Post Category → Ethics

Contracts v. Might Makes Right

TL;DR: When a first-time entrepreneur is navigating an environment full of entrenched players who all know and depend on each other, the difference between a balanced decision process and a shake down can come down to a contract. Take contracts, and the independence of the lawyers who help negotiate them, seriously.

Background reading:

A background theme of many SHL posts is the following: entrepreneurs enter their startup ecosystems, from the beginning, at a massive structural disadvantage relative to the various market players they are going to be negotiating with. Everyone else knows each other, has worked with each other over the years, and has already made their money. And then you show up.

Now assume that environment as the background, and then imagine you start striking deals with these people: for a financing, a partnership, participation in a program, etc., but assume there are no contracts or lawyers involved. What do you think will eventually happen? Here’s how it will play out: as long as you continue to deliver exactly what everyone wants from you, very little will happen. When everyone’s expectations and preferences are 100% aligned in the short term, the absence of contracts means very little. They’ll “let” you stay in the spot you’re in. 

Until things (inevitably) go sideways. A market shift suddenly means a change in strategy might be necessary, but there’s disagreement on how and when. A quarter comes in under projections, and there’s disagreement as to what that means. A potential outside investor expresses interest in making an investment, and there’s internal disagreement as to whether it should be pursued.

I focus here on the word disagreement, because in many situations on high-level strategic issues, the right answer isn’t always clear cut. The goal (grow the company, improve economics) may be clear, but the right execution strategy is far harder to see.  People will disagree, and where they stand on an issue often rests on where they sit. For example, “portfolio” players (institutional investors) will often be far more comfortable, and even insistent, on taking higher risk (but much higher reward) growth strategies than entrepreneurs and employees, who have only “one shot.”  See Common Stock v. Preferred Stock for a more in-depth discussion on the substantial misalignment between “one shot” players (entrepreneurs, employees), who usually hold common stock, v. portfolio/repeat players (investors), who usually hold preferred stock.

The core point of this post is this: in an environment of substantial disagreement, and where everyone other than the entrepreneur is a repeat player that knows and has economic ties to each other, the first-time entrepreneur (who speaks for the early common stockholders generally) will lose every time: unless contracts in place say otherwise. 

In the absence of laws and contracts, the law of the market is “might makes right,” and established, repeat players have all the might.  

Here is a scenario that I’ve encountered far too often (although increasingly less so as awareness has increased) that is almost comical when viewed objectively:

  • A financing has closed, putting in place a “balanced” Board of 2 VC directors, 2 common directors (one of which is a new CEO, the other a founder), and an “independent” director.
  • In attendance at the meeting are 6 people: the Board and company counsel.
  • The 2 VCs regularly syndicate deals with each other and have known each other for a decade.
  • The new CEO is a well-known professional CEO who has worked in several portfolio co’s of one of the VCs, and was “recommended” by that VC for the position.
  • The “independent” director is an executive well-known in the local market who also has worked with the VCs at the table for over a decade, both of whom recommended her for the position.
  • “Company counsel” represents 6 portfolio companies of the VCs at the table, and has represented them as investor counsel on as many deals, and is actually currently doing so for other deals. In fact, company counsel became company counsel because he came “highly recommended” by the VCs when they were first negotiating the deal with the entrepreneur.

So let’s summarize: there are 6 people at the meeting, and 5 of them have all worked with each other for over a decade, regularly send deals to each other, and in some cases (at least with respect to the lawyer and a VC) are currently working with each other on other deals not related to this company. And then there’s the entrepreneur.

Wow, now there’s one “balanced” Board, don’t you think? I’ve encountered entrepreneurs (whose companies are not clients) in this situation before. I let them know that, whatever they think their position at the company is or will be, they are simply leasing that position until their investors, who hold virtually all the cards and relationships, decide otherwise; and regardless of what the common stockholders think. It’s possible things turn out fine, as long as all goes as planned. It’s also very possible they won’t.  But what’s absolutely clear is who decides, in the end.

The difference between a well-advised entrepreneur and the one in the above scenario is this: the former will have real protections in place to ensure the common stock are treated fairly, and have their voice on key company matters. The latter may feel protected, but ultimately their position is at the discretion of their investors; and protection that is contingent on the whims of people on the other side isn’t protection at all.

