Startup Accelerators and Ecosystem Gatekeeping

TL;DR: Startup accelerators face a fundamental challenge to their value proposition: they don’t “own” their networks, and therefore struggle to continue extracting fees for accessing them. Their responses to that challenge take a number of forms, and generally involve either dropping their price or attempts at controlling ecosystem players; the latter of which is misaligned with the interests of entrepreneurs and startups.

Related reading:

As I’ve written before in the above posts, Startup Accelerators became “a thing” in ecosystems because they were a reasonably optimal method for solving the “noise” problem faced both by startups and investors; a problem which became more visible as the cost of starting a company went down. With far more people “starting up,” early-stage investors needed someone to help them filter out duds. The solution, referred generally as “sorting,” is similar to the value prop offered by elite universities to employers needing talented labor, and students needing credible ways to signal their talent.

By creating credible brands (signals) for quality entrepreneurs, accelerators reduced the search costs for early-stage investors who, instead of needing to filter through lots of duds themselves, had a concentrated place to build their pipeline. That value proposition attracted investors, advisors, great employee hires, etc., and over time successful “alumni,” which magnifies the value proposition to entrepreneurs who, in exchange for equity, got a fast-track to building their network and raising capital.

For some time, you had a virtuous cycle with clear “network effects.” Attract great entrepreneurs, which then attracts investors and other key people, which then attracts more great entrepreneurs, and so on and so forth; just like a classic network effect for a software platform. During this period, accelerators can build significant leverage over their ecosystems as gatekeepers to talented entrepreneurs, and use that leverage to push the market in directions the accelerator wants.

The “Network” Can’t Be Controlled

But accelerators face a distinct problem that doesn’t get talked about a lot publicly, but local market players absolutely know is there: they can’t lock in (air quotes) “their” network. It’s not proprietary. The “networks” of startup accelerators are really just compilations of individual peoples’ networks; not at all like a “network” of a tech platform for which the tech “owner” can sustainably charge access fees. Those people in the accelerator’s “network” aren’t employees of the accelerator, nor are they paid out of its returns, and so they aren’t aligned in propping up the network’s “access fee.” Inevitably, people find it worth their while to simply bypass the accelerator and makes themselves accessible to founders directly, after having built their own personal brands with a few iterations with the accelerators’ initial cohorts. If a team needs X, Y, and Z, and I know X, Y, and Z and can help them get access with my own branding/signal, why should they have to pay this 3rd-party a fee to access those people?

So after a few years of an accelerator having filtered and aggregated a network, helping great people find great founders, and great founders find great people, the network takes on a life of its own. Suddenly with a little hustle and networking, it’s not nearly as hard as it was 5 years ago to simply navigate the “network” without ever needing to pay the gatekeeper. I’ve seen this play out in a number of startup ecosystems across the country, where accelerators faced an initial golden age when they were seen as prime “sorters” of an opaque ecosystem willing to pay for the sorting, and then suddenly the quality of entrepreneurs they can get to pay their “fee” starts to take a clear downward turn. Top entrepreneurs are, by definition, fantastic hustlers. They aren’t going to pay you for something once they’ve realized they can do it themselves with a little effort, or that someone else is offering similar “access” at a lower “fee.”

Once top entrepreneurs realize that they can bypass the accelerator and access its “network” directly, and word gets around, the value proposition of the accelerator can begin to unwind. Suddenly the accelerator cohorts start to fill not with the most highly skilled entrepreneurs (those hustle it out on their own now), but with lower quality entrepreneurs less capable of making things happen “in the wild” and therefore more needy of the accelerator’s high-touch, high-priced assistance. As the quality of the accelerator’s average entrepreneur goes down, the leverage over key people on the other side of the “market” – investors, advisors, etc. – goes down, and fewer of them show up to the accelerator; which then reduces the value prop for entrepreneurs, and you get the exact reverse of the original virtuous cycle.

Seeing this dynamic play out, accelerators have three ways of responding, and I’ve seen them in different markets.

Drop the Price

The first is to simply acknowledge that the accelerator cannot maintain the original value proposition they had before the ecosystem/network had matured, and drop their price accordingly. With less significant of a signal, and less leverage over the market, the high 6-8% fee can’t be sustained, so build something leaner that can be offered at a 1-2% level perhaps. I’ve seen these “leaner” accelerators enjoy some success. Some accelerators started out with the expectation that they were going to dominate a startup ecosystem with high “access” fees, and then over time got humbled when the market delivered a reality check.

Employ the Network

Another option is to convert the accelerator into a kind of “startup studio,” where the main pieces of the network are actually employees paid by the accelerator, or at least with deeper economic ties to the accelerators’ performance; reducing their incentive to leak out of the network. The key challenge here is whether the accelerator really has the cachet/leverage, and resources, to employ those people; or whether A-players find it far better to simply stay outside and keep their pipelines more open.

Another way to “employ” certain network players doesn’t require actually employing them, but simply maintaining some economic control over them. For example, a prominent accelerator might use referral relationships with certain law firms as a way to keep those firms from questioning the accelerators’ behavior, even if it’s clearly at times not in the best interest of the startups the firms represent. That strategy is straight out of the playbook of VCs. See: When VCs “own” your startup’s lawyers and Relationships and Power in Startup Ecosystems. Offering or restricting “access” to potential investments, clients, employers, etc. has always been a currency used by startup power players to keep other market participants loyal and “well-behaved.”

Try to Lock Down the Network

This is where things start to get interesting. So I’m an accelerator enjoying success, but I can clearly see that over time my ability to keep extracting gatekeeping fees over my “network” is weakened by my inability to maintain control over the investors, founders, advisors, etc. within it. Possible solutions:

  • Lock Down Demo Day – Maintain tighter control over who gets access to demo day and, importantly, “discourage” founders from raising financing outside of demo day.
  • Lock Down Financing Structures – Maintain tighter control over how financings within the network occur, by “soft mandating” that they follow templates created and controlled by the accelerator.
  • Lock Down Network Communication with Technology – Create proprietary message boards, mail lists, and other media platforms for communicating within and navigating the network, to “incentivize” networking in ways that give the accelerator visibility and control.

Of course, none of this will ever be communicated openly as mechanisms for the accelerator to maintain power over an ecosystem/network, including founders. They’ll be spun as ways to provide efficiency and value for founders and other people. But as with much spin, there is a point at which it fails to pass the laugh test.

