Post Category → Founders

Legal Office Hours for Remote and Distributed Startups

TL;DR: Though I work with all kinds of startups in various locations, I’ve become particularly interested in, and connected to, the distributed/remote startup ecosystem; and decided to throw in a few hours of my time each week to support new teams growing specifically under that model via free virtual office hours. Info on that is near the end of the post.

Over the past several years, I’ve become fascinating with the idea of a startup ecosystem largely detached from geographic constraints, with companies recruiting talent based on fit and merit, regardless of where they live. For years I lived in the Hill Country outside of Austin, barely ever working from the firm’s downtown office because I just didn’t see a need to; and my clients didn’t care. Highly regarded Startup Lawyers don’t really need to spend much time in coffee shops or conventional offices. All they really need is a solid internet connection. Sidenote: I think Elon Musk’s StarLink (high-speed broadband anywhere) could be a game changer for the gorgeous Colorado mountain towns around where I presently live.

As my family – particularly my wife, who grew up in SoCal – realized that my growing client base didn’t care at all about my physical location, their willingness to continue putting up with Austin’s mosquitoes and deadly snakes (big problem outside of urban core), humidity, horrible traffic, decidedly limited outdoor beauty (save for a lake) and seemingly endless scorching summers (Mid-May through mid-October really sucks) reached a breaking point. Austin is an amazing and thriving city for many reasons, but it is not for anyone who likes needs the outdoors. No city is for everyone.

Because my wife and I had already decided to homeschool our three young kids, we had almost total freedom to pick a destination; and ultimately we landed on living near the mountains about an hour outside of Denver. Amazing weather and mountain views, literally limitless outdoor recreation, and a short flight or road trip to almost anywhere we needed to go. And yes, still rock solid broadband so I can close deals and work with clients just as easily as I did before. Little did we know that with both “homeschooling” and “remote” work, we’d started riding waves that would suddenly turn into a massive tsunami because of a pandemic.

I bring up this background to highlight how escaping the “tyranny of geography,” and the growing comfort with distributed startup teams, is not just an intellectual curiosity to me; it’s a core part of my life. When we’d announced that we were leaving Austin, there was no shortage of people who thought I was absolutely nuts and lighting a match to my legal career. They didn’t know I’d already been living in “the Texas countryside,” with a thriving ECVC client base and firm, for years. If my clients – all scattered across the U.S. and world – didn’t care that I was living on acreage in the Texas hill country, I knew they wouldn’t care about my living in the mountains of Colorado.

As our own adventures with remote/distributed work have continued, I’ve watched the broader ecosystem of “remote” startups mature as well. The number of companies using a distributed team, with few if any people in the Bay Area, has grown exponentially over the past 5 years or so; and we’re also increasingly seeing institutional investors who are happy to “venture” outside of their local markets in search of high-potential businesses that aren’t on the classic Silicon-Valley style VC circuit. Suddenly the distributed startup ecosystem has moved from a fringe quirk to a desirable asset with distinct competitive advantages.

But there’s one distinct disadvantage of “remote” startups that I keep seeing come up over and over again: they don’t connect as easily with serious lawyers. Most ECVC (emerging companies and venture capital) lawyers are still heavily tied down to local geographies, particularly the Bay Area. Strong teams in non-traditional markets often end up either using nearby lawyers who are totally lacking in the appropriate expertise/specialization, or they just wait until their investors happily “recommend” their favorite $1,000/hr Bay Area lawyer whose firm represents Uber and Apple. People who read SHL regularly know that I’ve discussed ad nauseam the deep problems (conflicts of interest) with using your investors’ pet lawyers; and also how the Bay Area market often promotes norms/practices (“unicorn or bust”) that are a poor fit for “normal” startups.

As I’ve been living through this pandemic and watching the growing zeitgeist around distributed startups, it occurred to me that I’m in a place where I could contribute some of my time to supporting the ecosystem. So I’ve decided to allocate a few hours of my time each week to free virtual “office hours” specifically for distributed teams. We can spend, via a phone call or Zoom, up to an hour talking about any legal/strategic issue on the team’s mind: formation, founder relationships, fundraising and structuring, governance, hiring, etc. No expectation of billing or future engagement. I really just want to get more visibility into how this growing ecosystem is evolving, and how existing market players can help it thrive.