Well-drafted contracts are, when negotiated in a transparent manner, a key mechanism for controlling the power of sophisticated repeat players who, absent those contracts, can simply force through whatever they want because of their political / economic leverage. What else might this reality tell us about negotiation dynamics in startup ecosystems?

Rushing through negotiations / contract drafting favors established players.

If the default market position gives power to established players, and contracts are a mechanism for controlling that power, the inevitable result is that those established players (at least the most aggressive ones) will try to get entrepreneurs to rush through contract negotiations.

“Let’s just go with what’s standard.”

“It’s all boilerplate.”

“Let’s save legal fees and put them toward building the business.”

“Time kills deals. Let’s get this closed.”

If someone is telling you that what the documents say doesn’t really matter, or that you should just stick to a template, it’s because, outside of the contract, they’re in control.  That doesn’t mean you should burn endless amounts of time negotiating every point, but take the material provisions seriously.

A market ethos of “relax, we’re all friends here” is designed to favor power players.

Old-school business folks know very well how large amounts of alcohol have often been used to seal business deals. In the startup world, alcohol may still be used, but just as effective is fabricating an environment suggesting to first-time entrepreneurs that everyone is just holding hands and singing kumbaya, and being independently well-advised isn’t necessary.

I’m all for having very friendly relations with your business partners. Life is too short to work with people you don’t get along with well.  But any time someone extends that thinking to the point of telling entrepreneurs that “everyone is aligned” and they should let go of the skepticism to focus on “more important things,” I call bullshit. Alcohol and kool-aid; stay sober in business.

“Billion or bust” growth trajectories mean contracts matter less. Outside of those scenarios, they matter more. 

Among emerging company (startup) lawyers, it’s always been well-known that the Silicon Valley ecosystem as a whole takes standardization, automated templates, and rapid angel/VC closings to an extreme relative to the rest of the country/world. I’ve pondered why that’s the case, and in discussing with various market players, concluded that it has a lot to do with the kinds of companies that Silicon Valley tends to target: billion or bust is a good way to summarize it. I wrote about this in Not Building a Unicorn. 

If the mindset of an ecosystem is significantly “power law” oriented in the sense that “winners” are billion-dollar companies, and everyone else will just crash and burn trying to be one of those billion-dollar companies, I can see why the finer details of deal negotiation may be seen as an afterthought. That environment, which is very unusual when compared to most of the business world, leaves a lot less room for the “middle” scenarios – things aren’t going terribly, and we’re clearly building a solid business. but neither is this a rocket ship, and there are hard questions to be decided – where the deep details of who has what contractual rights really matter.

In a heavily binary “unicorn” world, you’re either knocking it out of the park, in which case no one even reads the contracts and just lets you do your thing, or you’re crashing and burning, in which case the docs are just useless paper. As a law firm headquartered in Austin and structured for non-unicorns, we don’t work in that world, and actually avoid it.

For true “balance,” pay close attention to relationships.

In my opinion and experience, the best outcomes result when the power structure of a company (both contractual and political) doesn’t give any single group on the cap table the ability to force through their preferences, but instead requires some hard conversations and real “across the aisle” coalition building to make a major change.

Balanced boards are, on top of other contractual mechanics, a fantastic way of achieving this, when they are in fact balanced. The above-described scenario where everyone except for the entrepreneur knows and has strong economies ties to each other, including a company counsel “captive” to the VCs, is a joke; and sadly, a joke played on too many startups.

As I wrote in Optionality: Always have a Plan B, build diversity of relationships into your Board and cap table. Feel free to let “the money” recommend people, because their rolodexes are valuable, and are often part of the reason why you’ve engaged with them. But you should be deeply skeptical of any suggestion that the preferred stockholders should, alone, decide who the CEO is, who company counsel is, who the independent director is, etc. etc. Letting them do that certainly may get your deals and decisions closed faster, but unless you are successful in delivering a true rocket ship, you will ultimately regret it.

The common stock, including the founding team and early employees, need a strong voice at the table, especially given the power imbalance with repeat players. Well-negotiated contracts and independent, trustworthy company counsel are the way to ensure they have that voice.