Listen in the market (what gets said privately rarely mirrors what is said publicly), and it becomes clear that the more aggressive accelerators have for some time been building local resistance; irritating investors who resent having a “big brother” dictating how to do biz dev and deals, irritating founders who don’t want to pay a gatekeeping fee for accessing specific ecosystem resources, and irritating other market players who don’t want a rent-seeker standing in-between them and potential business.

When an accelerator “discourages” a startup team from fundraising outside of demo day, it’s going to offer some paternalistic platitude about how having a controlled process helps “protect” the entrepreneurs, but what it’s really about is ensuring the accelerator has (i) leverage over the investor community via ability to deny and control access to its founders, and (ii) leverage over founders by controlling the venue in which they fundraise; which sustains the power of the accelerator to charge high gatekeeping fees.

Once I’ve publicly announced my cohort, the sorting is done and the signal is out. Investors don’t need me (the accelerator) anymore, and in many cases nor do the founders whose main purpose of joining the accelerator was to get “branded” to make getting meetings with investors easier. That threatens the power of the accelerator, which wants to charge not just for sorting/signaling, but for access to a network. “Locking down” outside fundraising, with some clever spin as to why it’s good for startups, is the response.

If an accelerator builds proprietary communication channels for alumni to utilize, maybe that’s to be helpful. Or maybe it’s a way of preventing the network from doing exactly what networks do organically, which is resist gatekeeping and build multiple nodes/channels to prevent a single point of entry through which a rent-seeker can extract access fees. Accelerator’s don’t hold monopolies on brands/signals that startups can leverage to get funding, and therefore other people (like angels, seed funds, and respected founders) within a “network” who can connect founders to money/other resources (offer cheaper “signaling”) are, in a sense, competitors whom the accelerator has a strong incentive to control. Maintaining control / visibility over communication channels is a way for accelerators to prevent leaner competition.

Accelerators are Service Providers, Like Everyone Else

The general conclusion from all of the above should not be that startup accelerators are bad or good; on an individual level many are of course full of great people. Instead, it should be that accelerators are profit-driven service providers and political actors, just like everyone else. They want to charge a higher price, and will do what they can to maintain their power to charge that higher price. Other market players will attempt to build alternatives, and drop that price, and the accelerators will respond by trying to compete with, block, or control those other market players. It’s just like VC, Law, and any other industry that caters to startups.

When transparent meritocracy and markets start to challenge a player’s ability to charge high fees, they often turn to politics; using backdoor relationships to build loyalties and amplify supportive messaging. Accelerators who maintain tight referral and economic relationships with specific funds, firms, and other market players do so in order to ensure there’s a loyal base of people out there toeing the party line, even as opposing voices in the ecosystem start to emerge.

For entrepreneurs, the message is simply to understand where their interests are aligned, and where they’re misaligned, with the interests of accelerators. Branding and signaling are useful. To the extent they are useful to you, use them, at the appropriate price. But by no means allow them to dictate how or when to fundraise, or how to navigate the network. It’s in startups’ interest (and that of ecosystems generally) to stay flexible and keep their options open, even if accelerators would prefer having a tight grip. The golden era of accelerators is almost certainly over, as startup ecosystems and networks have begun to mature, offering multiple accessible paths to networking and investment. But they will still have a place and function for a pocket of the ecosystem that needs them.

To the extent accelerators use politics and leverage to lock down ecosystem resources that founders could otherwise access on their own just fine, or demand that startups and investors do things in a specific way favored by the accelerator, they are no longer transparent market players; they’re rent-seeking gatekeepers. If there’s anyone that startup entrepreneurs love painting a bullseye on, it’s gatekeepers.

Trust, “Friendliness,” and Zero-Sum Startup Games

Background reading: Relationships and Power in Startup Ecosystems

TL;DR: In many areas of business (and in broader society) rhetoric around “positive sum” thinking and “friendliness” is used to disarm the inexperienced, so that seasoned players can then take advantage. Startups shouldn’t drink the kool-aid.

An underlying theme of much of my writing on SHL is that first-time founders and employees of startups, being completely new to the highly complex “game” of building high-growth companies and raising funding, are heavily exposed to manipulation by sophisticated repeat players who’ve been playing the same game for years or even decades. There are many important tactical topics in that game – around funding, recruiting, sales, exits – all of which merit different conversations, but the point of this post is really a more “meta” issue. I’m going to talk about the perspective that should be brought to the table in navigating this environment.

A concept you often hear in startup ecosystems is the distinction between zero-sum and positive-sum games. The former are where there’s a fixed/scarce resource (like $), and so people behave more competitively/aggressively to get a larger share, and there’s less cooperation between players. In positive-sum games, the thinking goes, acting competitively is destructive and everyone wins by being more cooperative and sharing the larger pie. Sports are the quintessential zero-sum game. Someone wins, and someone loses. Capitalism is, broadly, a positive-sum game because in a business deal, both sides generally make more money than if the deal had never happened.

The reality – and its a reality that clever players try to obscure from the naive – is that business relationships (including startup ecosystems) are full of both positive and zero-sum games, many of which are unavoidably linked. It is, therefore, a false dichotomy. In many cases, there are zero-sum games within positive sum games. In fact, rhetoric about “positive-sum” thinking, friendliness, trust, “win-win” is a common tactic used by powerful players to keep their status from being threatened.

For a better understanding of how this plays out in broader society, I’d recommend reading “Winners Take All: The Elite Charade of Changing the World” by Anand Giridharadas, who deep-dives into how, in many cases, very wealthy and powerful people (i) on the one hand, fund politicians/legislation that cut taxes and funding for collectively solving social problems while (ii) simultaneously, spending a smaller portion of the saved money on “philanthropic” or “social enterprise” initiatives aimed at addressing those same social problems, but in a privatized way where they are in more control. The net outcome is that those powerful players direct discussion away from collective solutions that may require addressing some unavoidable zero-sum realities, and instead get society to myopically focus on a narrower segment of purportedly “win-win” options that don’t actually threaten their power and status.