My personal thesis is that America’s size and unique geo/climate diversity is an enormously under-utilized asset in tech. Why should entrepreneurs and employees be forced to live in a handful of narrow, crowded, and increasingly over-priced concrete jungles when there are an endless number of beautiful, affordable, perfectly livable places that need high-potential residents but just don’t have the “tech” base to employ people locally? Because of some nonsense about the importance of “body language” and regular in-person meetings? Please. I think this pandemic is not just helping everyone realize the superficiality in some of their assumptions about remote work, but about a lot of virtual interactions: education, healthcare, and even connecting with the investor community.

A secondary thesis of mine is that the more geographically diversified a startup team’s network becomes, the less exposed they are to local startup power politics. Every geographically constrained ecosystem has organizations that have consolidated a level of local influence/control so high that it can feel like you need to kiss a brass ring in order to access resources you need. That dynamic is the opposite of what a real ecosystem should be; a decentralized resource where no single player can play gatekeeper and extract more value than their own value-add really merits. Promoting a more distributed startup ecosystem reduces the influence of overly self-interested power players, and enhances the kind of transparent meritocracy that helps teams access the right people with minimal wasted time.

Startup ecosystems are ultimately about relationships and people; not about artificial city or state borders. It’s time we talked more about the American ecosystem, and freed entrepreneurs and talented employees to work and live wherever is best for their companies and families. In the process, we’ll spread economic opportunity further across the country, and reduce many of the ills that have resulted from cramming people into too few of cities with not enough space and resources to make “living” affordable and accessible.

Summary of my background: Practicing over 10 years exclusively in emerging companies and venture capital law. Honors graduate from Harvard Law with various awards. Over half a billion in transactions covered, including with top VCs like a16z, sequoia, accel as counterparties. Built out one of the top elite ECVC law practices as managing partner.

Info on participating in virtual legal office hours for remote/distributed teams:

My LinkedIn Profile

Shoot me an invite request on LinkedIn (preferable), or send me an e-mail at [email protected].

Criteria (please explain in intro connection how you meet the below):

  • You already have, or expect to have, a distributed team. Not a 1 or 2 people that you “let” work remotely, but a full orientation around enabling remote work such that no one outside of whatever you might call “HQ” is disadvantaged in opportunities, because the whole team is included in events/meetings. It is fine to still have an informal HQ in the Bay Area, or other classic markets like Austin, LA, Seattle, NYC, etc.
  • The market you are going after has a credible shot at producing an at least $50 million (enterprise value) business. Unfortunately my domain expertise is really poorly fitted for mom-and-pop style businesses, or small apps.

This isn’t any kind of formal program with a hardened schedule, because my own availability varies day to day with deal/client work and firm admin, and I’ll scale my time allocation up or down as the number of teams fluctuates. Some of these calls surely will (and have) turn into long-term client relationships, but that is most certainly not an expectation here. I find no-agenda discussions with new founding teams extremely fun.

Independent Counsel in an Economic Downturn

TL;DR: In all parts of an economic cycle, up or down, there is significant value in having independent (from investors) strategic counsel that you can trust to protect the common stock in navigating negotiations with investors who are 20x as experienced as the founding team. In a downturn, however, the number of “company unfriendly” possibilities in deal and governance terms goes up ten-fold. That means the value of independent, trustworthy counsel shoots up as well.

Background reading:

I’ve written multiple posts on the topic of how first-time entrepreneurs place themselves at an enormous disadvantage when they hire, as a company counsel, lawyers with deep ties to their lead investors. To people with good instincts, the reasons are obvious, but for those who need it spelled out:

A. First time entrepreneurs are regularly interacting, on financing and governance issues, with market players who are (i) misaligned economically with the common stock, and (ii) 20x as experienced as the management team and largest common stockholders. They rely heavily on experienced outside advisors to “level the playing field” in the negotiations.

B. One of the most impactful strategic advisors an early set of founders/management can look to for navigating this high-stakes environment is an experienced “emerging companies” specialized corporate lawyer (startup lawyer), who (if vetted properly) sees far more deals and board matters in any given month than many sophisticated investors see in an entire year.

C. Because investors have contacts with/access to lots of potential deal work, and corporate lawyers need deal work, aggressive investors have come to realize that their “deal flow” is a valuable currency that can be leveraged with an overly eager portion of the “startup lawyer” community; shall we say, “nudging” them to follow the investors’ preferred protocols in exchange for referrals. By pretending that only a handful of firms have credible/quality lawyers, they also try to block law firms with more independent, but still highly experienced, lawyers from getting a foothold in the market.