How fake “Startup Lawyers” hurt entrepreneurs

TL;DR: Entrepreneurs need to be aware of the growing trend of lawyers from random backgrounds re-branding themselves as “startup lawyers,” despite having only the thinnest understanding of the subject.

Background reading:

There are two trends worth discussing in this post, both of which I’ve seen seriously hurt entrepreneurs and startups.

Thrown to the juniors.

First, one reason many entrepreneurs are dropping very large law firms for more “right sized” boutiques is that those law firms have become so unaffordable for almost any early-stage company that entrepreneurs end up working almost exclusively with very young, junior lawyers. I touched on this issue briefly in The Problem with Chasing Whales.  One partner in our firm worked on a seed financing in which his BigLaw counterparty literally said on their phone call “I only have 15 minutes to spend on this deal; otherwise I start having to write off time.”

The firm you engage may have a marquee brand, but if to that firm you are small potatoes, you will end up working with that firm’s B or C-team, which will put you much worse off than having hired a set of lawyers that take your company more seriously.

Junior professionals absolutely have a place in law, but that place is not working directly with CEOs on their most strategic decisions, no matter the size of the company. It’s working mostly in the background, with real senior level involvement and oversight. When an entrepreneur is thrown to junior lawyers, it reflects how the firm has prioritized (or not) that work, even if to the entrepreneur the project is extremely important.

Fake “startup lawyers.”

But the title of this post is really about a second, even more troubling, trend. I’ve been seeing an increasing number of litigators, real estate lawyers, patent lawyers, and lawyers with all kinds of backgrounds who have suddenly decided to brand themselves as “startup lawyers.” A little tweak to the website, read a few blog posts, perhaps host a free session at a co-working space or two, and voila, now they’re ready to help entrepreneurs.

Holy crap is this dangerous. Imagine if you were talking to a doctor about a potentially serious heart condition, inquired about their experience, and then got back the following response: “well, I’ve been a dermatologist for the past 5 years, but after reading a few blog posts I decided I’d try my hand at cardiology.” Walk out the door, fast.

In the “thrown to the juniors” case, at least those juniors have some accurate, up-to-date institutional infrastructure (templates, checklists, internal firm training, partner review, etc.) to rely on as they try to help startups. But these random re-branded lawyers are essentially training on early-stage companies, while relying on extremely generalized resources (like this blog) as guidance. We see mistakes everywhere, often because we get hired to clean up the mess.

In every serious law firm with a real reputation for representing emerging companies, lawyers who call themselves “startup lawyers” are corporate/securities specialists with a strong understanding of early-stage financing, tax, commercial, IP, M&A, and labor law as they typically relate to early-stage companies. They have the depth and breadth of expertise to properly serve as an early-stage company’s “outside general counsel,” of sorts, while relying on deeper subject matter specialists when needed. 

But a litigator or patent lawyer who read a few blog posts and stayed at a holiday inn express? Disaster. As I’ve written many times before, “startup law” is largely built on contracts, and the entire point of contracts is that they are permanent unless everyone involved agrees to “fix them.” There’s no “v1.1” update to fix bugs. That means the iterative, “move fast and break things” “we can fix it later” culture of software development is the last approach anyone in their right mind will apply to legal issues.

Stop treating entrepreneurs like suckers.

Ultimately, what these developments reflect is an underlying mindset among lawyers (and other market players) that “startup” is synonymous with “little shit companies.” First-time entrepreneurs may be very smart, but they don’t know what they don’t know, and they rely on their ecosystems and advisors for guidance in almost every area. It’s the same problem that leads them to get pushed to hire captive lawyers who really work for their investors, instead of hiring independent counsel that will actually do its job. 

Just throw a junior, or a random lawyer who managed to maneuver into a few referrals, to them; they’ll figure it out. They’re just a tiny company anyway. Whatever.

So my request to the broader ecosystem is: please, stop referring entrepreneurs to your random, local lawyer friend who decided to take a stab at this “startup law” thing. That’s not how this works, and you are hurting real people, building real companies with long futures built on the foundations put in place by these fake advisors.

