Post Category → Advisors

Negotiation and Inexperience

TL;DR: Having access to trusted advisors, and the time to consult with them, is essential for anyone negotiating terms with which they have very little experience. Don’t accept someone’s argument that you must negotiate important issues live. It’s simply untrue, and a tactic for gaining unfair leverage.

Background Reading:

A recurring theme of SHL posts is that entrepreneurs, particularly first-time entrepreneurs, need to be extremely mindful of the imbalance of experience between themselves and the many sophisticated, repeat players they’re going to be negotiating with as they build their companies. It’s obviously common for entrepreneurial personalities to be more comfortable (than most) with risk, and to go head-first into negotiations and activities without proper backup. But for really big, irreversible decisions, it will backfire, and others will happily use it against you.

One of the most overused phrases for getting naive negotiators to give in on issues they should push back on is “this is standard.” When you have no historical or market perspective – what’s normal, what’s fair, what are the risks, how will this play out in 5 years? – you can be easily manipulated into all kinds of bad outcomes. I’ve been at more than my fair share of board meetings or negotiations where someone at the table makes a completely biased, nonsensical claim that something is “standard,” at which point I’ve had to step in to set things straight, and gladly offer up data or a quick market survey.

There are two main things that I tell all companies to focus on in this regard:

  1. Have a group of experienced, trusted advisors that you can quickly communicate with on serious issues.
  2. Do not let yourself be bullied into a setting where your inexperience puts you at a substantial disadvantage.

Trusted Advisors

When I speak of trusted advisors, I’m not referring necessarily just to your Company’s “advisory board,” which serves a broader purpose of helping you on long-term strategic, business, and technological issues. I’m referring to people you can call or e-mail for specific, tactical guidance on more pressing matters; your “inner circle.” Seasoned entrepreneurs, mentors from accelerators, lawyers (who are independent from your lead VCs), and trustworthy angel investors often make up this group for most CEOs I work with. The most important thing is that they (i) have visibility into the broader market, to help you actually understand what is acceptable, and (ii) will be direct and honest with you when you most need them to.

Imbalanced Negotiation Settings

While it is far less common in the tech world than in other areas, you occasionally still encounter people (particularly VCs) who insist that the only appropriate way to “really” negotiate is live, and in person. And let me tell you: this is bullshit.

Of course, live discussion is important for communication and relationship-building; it has its place. But more often than not, attempts to force entrepreneurs and company executives to negotiate key issues live, or under a very tight deadline, is a tactic to gain unfair leverage from their inexperience. Of course the guy who’s done this type of deal 30 times wants you to agree to terms live, face to face, away from your set of advisors. It has zero to do with business norms. Plenty of high-stakes deals are negotiated asynchronously. 

How you push back and (respectfully) assert yourself in negotiations with other business parties will set the tone for your long-term relationship. If you allow them to force you into circumstances that favor them, they will do it indefinitely. There is nothing wrong with responding, diplomatically, that while you of course would love to grab beers and meet up in person for more casual matters, for real business, you expect time to consult with advisors.

If you’re working with people whom you should want to build long-term relationships with, they will respect your request.  In fact, I’ve known some great VCs and other business people who are very upfront about the experience imbalance with new entrepreneurs, and insist that companies work closely with key advisors.  Those are people playing a long game, and who know that their reputation in the market matters more than short-term opportunism.

If the person you’re negotiating with rejects your request, and dictates to you the medium of negotiation, then at a minimum you’ve gained some key information on what the relationship is going to really look like if you choose to move forward.

Commercial / Tech Transactions Lawyers

TL;DR: Apart from early-stage specialized corporate lawyers (startup lawyers), there’s a second kind of lawyer that almost every early startup needs: a commercial/tech transactions lawyer.