D. Founders, because they lack their own contacts and experience vetting lawyers, often find themselves influenced into hiring these “captive” lawyers. As a result, they are deprived of some of the most strategic and high-value guidance that smarter teams are able to tap into for protecting the common stock.

For a deeper dive into how this game is fully played out in the market, read the above-linked posts. The point here is not to promote an exaggeratedly adversarial take on startup-investor relations, but to emphasize a simple reality of how things really work.

The main point of this post is: in an economic downturn, when company “unfriendly’ terms are going to be far more on the table than they were in years past, the value of independent strategic counsel is magnified ten-fold. In go-go times when competition for deals and excess amounts of capital shoot valuations up and “bad terms” down, deal terms gravitate toward a closer-to cookie-cutter, minimalist kind of flavor: good valuation, 1x liquidation preference non-participating, minimal covenants, and sign the deal.

That doesn’t mean there’s really a “standard” – I’ve also written extensively about how saying “this is standard” has become the preferred method for clever investors to trick startup teams into mindlessly signing docs that are against their company’s long-term interests. But, in good times deals do tend to start looking a lot more like each other in a way that makes negotiation a little easier.

But when there’s an economic shock like what we’re experiencing right now from COVID-19, and the investor community starts to improve in their leverage, it’s inevitable that you start seeing a lot more “creativity” from VCs with terms: higher liquidation preferences, participating preferred, broader covenants and veto rights, more aggressive anti-dilution, tighter maturity dates on convertible notes, etc. etc.

In this environment, it is incalculably valuable to have people to turn to, including independent deal lawyers, who can tell you what really is within the range of reasonableness, what to accept v. push-back on, and generally what is “fair” given the environment you’re fundraising in. Independent counsel will help you protect the common stockholders, while granting your investors some terms that you may not have needed to accept a year or two ago. Captive counsel, however, will know that his/her “good behavior” (for the investors) in structuring the terms will ensure more deal flow from their real clients. And because most startup teams are understandably lacking in market visibility, they have no way to quality-check the advice they’re getting. Trust is everything here.

Research and diligence your legal counsel just like how you’d diligence any high-stakes advisor. Importantly, ask them what VCs they (and their firm) represent and/or rely on for referrals. They may be great, very smart people, but if the answers you get make it clear that they are closely tied to people likely to write you checks, find someone with more independence. A muzzled corporate lawyer is ultimately an over-priced paper pusher.

 

The Race to the Bottom in Startup Law

TL;DR: There is a long-standing race to the bottom occurring in startup law, led by certain firms who’ve chosen to ignore the ethical standards of the profession in order to maximize revenue; including by flouting rules on conflicts of interest through aligning themselves with influential investors and “power brokers” in the market. The end-result of that race is damaged startups who are being led to believe that they’re getting “efficiency,” when what they’re really getting is biased garbage advice and a time bomb.

Background Reading:

Regulated professions are regulated for a reason. In the case of law, much like healthcare, you are dealing with significant information asymmetries on very high-stakes issues where decisions have permanent consequences; where malpractice or bad ethics can seriously and irreversibly damage a “client.” That is undeniably the case in high-growth Startup Law, where you very often have inexperienced business people (founders, early employees) navigating very complex and high-dollar issues; and to make it even harder, on the other side of those issues are often misaligned money players who are 30x as experienced at the entire game than founders/employees are.

The world of early-stage startup businesses is quite unique in this respect from the rest of the business world. In most high-dollar business contexts, there’s an equal balance of experience and influence on both sides of the table. Company A has seasoned execs, and Company B has seasoned execs. But not so in early-stage. Company X often has entrepreneurs who are doing this thing for the first time, and have very few connections to the broader business ecosystem. Investor Y, whom they are negotiating with and who influences decisions on their Board, has been in the business for 10-20+ years, has done 50-100 deals, and has spent all of that time becoming fabulously networked with other investors, accelerators, serial executives, lawyers, advisors, mentors, etc.

This imbalance presents an opportunity; an opportunity to use the experience/power inequality to push deals and high-level business decisions in the direction that the money players want, often without the inexperienced players really even understanding what is happening. Now, what is the role that lawyers (counsel) are supposed to play in this game? Lawyers serving as company counsel are supposed to take their broad level of experience and market understanding – surpassing that of most investors – and use it to “level” the playing field for the common stock (founders and early employees). Experienced, talented corporate lawyers are supposed to be the “equalizers” that early-stage companies (particularly common stockholders) rely on to ensure no one takes advantage of them on deals and corporate governance. Great for the common stock. Not so great for the clever money; which would obviously much prefer to keep the field slanted in their favor.