And to entrepreneurs: be careful out there, and do your diligence. Many of us know that you wouldn’t quit your job for, or pour your life savings into, a “little shit company,” so align yourself with an inner circle of people who think accordingly.

Burnout, Depression, and Suicide

Background Reading: Founder Burnout and Long-Distance Thinking 

This is going to be another personal post; less about how to close a financing or avoid legal issues, and more about the bigger fundamental issue of life outside of work. Because if you think what happens outside of work doesn’t heavily influence what you achieve at work, you’re clueless. Please move onto another SHL post if you want Startup/VC law advice.  This post is prompted by the very unfortunate passing of Anthony Bourdain, whom I admired as a voice of authenticity in a world that sterilizes and bullshits far too much.

Depression and suicide are two things with which my bloodline is far too familiar. Since I was a young kid – watching family members lock themselves in rooms for days and weeks in the dark, and openly discuss swerving their car into oncoming traffic, sometimes while I was in it – it’s been at the top of my mind.

Despite my many faults – my wife of 10 years is always happy to provide a list – one thing I know I’m good at is being observant. I watch people very closely, and pick up on patterns and subtleties that others miss.  As the old saying goes: the wise learn from the mistakes of others, the smart learn from their own mistakes, and fools never learn.

Another thing I’m particularly fond of is what I call asking the “meta question,” meaning trying to separate symptoms from the disease, and talk about the root cause of something. Because far too often people get caught up with trying to band-aid the symptoms of something, without digging deeper and probing into fundamentals.

What’s absolutely crystal clear is that suicide and depression are way up in America. It is clearly a paradox, given that on many objective metrics, life has never been better: life expectancy, technological advancement, overall wealth, homicide/major crime rates, gender equality, etc.

The standard reaction to this rise in depression/suicide is to focus on mental health. If we just had more infrastructure for affordable therapists and anti-depressants, all would be better. But that obviously misses the bigger historical point. Life was, on many levels, way harder even just 50 years ago, and we didn’t have an army of public therapists then; yet depression and suicide were less prevalent. Clearly there is a meta issue here worth discussing.

To share my thoughts and observations on the topic, I’m going to first list out a few concepts that I’ve picked up over the years from reading, education, having good conversations over coffee, etc.:

Maslow’s Hierarchy of Needs – This is the idea that as peoples’ more physiological needs are met (shelter, food, etc.) and become less of a top-of-mind concern, their psychology shifts to prioritize “higher” needs, like love, belonging, art/beauty, etc.  People who grow up in more stable, loving environments (or societies) tend to be more open, creative, and communal, but that can also result in being more sensitive and emotionally vulnerable.

Specialization v. Generalism – Economic development inevitably leads to human specialization. People in rural communities are often decent at a lot of things, and more self-reliant, because they have to be. They’re also poorer. People in advanced markets tend to have much narrower, specialized skillsets, which they then sell in the market to earn surplus income to buy everything else.

Grit – The idea that exposure to hardship/struggle can build mental resilience, in the same way that exposing muscle to pressure makes it stronger, as long as it doesn’t go so far that things start to break. Moderate stress is good. Too little or too much is bad.

Dopamine v. Serotonin  – D and S are neurotransmitters. Without getting too bogged down in details that I certainly will botch, D is largely the “desire/drive” brain chemical. Heavily involved in addiction. Serotonin is heavily involved in calmness, satisfaction, a feeling of fulfillment. D and S have a tension with each other. If D overruns things, S decreases, which leads to depression.

Higher Pleasures v. Lower Pleasures – In the way that complex carbs are longer-lasting while simple carbs are often tastier but shorter-lasting, lower pleasures tend to be activities in life that are thrilling, fun, and even memorable, but don’t have much of an on-going positive effect. Lower pleasures drive dopamine. Higher pleasures, on the other hand, tend to be less thrilling, and in specific moments may actually be difficult/painful, but they have significantly longer-lasting positive impacts. Lower pleasures tend to cost you mostly money. Higher pleasures tend to cost you mostly time, but increase serotonin.

