular option both among entrepreneurs (because it reduces dilution) and investors (because it provides certainty); and for good reason.

See also: Myths and Lies about Seed Equity to better understand the false arguments often made by investors to push founders away from seed equity as a financing structure.

Harden the denominator – Another option I’ve mentioned before in Why Notes and SAFEs are Extra Dilutive is to simply “harden” the denominator (the capitalization) that will be used for conversion on Day 1, while letting the valuation float (typically capped). This ensures everyone (common and investors) are diluted by subsequent investors, just like an equity round, while allowing you to easily model conversion at a valuation cap from Day 1. If the real motivation for the SAFE changes was in fact the ability to more easily model SAFE ownership on the cap table – instead of shifting economics in favor of investors – this (hardening the conversion denominator) would’ve been a far more logical approach than building significant anti-dilution mechanisms into the valuation cap.

See “Fixing” Convertible Note and SAFE Economics for a better understanding of how hardening the denominator in a note or SAFE valuation cap gives the “best of both worlds” between convertibles and equity rounds.

Add a Maturity Date – Again, the reason why, outside of Silicon Valley, so many seed investors balk at the SAFE structure altogether is because of the complete lack of accountability mechanisms it contains. No voting rights or board seat. No maturity date. Just hand over your money, and hope for the best. I don’t represent a single tech investor – all companies – and yet I agree that SAFEs created more problems than they solved. Convertible notes with reasonable maturity dates (2-3 years) are a simple way for investors and entrepreneurs to get aligned on seed fundraising plans, and if after an initial seed round the company needs to raise a second seed and extend maturity, it forces a valuable conversation with investors so everyone can get aligned.

Conventional convertible notes – which are far more of an (air quotes) “standard” across the country than any SAFE structure – don’t protect the noteholders from all dilution that happens before an equity round. That leaves flexibility for additional note fundraising (which very often happens, at improved valuations) before maturity, with the noteholders sharing in that dilution. If a client asks me whether they should take a low-interest capped convertible note with a 3-yr maturity v. a capped Post-Money SAFE for their first seed raise, my answer will be the convertible note. Every time, unless they are somehow 100% positive that their next raise is an equity round. The legal fees will be virtually identical.

Before anyone even tries to argue that signing YC’s template is nevertheless worth it because otherwise money is “wasted” on legal fees, let’s be crystal clear: the economics of the post-money SAFE can end up so bad for a startup that a material % of the cap table worth as much as 7-figures can shift over to the seed investors (relative to a different structure) if the company ends up doing additional convertible rounds after its original SAFE; which very often happens. Do the math.

The whole “you should mindlessly sign this template or OMG the legal fees!” argument is just one more example of the sleight-of-hand rhetoric peddled by very clever investors to dupe founders into penny wise, pound foolish decisions that end up lining an investor’s pocket. It can take only a few sentences, or even the deletion of a handful of words, to make the economics of a seed instrument more balanced. Smart entrepreneurs understand that experienced advisors can be extremely valuable (and efficient) “equalizers” in these sorts of negotiations.

When I first reviewed the new post-money SAFE, my reaction was: what on earth is YC doing? I had a similar reaction to YC’s so-called “Standard” Series A Term Sheet, which itself is far more investor friendly than the marketing conveys and should be rejected by entrepreneurs. Ironically, YC’s changes to the SAFE were purportedly driven by the need for “clarity,” and yet their recently released Series A term sheet leaves enormous control points vague and prone to gaming post-term sheet; providing far less clarity than a typical term sheet. The extra “clarity” in the Post-Money SAFE favors investors. The vagueness in the YC Series A term sheet also favors investors. I guess YC’s preference for clarity or vagueness rests on whether it benefits the money. Surprised? Entrepreneurs and employees (common stockholders) are going to get hurt by continuing to let investors unilaterally set their own so-called “standards.”

One might argue that YC’s shift (as an accelerator and investor) from overly founder-biased to overly investor-biased docs parallels the natural pricing progression of a company that initially needed to subsidize adoption, but has now achieved market leverage. Low-ball pricing early to get traction (be very founder friendly), but once you’ve got the brand and market dominance, ratchet it up (bring in the hard terms). Tread carefully.  Getting startups hooked on a very friendly instrument, and then switching it out mid-stream with a similarly named version that now favors their investors (without fully explaining the implications), looks potentially like a clever long-term bait-and-switch plan for ultimately making the money more money.