So let’s say I’m a very smart money player, and if I can find a way to neutralize the role of independent company counsel, to maximize my leverage, what should I do? Negotiating very aggressively against the lawyers and startups is a failed strategy. It’s too visible. Early-stage capital has become more competitive, and money players rely on personas of “friendliness” for deal flow. Angrily pounding the table would quickly shatter that persona. You need to me much smarter than that at this game.

You start with asking yourself: what do these lawyers need in order to fully do their job as strategic advisors? The answer is two-fold: (i) clients, and (ii) time. Without clients (referrals), lawyers can’t stay in business. And without time to study issues and negotiate, and ability to charge for that time, they can’t advise companies properly. That’s where the strategy lies. I often refer to this strategy as the “Race to the Bottom” in Startup Law.

Buy counsel’s favor with referrals.

As a repeat player with “access” to lots of deals and potential clients, investors can “buy” the favor of law firms by simply channeling referrals to them. First-time entrepreneurs have absolutely no counter-balancing resource in this area, because they just aren’t that well-networked or influential. Pay close attention in startup ecosystems and you’ll often realize how many of the most prominent lawyers built their practices by riding referrals from a few repeat players. Doing a great job for companies certainly can get you business, but doing a great job for investors (so that they refer companies and deals to you) can get you 20x that, because of the volume they touch.

So Step 1 of the Race to the Bottom is to make it clear to law firms that those who “behave” (by biasing the advice they give to inexperienced startups) will get business, and those who don’t won’t. The lawyers/firms most motivated by maximizing their business, and most willing to flout conflicts of interest in order to get that business, start competing at how far they can go to win the favor of these juicy referral sources, while minimizing the visibility of this game to inexperienced outsiders.

Squeeze counsel’s time.

For a company lawyer to do their job in advising a startup, they need time. Answering questions, explaining issues, and negotiating all take time, especially when the executives you’re working with are completely inexperienced (which in early-stage startups, they often are). Seasoned investors, however, don’t need nearly that much time from lawyers, because they’ve played the game 30 times already. So startups need a lot of lawyer time, but investors don’t. Opportunity? You bet.

But again we reach the “visibility” problem. If an investor simply tells the founders, “stop talking to your lawyers,” that’s too easy to read into. A far more successful narrative is: “let’s save some legal fees.”

“Your lawyer is just over-billing. Their request isn’t “standard” and is a waste of time.”

“This deal is all standard/boilerplate. Let’s move quickly to close without lawyer hand-waiving.”

“We really don’t have the budget to get lawyers involved on this Board issue.”

“I’m saving you some legal fees. Cap your legal bill at X.”

“Here, just sign this template (that I created). It’ll save you fees.”

I’ve often found it very amusing how certain aggressive investors, happy to write you large checks for funding talent wars and expensive bay area offices, suddenly have lots of (air quotes) “insights” to share when discussion turns to the legal budget. Increasing your burn rate makes you more dependent on the money, which they often like; but heaven forbid you spend capital on a service that reduces their influence/leverage. Thank goodness they’re ever so generously “looking out” for the bottom line.

If an experienced investor knows the lawyer across the table needs time to explain to inexperienced founders why the terms or decisions such investor is pushing for should be resisted, and such investor prefers that the lawyer stay quiet, the answer is not to explicitly tell the lawyer to shut up. Too visible. The investor instead gets the founders to do it themselves, by suggesting that they should focus on minimizing their legal bill. Nevermind that the issues a great (and independent) lawyer will bring up are 10-20x+ more consequential long-term than the rate the lawyer is charging. By getting founders to myopically think that legal advisory is just empty hand-waiving, and therefore be unwilling to pay for real counsel, investors are able to silence counsel by making it unprofitable for them to speak up. With no one else at the table who actually knows the game, the money then gets free rein to set the rules.

One particularly clever strategy here is worth highlighting: fixed or subscription fees. Most high-end lawyers bill by time, and for good reason. See: Startup Law Pricing: Fixed v. Hourly. The highly contextualized needs of varying businesses are simply too diverse for high-end outside corporate counsel to set broad standardized costs for legal work. High-growth businesses across diverse industries and contexts are far more diversified in their legal needs than the medical needs of patients (fixed fees in healthcare can work), and so there’s just no neat bell curve to enable a viable general flat fee system without setting serious (and dangerous) constraints on what a corporate law firm is able to do.