Traditional Culture v. Market Culture – Culture is largely the set of narratives and values that swirl in our brain to tell us how we should live, our role in the world, and the underlying purpose/meaning behind it. Many moderns dramatically under-appreciate the complexity and nuance in how culture plays into life satisfaction and progress.

Without culture, humans are just advanced monkeys. Traditional culture is the accumulation of centuries of slow-changing values and life-structures interacting with history, human psychology, social dynamics, etc. Market culture is the result of marketing/advertising messaging, often informed by PhDs in psychology and neuroscience, nudging people to engage in activities that ultimately maximize economic growth for someone.

Bottom-up Organic v. Top-Down Theoretical – There are two ways that cultural values, systems, and ideas in general emerge. A bottom-up “organic” approach starts from the ground, interacting with all the nuances and variables of reality, and iterates “upward” over time to arrive at an equilibrium.  A top-down structure starts with logic or theoretical principles, focusing on a kind of abstract consistency, and then imposes itself “downward” on reality. Organic emergence is messy, iterative, and often slow. Top-down is “cleaner” and more consistent, and usually faster. But also more prone to extreme errors. Traditionalists (at least those who aren’t dogmatic) tend to favor organic emergence of ideas. Intellectuals tend to favor the top-down.

Individualism v. Communalism – The free market pushes individualism as a primary value, because it maximizes economic growth. The more differences we can parse out among people, slowly nudging them to like different things, pursue different paths, the more things we can sell to them. It may feel like “discovering yourself,” but there’s a lot of outside nudging involved. Communalism, on the other hand, emphasizes similarities and long-standing histories between people. It’s driven by more traditional value structures, which focus less on peoples’ economic outputs, and more on their deep relationships to one another. It also is more constraining on individual freedom/choice.

Age-Mixing – Somewhere along the way, society got the idea that it’s better for everyone if people of the same age spend all of their time with each other. I suspect industrial-age schooling, and the efficiencies of standardizing education, are partially at play. Yet the evidence is clear that age-mixing produces significantly better outcomes on a psychological level. When you age-mix, older people (including older children) learn responsibility and empathy, and how to teach the younger. They also feel more “needed,” which gives life a sense of meaningful purpose apart from their market value.

And the younger benefit from the longer-term perspective of people who’ve “been there” and know how life progresses, instead of just being focused on immediate wants/needs. When people fail to age mix in their lives, they tend to be more hierarchical, competitive, myopic, and neurotic.

Ok, that’s a lot, and it took a while. But hopefully at least some of the concepts were enlightening. Now, using those concepts, here are my own personal observations/thoughts from my own life, my family’s history, and observation of others regarding the “meta” question of why society is so much more depressed and suicidal:

Affluence has taken away a lot of the hardship and struggle that once was a defining feature and motivator of people’s lives. Obviously, this is not necessarily a bad thing. I know so many people today whose life largely boils down to specialized work and leisure. They do one narrow thing that someone pays them for, and they buy everything else, so that they have “free time” to do things they enjoy; which usually involve seeking entertainment in the market. Specialization obviously makes people wealthier. But is there a point beyond which it makes people less happy?

Now you can order any meal you want on Uber Eats, and it’ll be delivered right to your door. That’s fantastic. It’s efficient. But what if the act of cooking, and even the act of picking out ingredients has some deeper psychological benefit that we missed? Now we can Lyft or drive to wherever we want, but what if the act of walking does something for us that we missed (and I don’t just mean burn calories)?

Market economics (and culture) says to specialize. Only do what has the highest market value, and you can just buy everything else. But traditional culture says hyper-specialization makes you fragile. You may become wealthier, but you also become less self-reliant and therefore more dependent on the market. And the idea that everyone should just do one narrowly defined thing, and then seek “entertainment” the rest of the time, is a speck in humanity’s evolutionary history.

Is the person who works their own garden and cooks on the weekends  just wasting their time on inefficient activities? Should the person who works on their car in their garage just stop wasting time and send it to a mechanic? Maybe. Or maybe there’s something more there than top-down market theory can grasp.

Social revolutions told people to throw away traditional, organic culture and “be themselves.” Modern “top-down” market culture then filled the void. The idea that you are born with some inner core “you” that you must discover over time, free from the influences of everything external, has a very romantic sound to it. It’s also totally false, or at best extremely incomplete. “You” are heavily a by-product of your environment. You don’t “free” yourself from culture; you simply adopt one over another.