There is much room to debate the degree to which Giridharadas’ perspective is an accurate representation of American philanthropy/social enterprise, but anyone with an ounce of honesty will acknowledge that it is definitely there, and large.  Once you’ve successfully won enough zero-sum games (acquiring wealth and influence), it can be in your self-interest to cleverly get everyone around you to now only think about “positive sum” perspectives, because by staying on only those topics, you’re guaranteed to never lose your status. Warm-and-fuzzy rhetoric and “friendliness” are often not a reflection of some newly discovered moral high-ground among the wealthy, but instead a self-interested strategy for wealth and power preservation.

While the details are clearly different, this dynamic plays out all over startup ecosystems. They are full of influential market actors (accelerators, investors, executives) acting as agents for profit/returns driven principals, and in many cases legally obligated to maximize returns, and yet listen to much of the language they use on blogs, social media, events, etc. and an outsider might think they were all employees of UNICEF. This is especially the case in Silicon Valley, which seems to have gone all “namaste” over the past few years; with SV’s investor microphones full of messages about mindfulness, empathy, “positive sum” thinking, and whatever other type of virtue signaling is in vogue.  Come take our money, or join our accelerator, or both. We’re such nice people, you can just let your guard down as we hold hands and build wealth together.

Scratch the surface of the “kumbaya” narratives, and what becomes clear is that visible “friendliness” has become part of these startup players’ profit-driven marketing strategies. With enough competition, market actors look for ways of differentiating themselves, and “friendliness” (or at least the appearance of it) becomes one variable among many to offer some differentiation; but it doesn’t change any of the fundamentals of the relationship. Just like how “win-win” private social enterprise initiatives can be a clever strategy of the wealthy to distract society away from public initiatives that actually threaten oligarchic power, excessive “friendliness” is often used by startup money players to disarm and manipulate inexperienced companies into taking actions that are sub-optimal, because they lack the perspective and experience to understand the game in full context.

With enough inequality of experience and influence between players (which is absolutely the case between “one shot” entrepreneurs and sophisticated repeat player investors) you can play all kinds of hidden and obscure zero-sum games in the background and – as long you do a good enough job of ensuring no one calls them out in the open – still maintain a public facade of friendliness and selflessness. 

As startup lawyers, the way that we see this game played out is often in the selection of legal counsel and negotiation of financings/corporate governance. In most business contexts, there’s a clear, unambiguous understanding that the relationship between companies and their investors – and between “one shot” common stockholders v. repeat player investors – has numerous areas of unavoidable misalignment and zero-sum dynamics. Every cap table adds up to 100%. Kind of hard to avoid “zero sum” dynamics there. As acknowledgement of all this misalignment, working with counsel (and other advisors) who are experienced but independent from the money is seen, by seasoned players, as a no-brainer.

But then the cotton candy “kumbaya” crowd of the startup world shows up. We’re all “aligned” here. Let’s just use this (air quotes) “standard” document (nevermind that I or another investor created it) and close quickly without negotiation, to “save money.” Go ahead and hire this executive that I (the VC) have known for 10 years, instead of following an objective recruiting process, because we all “trust” each other here. Go ahead and hire this law firm (that also works for us on 10x more deals) because they “know us” well and will help you (again) “save money.” Conflicts of interest? Come on. We’re all “friendly” here. Mindfulness, empathy, something something “positive sum” and save the whales, remember?

Call out the problems in this perspective, even as diplomatically as remotely possible, and some will accuse you of being overly “adversarial.” That’s the same zero-sum v. positive-sum false dichotomy rearing its head in the startup game. Are “adversarial” and “namaste” the only two options here? Of course not. You can be friendly without being a naive “sucker.” Countless successful business people know how to combine a cooperative positive-sum perspective generally with a smart skepticism that ensures they won’t be taken advantage of. That’s the mindset entrepreneurs should adopt in navigating startup ecosystems.

I’ve found myself in numerous discussions with startup ecosystem players where I’m forced to address this false dichotomy head on and, at times, bluntly. I’m known as a pretty friendly, relationship driven guy. But I will be the last person at the table, and on the planet, to accept some “mickey mouse club” bullshit suggesting that startups, accelerators, investors, etc. are all just going to hold hands and sing kumbaya as they build shareholder value together in a positive-sum nirvana. Please. Let’s talk about our business relationships like straight-shooting adults; and not mislead new entrepreneurs and employees with nonsensical platitudes that obscure how the game is really played.

Some of the most aggressive (money driven) startup players are the most aggressive in marketing themselves as “friendly” people. But experienced and honest observers can watch their moves and see what’s really happening. Relationships in startup ecosystems have numerous high-stakes zero-sum games intertwined with positive-sum ones; and the former make caution and trustworthy advisors a necessity. Yes, the broader relationship is win-win. You hand me money or advice/connections, and I hopefully use it to make more money, and we all “win” in the long run. But that doesn’t, in the slightest, mean that within the course of that relationship there aren’t countless areas of financial and power-driven misalignment; and therefore opportunities for seasoned players to take advantage of inexperienced ones, if they’re not well advised.

Be friendly, when it’s reciprocated. Build transparent relationships. There’s no need to be an asshole. Startups are definitely a long-term game where politeness and optimism are assets; and it’s not at all a bad thing that the money has started using “niceness” in order to make more money. But don’t drink anyone’s kool-aid suggesting that everything is smiles and rainbows, so just “trust” them to make high-stakes decisions for you, without independent oversight. Those players are the most dangerous of all.

How Paralegals and Junior Lawyers Can Hurt Startups

TL;DR: In engaging startup law firms, founders need to pay close attention to the differences between inexperienced junior legal professionals, like paralegals and junior attorneys, relative to experienced senior attorneys and partners. In order to fit their high-cost structures into tight startup budgets, some law firms significantly water down their services by forcing startups to regularly engage mostly with inexperienced junior people; many of whom are advising founders on issues they simply lack appropriate experience and judgment for. For high-stakes, complex issues, many of which come up in the early days of a company, this can lead to costly missteps for which startups end up paying a very high price.

Because of their inexperience, first-time founders often get tripped up in engaging their first legal services providers. Very often, they think they just need “a lawyer,” without understanding that, just like doctors, law has dozens of specialties and sub-specialties; and they need lawyers who specialize in emerging technology companies. But even if they narrow down the options of firms they are talking to, founders often lack an understanding of the differences in how various startup law firms/practices are structured in terms of senior professionals v. junior, and how that has a very material impact on the kind of service the company is going to receive.