Investors who push company lawyers to work on fixed/subscription fees know exactly what the end-result of that fee structure’s incentives will be: staying quiet about negotiation points, rushing work, and delegating to cheaper, inexperienced people who just follow standardized checklists/scripts. Market competition sets constraints on how much law firms can charge while remaining competitive, but in an hourly rate structure a law firm still has to at least do the work to get paid. Under a flat or fixed subscription fee, the incentives are reversed. Every extra minute of advisory or customization is lost margin, so cut every corner imaginable, as long as the client can’t see it. And because in the case of early-stage startups the client is often led by an inexperienced founder with no in-house general counsel to vet work product or know what questions outside counsel should be asking, hiding all the shirking/corner-cutting from the client is quite easy.

Firms who simply don’t care about ethics and quality are happy to have you pay them for doing the absolute bare minimum of work, via a flat or subscription fee; and clever investors will happily reward their weak company-side advisory with continued referrals.

The Race to the Bottom.

So what is the predictable end-result of this race to the bottom in startup law, where massive conflicts of interest with the investor community are conveniently overlooked, and lawyers are incentivized to keep their mouths shut and rush work in a standardized assembly-line built to the specifications of unethical investors? In terms of a law firm’s operating structure, it looks like this:

A. The law firm has deep ties to, and referral dependencies with, very influential money players in the startup ecosystem, including VC funds and high-profile accelerators; rendering it completely uncredible to suggest that those investors don’t influence the firm’s advisory. A significant portion of the firm’s business comes from investor referrals, ensuring the firm follows the investors’ preferred protocols.

B. Highly experienced, true Partners and Senior Lawyers are virtually non-existent at the firm, with minimal contact with early-stage startups. It’s only lawyers with many years of specialized experience and vetting who know how to navigate significant high-stakes complexity. Juniors – like lawyers who’ve only practiced for a few years, or paralegals – are only able to safely handle legal work that fits within narrow parameters. Often referred to as “de-skilling” in professional circles, this ensures that when a startup is negotiating against a highly experienced player, the person advising the startup is minimally skilled (and cheaper to the firm). They’ll basically check boxes and fill in forms. Investors will love it. The most highly experienced and talented lawyers (Senior Partners) are the most expensive people on a law firm’s payroll. By eliminating them, a firm can improve margins under a flat or subscription fee model, while torpedoing quality and flexibility. Firms that care most about growing revenue, whatever the impact on quality/ethics, are OK with that.

C. The firm vocally touts the purportedly enormous benefits of standardization, inflexible automation technology, speed, and fixed/subscription fees. By pushing a message that founders should just focus on minimizing legal bills and fixing their costs, the firm hopes they’ll overlook the quality issues with their weak, cookie-cutter counsel. This firm is happy to pretend that it’s in startups’/founders’ best interest to just handle legal work as quickly and automatically as possible. The fixed/subscription fees ensure that the firm is rewarded for cutting corners, delegating work to inexperienced people, and just filling in templates with minimal negotiation or advisory. They’re happy to peddle the templates/form documents, and follow the protocols, that certain aggressive investors (falsely) claim are “standard,” particularly those investors whom the firm depends on for referrals.

D. The firm attracts lawyers who are less interested in actually practicing high-stakes law for the long-term, and the quality accountability that entails, and instead care more about finding future job opportunities with high-growth startups or VC funds. The fact that the firm’s incentive structure totally constrains their ability to actually practice high-level law (and properly advise clients) doesn’t bother them, as long as they get paid and have access to good networking opportunities.

I’ve seen different law firms reach different levels of this race to the bottom. Without a doubt, Silicon Valley culture, with its historical “move fast and break things” approach to raising as much money as possible as quickly as possible in hopes of being a unicorn, has reached some of the most extreme points. Entrepreneurs who fully understand the implications of this race to the bottom, and want to avoid them completely for their business, should read: Checklist for Choosing a Startup Lawyer.