So as age-mixing gave way to age-sorting, and people stopped taking advice from grandparents, family, traditions, etc., the market was there to fill the void. But the values of the market are top-down and profit-driven.  When a grandparent tries to teach their grandchild about life, one can assume that in most circumstances the child’s long-term well-being is an end-goal. When a market actor teaches a child something, there can be any number of other incentives; often tied in the end to economics.

Remember that organic, bottom-up progression involves slow evolution; strongly path-dependent on the past, which is assumed to carry a kind of underlying wisdom/understanding that is perhaps difficult to articulate, but is nevertheless there. On the other hand, top-down progression is about intellectual consistency with some defining value structure, like freedom, or fairness.

Older generations had their views on family, life roles, responsibility, money, work, and they were the product of slow evolution over time, integrating feedback from history’s experiments and mistakes. They had their problems, for sure, but evidently large-scale depression and suicide was not one of them. Then social revolutions came in and demanded corrections, many of which made sense at a theoretical level, and were amplified by market incentives. But top-down theory breaks down when it hits messy, multi-variate reality.

Without getting too bogged down in specifics, there is a meta issue here: a theoretical framework that hyper-emphasizes individuality and freedom may be more productive economically, and intellectually “purer” but it breaks-down, or at least reveals fundamental flaws, when it hits the reality of human psychology; which evolved on older, more organically evolved values.

Modern market culture pushes us to pursue things that lead to greater economic activity (dopamine), while neglecting those that may actually make us happier (serotonin), but can’t be monetized.

There’s a better job for you in another state. Go, pursue “your” dreams. You can visit your parents, childhood friends, and cousins on holidays.

If you have kids now, you’ll get “tied down.” You can always have them later (maybe…). Build your career. Travel the world.

Why are you wasting time cooking for yourself? Bill a few extra hours, and have the food delivered.

Your parents’ and grandparents’ views on life are out-dated. “Be yourself” and “follow your own path” with your peers, who largely feel the same.

Apologies to my millennial friends with romantic notions about how the “experience” of travel “expands your mind” and is “life changing.” I love traveling too. But that doesn’t mean I don’t recognize really good marketing when I see it.

There’s a big difference between what makes you wealthier, free-er, or more “empowered” (abstract concepts that, conveniently, have a way of increasing GDP) and what actually makes you – advanced monkey with a brain evolved over millennia – happier and more resilient.

The market’s individualism (liberating, but cold and detached) and traditional communalism (constraining, but warm and connected) are competing goods that need to be balanced. We are sucking at that balancing. 

It is much harder to balance competing goods than to simply let one take over our lives, even if the former is far better for us in the long run. When virtually all of the messaging/reinforcement in our environments supports only one side (because that’s the side that literally pays for messaging/reinforcement, including advertising and our educational infrastructure), that’s where so many of us end up.

Individuality, freedom, and financial wealth (all quintessential American, market values) – “following your own path” “pursuing your dreams” “not getting bogged down” “crushing it” – are real, valuable things. They’ve all played a key role in my life, for sure.

But the happiest, most resilient people I’ve known (men and women) have never “bought” fully into the market ideology (and it is ideology) that they are the be-all end-all of life. They understand that what’s old may be flawed and constraining, but if it’s old, that means it’s lasted. And things last for a reason; even if that reason isn’t easy to explain or fit within a theoretical framework. Freedom, empowerment, etc. are surely valuable. But so are durability and longevity; in other words, life paths and values that have been proven to “work” in the long-run.

As another old saying goes, winning is not the same as winning an argument; not even close.  The human brain is not designed in logic.  There’s no reason to expect an optimal human life to be either.

So if someone asks me for my thoughts on depression and suicide: sure, more therapists, discussion, and anti-depressants; certainly for the specific people who need emergency help now. But the meta-answer is to ask deeper questions about humanity, and to start questioning the life values that have been sold (and I do mean sold) to us; no matter how much we think they are supreme. Because we’ve clearly broken something, and it’s worthwhile to look back and examine a time when it wasn’t broken.