In What Partners in Startup Law Firms Do, I walked you through what the different titles and levels of expertise at law firms mean. Partners at serious, respected firms have gone through extremely strict vetting and training processes, ensuring that they’re capable of delivering very high-stakes (very high-cost of errors) and flexible legal expertise in complex, multi-variate contexts that fast-moving startups often find themselves in. The process of moving away from Partners toward more junior-level attorneys and paralegals is often referred to as “de-skilling.” It requires adding rigidity and uniformity to work (checklists, templates, standardization, automation), so that less-capable professionals are able to handle limited-scope projects without blowing things up.

De-skilling is an important and very useful part of building up any law firm, because it allows firms to make highly-specialized and trained Partners accessible to companies when they’re needed (which is often, but certainly not all the time), while also handling lower-stakes and simpler work more efficiently and at lower cost.  While every law firm that works with startups offers a level of de-skilled work, it’s clear that firms vary dramatically in how far they go with it.

Some firms keep partners and senior-level attorneys highly involved with a startup from Day 1, while delegating periodically to paralegals and juniors. Other firms go so far as to make paralegals and junior lawyers the main point of contact for early-stage founders. To a first-time founder, the difference between these two approaches can seem subtle, but in terms of what is actually being delivered by the firm (and long-term outcomes), the differences are the opposite of subtle. In fact, we constantly see fast-growing startups make extremely expensive legal mistakes (or poorly thought-out strategic decisions) because the founders were relying on paralegals and juniors – as a “cost saving” mechanism – when those junior professionals were totally out of their league in the advice they were giving.

When paralegals and junior lawyers are made the main legal contacts of a startup, it’s the law firm’s way of saying “You’re little right now, and therefore just a number to us. But if you become something more significant, we’ll allocate our real expertise (senior level) to you.” The problem with this mindset is that many of the decisions made in the very early days of a startup are setting up the foundation and relationships that the company is going to live with throughout its trajectory. The company may be small at the moment, but actions being taken can be extremely high-impact and permanent, and therefore often require experienced judgment. This is especially true if the company doesn’t fit into a cookie-cutter context that can be distilled into a linear, simplified template for a junior to follow.

High-cost firms with weak(er) brands often over-delegate to inexperienced paralegals and juniors.

While a number of variables can play into it, the single largest driver of how much startup law firms rely on paralegals and junior lawyers is the interplay between the firm’s overall cost structure and the budget that startups engaging that firm are willing to accept. I emphasize that it’s the interplay of those two factors, because while some very high-cost law firms could stretch the amount of junior delegation that they throw onto startups, their reputation is sufficiently strong that founders who engage them are willing to pay the high cost of staying closely in contact with partners and seniors.

The very top of the top-tier of high-cost startup “BigLaw” – the top 3-5 firms, what I often refer to as the “Ferrari” tier – often doesn’t have to play games with excess de-skilling. They’re expensive, founders know they’re expensive, and yet they stay very busy anyway because if you’re legitimately on a Unicorn track (>$15MM Series A, clearly gunning for a 10+ figure long-term valuation) you’re a fool for using any other firm outside of that category. Companies on this track usually don’t struggle to pay their legal bills, even if they’ve engaged a Ferrari firm, because the size of their financings can more than accommodate a large legal budget.

It’s often the second tier of the very high-cost firms that I’ve seen start playing games with over-delegation to juniors. These firms also have extremely high operation costs, including all of the pricey infrastructure of the Ferrari tier, but they don’t have the brand credibility to command appropriately sized budgets from their early-stage clients. How do you make the math work in that case? You offer founders lower-priced fixed-fee projects, while putting in the fine print that the founders are going to spend 99% of their time talking to paralegals and juniors incapable of offering effective advice outside of very narrow contexts. Some of these firms will also throw in some half-baked automation software (cue the “machine learning” and “AI” buzz words) to make over-dependance on juniors seem “cutting edge,” when it’s actually a playbook that firms have been using for some time; and smart entrepreneurs know to avoid it.

The true Ferrari tier of Startup BigLaw often doesn’t need to play games with over-delegation to juniors, because founders who engage them know exactly why those firms are so expensive, have accepted it, and are willing to pay for experienced, senior-level attention. It’s more… OK let’s stick with the car analogy, the “Jaguar” tier of BigLaw (high-cost, but not the top of the top tier) that most often follows the junior-driven playbook. Their operating costs are the same as (or very close to) the Ferrari firms, but they have to offer discounts and lower budgets to attract startup clients (weaker brand); necessitating a watering-down of the actual offering to make the math work. What you end up with is still far from cheap, but requires you to stay within a very rigid, narrowly defined path for everything to not fall completely off the rails.

The point here isn’t to come down hard in saying that one approach or the other is right for every startup, but to simply ensure founders are aware of it, and use their judgment rather than being duped by clever marketing. Companies on what could truly be called “cookie cutter” trajectories can be OK having paralegals and inexperienced junior lawyers be their main legal contacts via what amounts to a “LegalZoom with a little extra” type of legal service offering. But experience has shown me that many entrepreneurs over-estimate how much of their legal work is (air quotes) “standard,” which can result in a blow-up once the legal technical debt comes due.

For negotiation-oriented issues, like structuring the subtleties of financings or serious Board-level discussions, there may also be ulterior motives behind investors pushing their portfolio companies to lean on inexperienced advisors (law firms that push startups to use junior people), with fabricated “standards” as an excuse. If it’s all just templates and standards, then what’s the harm in having your investors pick your law firm, right? Watch incentives and conflicts of interest. See: Negotiation is Relationship Building and When VCs “own” your startup’s lawyers.

When you, as a first-time entrepreneur, don’t know what you don’t know about high-stakes legal and financing issues, and you’re interacting with extremely seasoned and smart (but misaligned) business players, the last thing you want is to be relying on advisors who are only marginally more experienced than you are; or worse, are also “owned” by the money across the table.

High-end Boutique Law Firms are leaner and can offer lower costs, without over-reliance on inexperienced juniors.

Excess amounts of de-skilling and delegation to paralegals/juniors is not the only way that the legal market has attempted to lower legal costs for startups. An alternative, which we are a part of, is the emergence of high-end boutique law firms. These firms can offer regular access to true Partners and Senior Lawyers, but at rates equivalent to what the Ferrari tier charges for junior lawyers (hundreds less per hour); because they’ve cut out a lot of the overhead infrastructure that tends to inflate the cost of BigLaw. If your clients are Apple, Uber, and companies on that track (Ferrari tier of BigLaw), the way you build and market your firm will by necessity look very different from firms who deliberately target clients that, while serious and building important products/services, rarely make it onto the headlines of the NYT or WSJ (boutique firms).