To be crystal clear, I am a big believer in efficiency, and the thoughtful use of well-applied technology to stay “lean” on legal. It’s why I left BigLaw years ago to build out an unapologetically high-end boutique firm, where top-tier lawyers’ rates are hundreds of dollars an hour lower than the conventional firms they left. Their lives are also far healthier because they bill fewer hours. Legal technology is a part of our model, and we are definitely early adopters, but I’m not going to over-hype its significance. The truth is at the top tier of emerging tech/vc law, there’s too much complexity, contextual diversity, and massively high error cost for software to make a huge dent; with deep non-apologies to the software engineers hell-bent on “disrupting” lawyers with an app. We’re talking about highly complex, highly unique companies navigating serious decisions and 8-10+ figure transactions involving very sophisticated players; not a coffee shop or plumbing company.

We’ve grown profitably and sustainably every year since I got here, with 2019 being our best year yet. But I also care deeply about professional ethics, and doing the actual job that inexperienced and vulnerable clients pay me to do. That means cutting out fat from the legal industry, but not muscle. It means delivering highly experienced, specialized strategic counsel capable of flexibly addressing clients’ varying needs as they come up, while leaving out the many other layers of unproductive overhead that traditional firms are often burdened with. See: When Startup Law Firms Don’t Sell Legal Services. Top-tier law can be made leaner and more accessible, but it requires leadership/stakeholders that take professional ethics and quality standards seriously, rather than treating legal work like just another product to recklessly hack and market your way into maximal growth.

We’re in an extremely exciting time for the legal industry. While BigLaw will always serve the largest and most complex deals, I believe the future of the industry (at least the segment that serves non-billion-dollar “happily not a unicorn” clients) is a diversified ecosystem of lean, specialized firms operating far more flexibly and efficiently than traditional mega firms; enabled by technology and operating structures that cut costs without cutting corners. That is the kind of innovation clients, including startups, need and deserve. Blatant flouting of conflicts of interest, and massive dilution of the quality of legal counsel, is not innovation. It’s a race to the bottom, in which the losers (inexperienced teams) are being taken for a ride.

Why Startup Accelerators Compete with Smart Money

TL;DR: As the smartest VC money has continued moving earlier-stage, its value proposition for early checks starts to resemble what’s offered by high-priced startup accelerators: signals, coaching, and a network. That means elite early-stage VCs and accelerators can be substitutes, and the accelerators know this. This may lead the latter to recommend financing strategies to entrepreneurs that, from the perspective of the startup can be counterproductive, but enhance the market power of the accelerator relative to investors who can offer similar resources at better “prices” (valuations). Entrepreneurs should understand the power games everyone is playing, and become beholden to no one.

Related reading:

First, a few clarifications on definitions. When I speak of “smart money” in the VC context I’m referring to investors who bring much more to the table, in terms of useful resources and connections, than simply raw cash. They often bring an elite brand that serves as a valuable signal in the market (which itself raises valuations and helps with follow-on funding), credible insight and coaching that they can use to help founders and Boards of Directors, and a network that they can tap into for helping companies find talent and connect with commercial partners.

Classifying some money as “smart money” doesn’t necessarily mean that any money that isn’t “smart” must be stupid in a classic sense. It just means that the other money isn’t useful other than to pay for things. So in short, “smart money” refers to value-add investors who can do a lot more for a company than simply write a check; while “dumb money” means investors willing to pay very high valuations because they are simply happy to get access to this deal at all, and have very little else to offer beyond money itself.

Another clarification: for purposes of this topic, I am referring to high-cost, high-touch startup accelerators; meaning the traditional kind who “charge” 7-10% of equity and put in significant resources into programming, education, nurturing their network, etc. As I’ve written before, various organic market dynamics that are eroding the value proposition of traditional accelerators (see above-linked post) have produced a new “lean” form of accelerator that has dialed back its proposition, and reduced its “price” to 1-2% of equity. That latter kind of accelerator is not part of this discussion, because they behave very differently, and interact with smart money very differently.

Ok, so now to the main point. “Smart” very early-stage money (seed and pre-seed) can be viewed as a bundle of a few things:

  • Green cash money
  • Signaling and Branding – simply by being publicly associated with them, raising follow-on money, and getting meetings with other key players, will become dramatically easier.
  • Coaching – they’ve seen lots of successful (and failed) companies, and can provide valuable coaching to entrepreneurs.
  • A network – they’ve built a rolodex/LinkedIn network of lots of talented people that they are heavily incentivized to make available to you.