Background Reading:

Imagine you run into a doctor who says he can (i) perform heart surgeries, (ii) treat cancer, (iii) treat your asthma, and (iv) provide pregnancy care, on his own, and all at a lower than market cost. Is your first reaction “wow, this guy is an incredibly affordable genius!” ? A cardiologist, oncologist, pulmonologist, and OB/GYN all in one!

Probably not.

One of the first points I make to young tech entrepreneurs about how to source legal counsel is that the statement “I need a lawyer” is almost completely useless without specifying what kind (specialty) of lawyer. The complexity of the legal issues that even young emerging companies deal with is simply too high to entrust all of them to a single “generalist” claiming to be a jack of all trades. This is not a coffee shop, or a bakery. The stakes, and potential liabilities, are much higher.

OK, you might say. I’m a startup, so I need a startup lawyer. Well, that’s an improvement, but what exactly is a “startup lawyer”?

In my experience, the correct definition of a “startup lawyer” is a corporate lawyer with a strong specialization in early-stage emerging companies and venture capital/angel financings. Very different from an M&A Lawyer, or a corporate lawyer who handles middle market or public company work. Startup lawyers typically serve as GC (General Counsel) for early-stage startups, which requires them to have a workable understanding of tax law, securities law, commercial issues, IP, and labor/employment legal issues.  They’re not experts in those areas (corporate law is their specialty), but they’ve seen those issues enough to cover the basics, while also knowing when to rope in deeper expertise. Your corporate/startup lawyer should serve as the quarterback of your general legal team.

For most startups we see, probably 50-75% of Pre-Series A legal needs are covered by these startup-specialized corporate lawyers: formation, financing, hiring and firing, equity compensation, etc. Small amounts of patent or trademark work may be needed by appropriate specialists, but that’s a minority of cases pre-Series A.  But there’s a second kind of lawyer – who isn’t a “startup lawyer” – that virtually all of our early clients end up needing, and that all founders need to be aware of in sourcing their own counsel: commercial, or sometimes called “tech transactions” lawyers.

Startup/corporate lawyers typically handle the more ‘internal’ issues of a company and its stakeholders: relating to the company’s founders, its employees/service providers, and stockholders.  Commercial or Tech Transactions (let’s use C/T) lawyers, in contrast, typically manage legal issues and contracts relating to a company’s customers/users and potential commercial partners. A good 25-50% of pre-Series A legal needs will often get handled by a C/T lawyer. Examples of C/T Lawyer work:

  • License Agreements (Inbound and Outbound)
  • OEM, Reseller / Distribution Agreements
  • Terms of Service and Privacy Policies (which may also require Data/Privacy Lawyers, but usually not)
  • EULAs, API / SDK terms
  • Technology Transfer Agreements
  • Manufacturing / Supply Agreements

The nature of these kinds of agreements is very different from the kind of work a classic “startup lawyer” does, and while most solid corporate lawyers probably could wing a simple version of a tech transactions document, I am deeply skeptical of a lawyer who claims to be able to handle both all of a company’s corporate needs and their commercial/tech transactions needs for a serious amount of time. In the very early days it *may* work, but even with a small level of scale it’ll start to look a lot like the “genius” doctor mentioned above. The most dangerous (and, in the long run, expensive) type of lawyer is the one who doesn’t admit what he/she doesn’t know, but incentives to maximize personal revenue often lead lawyers to exaggerate their abilities.

So, in short: if you’re building a tech startup, you don’t just need “a lawyer.” You need specialists. And a true startup lawyer, even a very good one, is very rarely enough. Ensure you have access to a solid commercial/tech transactions lawyer (reputable startup lawyers work with them). If you don’t, you’ll eventually regret it.

“Founder Friendly”

TL;DR: “Founder friendliness” should mean not being hostile, but also not being submissive, to founders. Good entrepreneurs and advisors know that.