This “lower overhead” (lean) boutique approach to law is not without its trade-offs, and I make that clear in my writings on the emerging boutique ecosystem. Every firm structure ultimately still has to follow math, and there simply is no magical wand that you can waive to deliver (again with the car analogies) Ferrari performance and resources at Acura/BMW prices. The very highest-end law firms that cater to marquee billion-dollar companies (and aspiring Unicorns) are extraordinarily expensive to grow and run, and there are very smart people running them who are well aware of how to safely trim costs within the constraints of what it takes to serve their clients. Boutiques offer a fundamentally different cost structure, because they are designed for a fundamentally different kind of client that doesn’t need a lot of the resources of the Ferrari class.

And please spare me the vaporware marketing suggesting that some new whiz-bang-pow piece of automation technology fundamentally changes the math of law firm economics. At the tier of corporate legal work that we are discussing (scaled, high-complexity and variability, high cost of errors, contextualized subjectivity), the amount of work even within the realm of possibility of being automated away with AI and data is a microscopic portion of what serious firms do. With apologies to the soylent-sipping lawyer haters out there (I see you, Silicon Valley uber-engineers), Siri isn’t going to negotiate your financings, or navigate your corporate governance, any time soon. We love legal tech and have adopted a lot of useful new tools, some of which are still in private beta; but nothing in the next 5-10 year horizon is going to fundamentally re-make law firms. Not at this level of complexity.

Properly structured high-end boutique law firms can and do offer significantly lower costs than BigLaw, without denying startups regular access to Partner-level, flexible strategic expertise. But the savings come from removing costs and resources that are required only if you are trying to serve the very highest end of the tech market; and boutiques don’t.

I tell founders all the time, “If you legitimately think an IPO or billion dollar valuation is on your visible horizon, please hang up and call the Ferrari tier of BigLaw.” We don’t do IPOs, and we’re not going to do your 10-figure cross-border merger involving 5,000 employees, 500 stockholders, and four tax jurisdictions. Hard pass.

At E/N, our Partners are perfectly happy letting the Ferrari firms compete for and serve Ferrari clients, while we work with a segment of the tech ecosystem that has been badly underserved.  Our clients tend to exit between $50MM and $250-ish MM, and obviously at lower sizes if it’s an earlier-than-expected sale. Their legal needs and financings are sufficiently large and complex to pay rates high enough to support serious lawyers and right-sized infrastructure for scalability, but the founders also have an instinctive understanding that their trajectory isn’t going to be anything you’d call “cookie cutter,” nor are they aspiring to be a Unicorn.

High-end boutique startup law firms thus offer a balanced compromise and useful value proposition for founders building companies that clearly need credible, highly-trained and specialized senior-level expertise (without reckless over-reliance on paralegals and juniors, or half-baked automation software), but for whom the Ferrari tier of the tech legal market is clearly overkill. Boutiques cannot and do not scale like the very top-tier of BigLaw, but the fact is that an important segment of the tech ecosystem doesn’t need them to.

Founders exploring the legal market should, at a minimum, ensure that they understand not just the varying cost structures of law firms, but also the varying levels of expertise/service those firms are offering within their cost structures. Two firms might look like apples to apples on the surface, but what your budget actually gets you ends up being wildly different. Firms promising low fees in exchange for inexperienced junior professionals (who can’t navigate significant complexity/flexibility safely, and offer poorly-fitted rigid advice) are selling something that – to experienced players who aren’t easily fooled – looks far less like efficiency, and far more like a time bomb.

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 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.

The Problem with “Standard” Term Sheets (including YC’s)

TL;DR: Whenever an influential organization publishes a so-called “standard” financing document, important questions need to be asked about not just its specific terms, but also the entire concept of “standard” terms in general, and potential biases in their creation. In YC’s case, their decision to keep their “standard” TS very short (for speed purposes), and not address key economic/control issues, favors investors by deferring negotiation on those issues to a context (after signing) where common stockholders have less flexibility and leverage. YC’s default terms also give VCs substantial power that is hardly a “standard.” In the broader context (apart from YC), there are serious problems emerging in the startup legal market with how certain narratives around “standards”, closing fast, and the hiring of lawyers with deep conflicts of interest, are leading (and tricking) entrepreneurs & early employees into adopting legal strategies that hurt their long-term interests.

In Startup Law and financing, standardization and templates are often celebrated as noble, generous attempts at saving entrepreneurs money that they would otherwise “waste” on advisory fees. While it is definitely true that, to a point, creating uniform language improves efficiency, there are very real, and often dangerous, high-stakes issues that founders need to hear about regarding “standards,” but unfortunately they often don’t. The narrative of ‘reducing friction’ in financings has devolved into a clever excuse for imposing imbalanced terms on inexperienced startups, and keeping them ignorant of both the long-term implications and potential alternatives. 

Take Y Combinator’s recent so-called “Standard and Clean” Series A Term Sheet as just one example. YC has placed itself at the forefront of attempting to standardize early-stage fundraising docs for startups.  The SAFE (Simple Agreement for Future Equity) has become in Silicon Valley a dominant instrument for seed fundraising, though survey data (and our experience) suggests it’s not nearly as dominant outside of California.

Given that the SAFE was, relative to other instruments used in the market (like convertible notes) a quite company-friendly agreement, YC established itself as offering very “founder friendly” standards in templates they create.  So one would’ve expected that their “Standard and Clean” term sheet would follow the same trajectory. However, when we reviewed YC’s term sheet, our initial response – as lawyers who represent companies, and only companies (not their investors) – was “Uh oh.”

Side note: Recent changes to the SAFE instrument made by YC have made SAFEs significantly less company-friendly from an economics standpoint, which when combined with YC’s release of its problematic Series A term sheet template, suggests a reversal of YC’s historical philosophy on having “founder friendly” documentation. This means entrepreneurs should be extra cautious before rushing to use YC’s favored forms.

Short term sheets benefit investors

First, YC’s term sheet is remarkably short as far as equity term sheets go. The reason is somewhat reflected in their own blog post’s words:

“So don’t lose sight of the ultimate goal: closing fast and getting back to work.”