YC is more than entitled to significantly change the economics of their own investments. But their clear attempts at universalizing their preferences by suggesting that entrepreneurs everywhere, including in extremely different contexts, adopt their template documents will lead to a lot of damaged startups if honest and independent advisors don’t push back. The old pre-money SAFE was so startup friendly from a control standpoint that many investors (particularly those outside of California) refused to sign one. The new post-money SAFE is at the opposite extreme in terms of economics, and deserves to be treated as a niche security utilized only when more balanced structures won’t work. Thankfully, outside of pockets of Silicon Valley with overly loud microphones, the vast majority of startup ecosystems and investors don’t view SAFEs as the only viable structure for closing a seed round; not even close.

The most important thing any startup team needs to understand for seed fundraising is that a fully “standard” approach does not exist, and will not exist so long as entrepreneurs and investors continue to carry different priorities, and companies continue to operate in different contexts. Certainly a number of prominent investor voices want to suggest that a standard exists, and conveniently, it’s a standard they drafted; but it’s really just one option among many, all of which should be treated as flexibly negotiable for the context.

Another important lesson is that “founder friendliness” (or at least the appearance of it) in startup ecosystems is a business development strategy for investors to get deal flow, and it by no means eliminates the misaligned incentives of investors (including accelerators). At your exit, there are one of two pockets the money can go into: the common stock or the investors. No amount of “friendliness” changes the fact that every cap table adds up to 100%. Treat the fundraising advice of investors – even the really super nice, helpful, “founder friendly,” “give first,” “mission driven,” “we’re not really here for the money” ones – accordingly. The most clever way to win a zero-sum game is to convince the most naive players that it’s not a zero-sum game.

Don’t get me wrong, “friendly” investors are great. I like them way more than the hard-driving vultures of yesteryear. But let’s not drink so much kool-aid that we forget they are, still, investors who are here to make money that could otherwise go to the common stock; not your BFFs, and certainly not philanthropists to your entrepreneurial dreams.

Given the significant imbalance of experience between repeat money players and first-time entrepreneurs, the startup world presents endless opportunities for investors (including accelerators) to pretend that their advice is startup-friendly and selfless – and use smoke-and-mirrors marketing to convey as much – while experienced, independent experts can see what is really happening. See Relationships and Power in Startup Ecosystems for a deeper discussion about how aggressive investors in various markets gain leverage over key advisors to startups, including law firms, to inappropriately sway negotiations and “standards” in their favor.

A quick “spin” translation guide for startups navigating seed funding:

“You should close this deal fast, or you might lose momentum.” = “Don’t negotiate or question this template I created. I know what’s good for you.”

“Let’s not ‘waste’ money on lawyers for this ‘standard’ deal.”  = “Don’t spend time and money with independent, highly experienced advisors who can explain all these high-stakes terms and potentially save a large portion of your cap table worth an order of magnitude more than the fees you spend. I’d prefer that money go to me.”

“We’re ‘founder friendly’ investors, and were even entrepreneurs ourselves once.” = “We’ve realized that in a competitive funding market, being ‘nice’ is the best way to get more deal flow. It helps us make more money. Just like Post-Money SAFEs.”

“Let’s use a Post-Money SAFE. It helps ‘clarify’ the cap table for everyone.” = “Let’s use a seed structure that is worse for the common stock economically in the most important way, but at least it’ll make modeling in a spreadsheet easier. Don’t bother exploring alternatives that can also ‘clarify’ the cap table without the terrible economics.”

There are pluses and minuses to each seed financing structure, and the right one depends significantly on context. Work with experienced advisors who understand the ins and outs of all the structures, and how they can be flexibly modified if needed. In the case of startup lawyers specifically, avoid firms that are really shills for your investors, or who take a cookie-cutter approach to startup law and financing, so you can trust that their advice really represents your company’s best interests. That’s the only way you can ensure no one is using your inexperience – or fabricating an exaggerated sense of urgency or standardization – to take advantage of you and your cap table.