Background reading:

Because we’re known as Startup/VC lawyers who don’t represent Tech VCs (just companies), I often get asked about my thoughts on “founder friendliness.” Occasionally it’s someone inexperienced expecting me to say something totally one-sided, as if “founder friendly” means always giving founders what they want. The truth is, I’ve put my fair share of founders in their place, when appropriate. As I’ve written before, company counsel does not mean founder’s counsel.

Serious lawyers provide counsel, and represent something apart from the preferences of any particular person. They don’t just push paper in whatever direction someone tells them to. Real lawyers know when and how to say “no.”

To me, “friendly” means the opposite of “hostile.” It means respecting a person as an equal, being transparent with them, and strongly taking into consideration their own values, goals, ideas, etc.  But that is very different from spinelessly doing whatever they want you to do. The best founders seek out advisors, including investors, who will provide real, critical input; knowing that a bunch of sycophants will get them nowhere.

Founder Hostile

On the one hand, there is very much a culture among certain venture capitalists that treats entrepreneurs as necessary, but ultimately dispensable, steps toward returns. I have seen it firsthand, and while it exists everywhere, it is directly (negatively) correlated with (i) the number of investors willing to write checks into a particular ecosystem, and (ii) the degree to which entrepreneurs confidentially share information among each other on VC behavior, producing adverse selection issues for the real assholes. You very rarely hear about this on blog posts or twitter, but when the pep rallies and PR-oriented speaking panels come to an end, it is there.

VCs in this category vary in the level of sophistication with which they implement their “founder hostile” strategy.  Most know that playing hardball out of the gate won’t get them the deal, and they prefer more of a “bait and switch” approach where they sing the praises of the entrepreneurs upfront, and then slowly move the chess pieces over time. The moves are identifiable by people who know the game:

  • put “captive” lawyers and advisors in place;
  • avoid providing coaching / training resources to founders;
  • tightly control the recruitment of new executives to phase in loyalists;
  • keep a tight grip on unreasonable budgets so that achieving results is very hard, and failure justifies “necessary changes”;
  • maneuver to prevent competitive funds from putting offers on the table;

In the end, it doesn’t matter what the cap table says; it’s “their” company now.

Founder Submissive

On the other hand, in the most competitive deals and ecosystems, there is a counter-dynamic where VCs compete with each other, essentially, on how much unilateral control they’ll give entrepreneurs. This dynamic is strongest in California. It’s, in part, due to the failure of many VCs to effectively apply basic strategic concepts – like differentiation – into their market positioning. If you’re just another VC/fund with a few connections and ideas among dozens of others, what else can you do but try to be the “easiest money”? The end-result of having these “founder submissive” investors is often immature management teams that aren’t able to effectively scale. VCs with real brands are able to avoid this. 

As I’ve written before, a Board of Directors has fiduciary duties to all stockholders. As you’ll read in many different places, the moment an entrepreneur decides to take on investors, they have to step off the “king” train and focus on growing the pie, and eventually achieving an exit, for everyone.

That being said, under DE law Boards have primary fiduciary duties to common stockholders, insiders and outsiders.  As the largest common stockholders (usually), and those who’ve held the equity the longest, entrepreneurs are extremely important representatives on the Board for fulfilling those duties; whether or not they are in the CEO seat.  We know that preferred stockholders and common stockholders regularly have misaligned incentives.  A truly “balanced” Board will prevent one part of the cap table’s incentives and preferences from overriding those of the others.

“Founder hostile” VCs are problematic because they push for the perspective of institutional investors to override those of all the other constituents on the cap table. “Founder submissive” VCs are equally problematic because they expose the company excessively to founders whose priorities may conflict with the economic interests of the broader stockholder base.

The proper balance is, of course, in the middle; where the VCs with the best reputations operate.  Be transparent about your goals, incentives, and plans. Don’t beat around the bush about your investment horizon, exit expectations, and how you’ll approach executive succession when that time comes. Let the common stockholders, including founders, do the same. No BS or opaque maneuvering. And then work together, knowing that no one has the singular right to override the perspective of the others at the table.