Short term sheets get signed faster than longer ones, because there’s less to discuss. Here’s the problem with short term sheets, though: once you sign a term sheet, two things happen:

A. You are now locked in with a “no shop” clause. That requires you to inform any other investors you were talking to that you are taking someone else’s deal. Good luck going back to them if this deal ends up not closing.

B. You start racking up legal fees with your own lawyers, which for a cash-limited startup puts pressure to close, and accept terms on the table, in order to pay those fees.

In other words, once you sign a term sheet, your leverage and flexibility dramatically go down. It becomes far easier for investors to pressure you with this or that language (which they will usually claim is also “standard”) than it would’ve been during the term sheet phase. So rushing to sign a short term sheet favors investors over startups.  Slowing down and clarifying all material points at the term sheet phase also saves legal fees, because it reduces back-and-forth with the lengthier definitive documents.

Fair enough, you might say. YC favors moving fast anyway, because there can be benefits to moving fast for everyone. OK.

YC gives VCs full veto rights on equity financings

Here’s a second issue: as drafted, YC’s “standard and clean” terms give your VCs and other investors a complete veto right over all future equity financings, regardless of what the Board composition is. In other words, even if the common stock controls the Board (which shouldn’t necessarily be the case), and has a deal on the table with great terms, your VCs can block it simply because they, for whatever self-interested reason, don’t like it.

This is usually a point at which at least a few founders might be thinking “WTF?”

When you move to close an equity financing, there are at least two approvals that need to happen: Board and Stockholder votes. The Board vote is subject to fiduciary duties, but the stockholder vote isn’t, save for a few narrow circumstances. In a stockholder vote, you can block something for whatever reason you want, effectively. Yes, we have seen VCs block deals that common stockholders wanted, and with great terms; but because the VCs had self-interested reasons for favoring another deal, they refused to approve. This can give them remarkable power over what deals get done and don’t.

To be fair, YC points out this hard veto right in their blog post’s footnotes. Putting aside the fact that those footnotes won’t make it into a redline, probably their expectation is that good startup lawyers will always mention the issue to their clients, and negotiate if possible. In other words, their “standard” perhaps isn’t as big of a problem because it will be negotiated. And that brings us to a more important point in this post, which isn’t about YC specifically, but the entire concept of “standard” terms.

What is “standard”?

What exactly do we mean when we say something is “standard”? Whose data are we using?

Given that investors are on one side of a deal, and entrepreneurs (and other employees) on another, might we be a little cautious in letting investors be the ones telling the market what the “standards” are?

When YC, with its prominent brand, places the label of “standard” on giving VCs unilateral veto rights on future financings, that influences the market, even if unintentionally, in favor of VCs. Now lawyers representing the interests of startups/common stockholders (like us) have to negotiate not just with investors across the table, but against a now so-called “standard.”

We’ve closed many, many deals where we don’t give VCs this kind of broad veto right, and soften it significantly to make it more balanced. But now when we push back on giving VC’s these veto rights, their response is going to be: “Look at YC’s term sheet. Giving us a hard veto is the market standard.”

Which leads to another question: what is the appropriate threshold for something becoming “standard”? 75%? More than 50%? If 49% of deals don’t have a provision, or even 10%, there are good arguments that there are in fact multiple “standards.” But when some “standards” favor repeat players with microphones and dominance over startup ecosystems, while other “standards” favor “one shot” players (like first-time entrepreneurs and employees), which ones do you think get publicized? Taking a 75% standard, as an example, and then prominently publicizing it as the “standard” can be a way to move the market to 100%, with “efficiency” as a weak excuse for eliminating flexibility on such a high-stakes provision.

Even if we had perfect objective data, at what point should startups place more weight on their own priorities, unique context, and leverage for the permanent, highest-stakes economic and power terms of their company’s governance, instead of aggregated, anonymized data covering a huge diversity of companies?

One could argue that the publication by investors of their own so-called “standards” is a kind of assertion of market power, and a way to influence long-term the data that is then used to justify those same standards. Do common stockholders have the ability to do the same and ensure balance? No, they don’t. They depend on individual lawyers to represent their interests and help make up for the power inequality. And that finally brings us to an even bigger problem.

The “own the advisors” game.

Let us paint a picture of a “game” of sorts for you. The game has two broad sets of players: “one shot” players and repeat players.

The “one shot” players are first-time entrepreneurs and early employees; common stockholders. They are usually not diversified, which means their wealth is concentrated in their one company. They also typically lack significant personal wealth, and don’t have downside protection on their equity, further magnifying their “skin” in this “one shot” that they have. Finally, not having played the game before, they rely on experienced, trusted (hopefully) outside advisors (like lawyers) to help them not get taken advantage of.

The “repeat players” (investors, accelerators) are in the polar opposite situation. They are wealthy, diversified, downside protected (liquidation preference or a debt claim), and they’ve played the game many, many times. In the case of the largest repeat players, they’re also incentivized to take significant risks in order to “swing for the fences” and go after risky big prizes, even if doing so increases the number of total failures; failures which hit the one shot players far harder because they aren’t diversified across a portfolio juiced for “power law” returns.

There is a fundamental misalignment here that never goes away, and feeds into many high-stakes decisions (and disagreements) in a company’s history around recruiting, risk, fundraising, exits, etc. Both sides want to make money, but they are often misaligned in their perspectives on how to do so, whom to raise funding from (and on what terms), and what level of risk is acceptable. The repeat players have 100x the experience of the one shot players, but the one shot players hope their advisors can help “balance” the inequality as they navigate this misalignment.

Now, let’s say I’m a very smart repeat player – a “chess player” of sorts – and I’d prefer that this “balancing” not really happen. I make more money, and keep more control, if I can somehow get in the way of the lawyers helping the one shot players. But at the same time, if I look too visibly aggressive in doing so, the one shot players won’t want to play with me at all. So as an investor I want to win, but in a way that preserves a public image of selflessness so that inexperienced players keep coming to me, and preferably with minimal defenses. What’s a good multi-step strategy?

Here’s a suggestion.

1. Create “standards” for the game, based on limited data, and with microphones, that the one shot players can’t see or influence. Publish these so-called “standards” while emphasizing how much money they’ll “save” everyone by using them. Talk a bit about how you were once yourself a one shot player (former entrepreneur), so you’re really doing this out of selfless empathy for the new folks; even if now you’re highly misaligned.

2. Build relationships with lawyers that the one shot players hire for advice, by hiring those same firms on the much larger volume of deals you control, and also referring other people to them from your broad network as a repeat player. This ability to refer lots of work to said lawyers is a “currency” that the inexperienced one shot players always lack.

3. Recommend to the one shot players that they hire these same awesome lawyers that you (the repeat player) prefer, because of how “efficient” and “high quality” they are, and how well they know the “standards.” You know that those lawyers view you as a source of 50x as much “deal flow” as any one shot player, and would never do anything to jeopardize that deal flow. Emphasize how much money will be “saved” by using “familiar” lawyers.

4. Tell the one shot players that, given everything is “standard” anyway, they should focus on “closing fast” and saving fees. In fact, they should hire the lawyers on a flat fee, which ensures that the faster the lawyers move (the less time they spend advising the inexperienced startup and negotiating on its behalf), the more money those lawyers make. You can have two sets of lawyers who charge the exact same end-price, but those charging a “flat fee” (as opposed to billing by time worked) are actually rewarded for doing less work, with an improved margin.

5. With the “standard” (that repeat players created) in hand, the lawyers (that repeat players control) “close fast” (earning a better margin on their flat fee), with minimal discussion or negotiation, so everyone can move on and not “waste money” on unnecessary advisory.

6. The repeat players, very happy with how “high quality” and “efficient” the captive lawyers were at closing on their standard, refer them more work; regardless of how well it served the one shot players who, on paper, were the client.

7. Rinse and repeat over many iterations. Now we have market data that validates the “standards” that the repeat players created, further entrenching it.    

Does this game sound familiar to anyone? We bet it does to startup lawyers.

We go more in-depth into how the game is played, and strategies for avoiding it, in Relationships and Power in Startup Ecosystems and How to Avoid “Captive” Company Counsel.

The core point is this: there is a structural problem with how certain startup ecosystems have evolved to approach “legal” and the hiring of lawyers. It’s the result of a significant imbalance of power between “one shot” startups and the repeat player investors/accelerators they work with, the latter of which have found many (not all) startup lawyers quite eager to flout conflicts of interest in order to generate business for themselves.

“One shot” common stockholders (entrepreneurs, employees) and “repeat player” investors (including accelerators) are not fully aligned in terms of economics and incentives, given the above-described differences as it relates to diversification, wealth, experience, and downside protection. Repeat players, through their ability to operate as brokers/gatekeepers of referrals, have increasingly pushed founders to hire law firms that are ultimately “captive” to investors, and even then sometimes insist that those law firms adopt billing practices (like flat fees) that actually reward lawyers for rushing work and under-advising inexperienced startups. 

And all of this is done under the pretense of wanting to help founders “save” money. In this game, the appearance of “founder friendliness” is often a marketing tool to help lull first-timers into forgetting how misaligned they are from the money players, and then taking advice from those same money players that ends up, unsurprisingly, being an “own goal.” Former entrepreneurs-turned-investors are often the most skilled at using their pasts (as entrepreneurs) as smoke and mirrors to get now first-time entrepreneurs and early employees to forget their misalignment, and take their advice as gospel.

In fact, if you look around the market and find startup law practices that have grown at an abnormally fast, seemingly non-organic, pace, what you’ll often find is lawyers willing to juice this conflict of interest-driven game as far as possible, to a point getting preciously close to meriting litigation. We’ve seen at least one threatened law suit already.

We see the negative consequences of this game all the time around the country, as inexperienced “one shot” common stockholders (including entrepreneurs) are duped into signing (air quotes) “standard” deals, and taking certain “standard” actions, while having no real clue as to what the long-term consequences are because everyone was celebrating how great of an idea it is to “close fast” and keep it “standard.” When the long-term consequences of the “standard” docs and actions play out, it becomes clear no one ever actually explained to the inexperienced common stockholders and the company what the real implications were, or how they could’ve been negotiated for more balance; because everyone capable of doing so was ultimately incentivized to favor the interests of the money. 

So not only are we increasingly pushing so-called “standards” that are themselves biased and questionable, we’re depriving the most inexperienced and exposed people in the ecosystem, the new entrepreneurs and early employees, of the right to even be truly independently advised in assessing those “standards.” And we’re selling it all as noble and well-intentioned because it purportedly “saves” them fees, even if the long-term negative consequences for them far exceed whatever fees they “save.”

To be sure, not every team gets hurt by the emergent “close fast and keep it standard” dogma; in much the same way that not everyone who smokes gets cancer. Some teams manage to protect themselves in other ways, regardless of what the docs say, or are lucky to work with lawyers who fully do their job. But the issue is so pervasive, and there is enough damage occurring to inexperienced players, that it needs to be, at a minimum, discussed out in the open by people not incentivized to dismiss or downplay it.

We believe that startups are more than capable of making their own decisions as to how they want to hire advisors, including counsel, once they’ve heard the full story and potential implications. Part of the problem is how little open and honest discussion occurs on the topic, and how much market pressure to use captive lawyers is applied quietly in the background, precisely because the market is dominated by repeat player perspectives; many of which are cleverly spun and publicized as “friendly.”

Negotiating the YC “Standard and Clean” Term Sheet

To be crystal clear, this broader diagnosis of the market is not about YC at all. YC is a great organization, and many of our firm’s clients (including YC companies) have fantastic things to say about their program. We have no idea what YC’s arrangements are in terms of referring companies to certain conflicted or non-conflicted law firms, or the kinds of economic arrangements they promote with those firms. For all we know, YC legitimately believed that they could post this “standard,” and then expect truly independent, non-captive lawyers to then do their job and produce fair outcomes.

But while we have your attention, given that this “standard and clean” term sheet is already out there, a few suggestions that we would give to companies and common stockholders before signing it:

A. Soften the vetoBuild some “boundaries” around the veto right on future financings. For example, if the valuation is a certain amount above the current price (not a down round), perhaps a Board vote should be sufficient. The Board is subject to fiduciary duties, which can constrain bad actors. Maintain some kind of “path” to a value accretive financing, even if the current money gets hostile and tries to reduce competition, or force a deal with their “friends.” There should also typically be some kind of ownership threshold below which all VC vetoes go away.

B. Clarify the shadow preferred’s economicsBe clearer about the economics of the “shadow preferred” referenced for Notes/SAFEs. What are their liquidation preferences? Term sheets are a good opportunity to address any liquidation overhangs if the Notes/SAFEs themselves don’t address them.

C. Clarify the common stock’s board voting rightsDo the common stockholders have to be employees in order to vote for the common stock’s board seats? This has significant power implications long-term, because there can be any number of reasons why early common stockholders might leave the company (or be forced out), and still want a voice (even if not control) in governance; and for good reasons. When there’s a power shift, common stockholders remaining on payroll are usually far more beholden to the money, and because their equity was often issued later (at a higher price), their economics and incentives are more aligned with later investors. Make VCs explain in full just why exactly it’s so important that all common directors be service providers, or be elected by service providers, to the company. Listen closely enough, and you’ll understand how the arguments are often thinly veiled power plays.

Also, does one common director have to be the CEO? This is usually (but not always) the case. Discuss it and spell it out in the term sheet. Just like the previously mentioned point, given that the CEO position often eventually gets filled by a later common stockholder recruited by the Board, with different priorities and incentives from early common stockholders, this has control implications long-term. Again, tying common director positions (and the voting in their elections) to being on payroll is often a subtle power move to eventually exclude (as a company scales) early common stockholders from having visibility and a say in company governance; because they’re the people most likely to disagree with later-stage investors on how to scale, when to exit, and how much risk is acceptable.

Provide a “yes” or a “no” to these questions. Silence means shifting negotiation post-term sheet, where the common have less flexibility. Be mindful of how some players will spin this discussion into a caricature of founders not wanting to give up control. Control and a voice/visibility are two completely separate issues. There are many constituencies on a cap table with various incentives and interests. There are good arguments for why, as a company scales and the stakes get higher, early common stockholders – who are the most exposed to dilution and risk – should still have some say and visibility (even if not control) in company governance, to voice concerns around risk, financing strategy, recruiting, exits, etc. Conflating the narrow context of a founder unwilling to share control with the far broader, and far more legitimate reality that early common stockholders and investors have very different incentives and perspectives on company growth, is a common straw-man tactic for obfuscating the issue.  Both sides deserve to have un-muzzled voices in governance.

D. Clarify the anti-dilution exceptionsBe clearer about the exceptions to anti-dilution adjustments, instead of engaging in a post-signing “battle of the standards.” While not always an issue, these can sometimes be ways for the preferred to squeeze the common by refusing to waive anti-dilution unless they “give” on something. Spell them out in the term sheet.

E. Clarify how all Board voting will happenAre there specific Board actions that, aside from a Board majority, the investors expect for their own directors to have veto over? If not, say so. If so, list them. VC docs often have a section, apart from stockholder veto rights, that give the preferred directors veto (at the Board level) over certain key actions. If you’re silent about this issue, instead of making it clear that a majority governs all the time, investors will often claim that it’s an open point for negotiation in the docs. Silence is not your friend.

If YC truly wants their term sheet to serve as a balanced (and not biased) reference point for Series A deals (and I believe they do), they should prominently address at least these core economic and control issues; not in a passing blog post reference, but squarely in the document with appropriate brackets so as not to signal a “default” and therefore not slant negotiations. Having public templates as starting points, like the NVCA has done for some time, can be helpful, and we utilize them regularly to streamline negotiation and save fees. But it’s a big responsibility and needs to be done carefully; with input from people on the other side of the table whom the money can’t “squeeze” if they speak honestly and openly.

The general theme here is that you should be clear in the term sheet on all material issues. Nothing is more material than economics and control. Keeping it short, and glossing over things by referencing a nebulous “standard,” or simply not addressing a point at all, favors investors because it transfers negotiation to a context where the company has less optionality and flexibility. We’ve closed deals that land, after transparent discussion and negotiation, in any number of places on these above-mentioned points. The real point we’re trying to emphasize in this post isn’t about pushing deals to go in one direction or another – that depends on the context – but highlighting just how often these issues aren’t even discussed with startup teams because of games that investors and lawyers are playing, and their incentives to “close fast.”

Some people argue that you should “sign fast” on a term sheet because if you negotiate, you might “lose the deal.” We don’t see that actually happen in practice, and can’t think of a clearer signal that you might not want to take someone’s money than being told that the deal will die if you try to clarify even a few material points. This, again, is the kind of sleight of hand rhetoric that sounds like it’s advice to help entrepreneurs, when in fact it helps investors. In reality, spending more time to achieve alignment on a more detailed term sheet expedites drafting and closing once the term sheet is signed.

Start asking the right questions.

In a game of the inexperienced v. the highly experienced, moving very fast, and not taking the time to ask important high-stakes questions, favors the experienced. Great startup lawyers prioritize deals because they know they deserve urgency, but show us lawyers who act as if speed should be a founder team’s top priority in a financing, and we’ll show you lawyers who are captured by money players. In too many cases, startup entrepreneurs’ cultural inclination toward speed and automation – which in the right contexts is a good thing – has been hijacked by misaligned but very clever repeat players in order to dupe the inexperienced into adopting legal strategies that actually hurt their interests.

Wrapping this topic up, as counsel our job isn’t to always provide startup clients direct answers, but sometimes to simply ensure they, in their inexperience and unequal power in the market, are asking the right questions. Questions like:

  • What do we really mean by “standard”? Can the data be manipulated?
  • Whose “standard” is it, and are they biased? Can their “founder friendliness” be a marketing tactic instead of full reality?
  • How much should I even care whatever “standard” means, at least as it relates to my most high-stakes terms, if I’m building a unique company with its own priorities, context, leverage, etc.?
  • Might it be a bigger problem (than my investors will acknowledge) if my company counsel is far more motivated, via referrals and other economic ties, to keep my investors happy instead of the inexperienced common stockholders whose skin is entirely in this one company?
  • Is “moving fast” and rewarding my company’s lawyers for minimizing their involvement (with flat fees) really in my best interests, or is “saving money” a clever excuse to keep me ignorant and not properly advised of what I’m getting into, so that more experienced players can then take advantage of the imbalance?

We don’t pretend to have universal answers for these questions, because there aren’t any. Where you land depends on the context, the people involved, their unique priorities, and the kind of relationship they expect to have going forward. You know, a lot like term sheets.

This post (which is not legal advice, btw) was co-authored with my NYC colleague, Jeremy Raphael.