Now, let’s compare that bundle to the value proposition of traditional accelerators:

  • Signaling and branding
  • Coaching
  • A network

See the overlap? Startup accelerators are basically a service provider whose core service is the above bundle. In exchange for equity and the right to a portion of your funding rounds, their “service” is that they’ll (i) apply a brand on your company that makes it (at least for the good accelerators) easier to access money, (ii) provide you some coaching and education, and (iii) share their network with you.

The core value proposition of early smart money can be effectively the same as an accelerator: a brand to leverage in networking and fundraising, coaching, and a network to navigate. Accelerators and smart early money are, therefore, substitutes; and substitutes inevitably compete with each other. Some might argue that the “programming” (the educational content) of accelerators is a key differentiator, but realistically the smartest entrepreneurs aren’t joining accelerators to get an education. They’re joining for the brand, the network, and to make it easier to find more money and talent; all of which entering the portfolio of a resource-rich and well-respected early stage investor can provide.

The earlier in a company’s life cycle that smart money is willing to go for their pipelines (and many smart funds are going very early), the more startup accelerators will find themselves competing with lots of market players offering a very similar bundle of services. Given that smart early money can challenge the value proposition of accelerators, aggressive accelerators are incentivized to, in subtle ways, push startups away from smart very early-stage money and toward dumber money, because it increases a startup’s dependency on the accelerator’s resources, and therefore helps justify the accelerator’s cost.

How does this fact – that aggressive, elite startup accelerators want to cut off smart early-stage money from competing with them – play out in the real market? Some of the ways I’ve already described in Startup Accelerators and Ecosystem Gatekeeping, but I’ll elaborate here.

Demo Day – Aggressive accelerators can push entrepreneurs to not do any fundraising other than through channels that the accelerator can control, like Demo Day, and then they can restrict access to Demo Day to investors who serve the interests of the accelerator (don’t compete with it). As I’ve written before, it is not in startups’ interests to restrict their fundraising activities solely to channels that accelerators can influence (because it allows accelerators to serve as rent-seeking gatekeepers). Many accelerators aggressively restrict how their cohorts are able to fundraise, enhancing the accelerators’ market power relative to VCs.

Fundraising Processes that Select Against Smart Money – One thing that’s been interesting to observe in the market is how entrepreneurs who go through certain accelerators are much more likely to emerge with a view that early-stage venture capital has largely been commoditized. If you think that all early money is the same, and all that matters is getting the best economic terms possible, you are going to approach fundraising in a very different way from someone who better appreciates the very subtle, human-oriented dynamics of connecting with value-add (smart) lead investors. “Party rounds” where entrepreneurs don’t allow anyone to serve as the lead are a very visible manifestation of this.

Entrepreneurs who treat fundraising as a kind of auction process, where you amplify FOMO and aggressively get the money to compete for the best price, are often creating a fundraising system that much of the smartest money will simply opt out of. Quality smart money players are looking to build long-term relationships, and that takes time. Their resource-intensive approach to investing also requires building meaningful positions on a cap table; a slot in a party round won’t work.

Elite value-add VCs know that they bring much more to the table than a random investor willing to pay a high valuation, and so the end-product of a hyper-competitive fundraising process that forces them to compete with a swarm of dumb money simply isn’t worth their time. The valuation will be too high, and their allocation on the cap table too low.

Aggressive accelerators know this, and it’s why they often nudge founders toward engaging in these kinds of hyper-competitive fundraising processes that push out smart money, because by removing other “smart” early market players with their own networks and brands, the accelerators enhance the relative value of their own network. The strategy is to marginalize any potential substitutes, so startups see the accelerator and its own network as the only “smart” player they need.

If you, as a founder, have come to believe that value-add VCs – who can deliver A LOT more value than simply cash – don’t exist, you may have fallen for a lot of the propaganda on social media pushed by traditional accelerators and the “dumb money” funds affiliated with them. Value-add VCs most definitely exist, and founders who’ve raised from them will say they’re worth their weight in gold. Accelerators may spin a story as to why it’s in founders’ best interests to be hyper-aggressive with their fundraising, and alienate many value-add VCs in the process, but startups need to understand this is driven far more by what’s in the accelerator’s interests than the startup’s.

It’s also worth pointing out the irony in certain accelerators telling founders that they should maximize valuations and minimize dilution in fundraising, while the same accelerators keep their own admission prices (valuations) fixed; and in the case of accelerators who’ve moved to post-money SAFEs, the price has actually gone up. If the market has become flooded with early-stage capital and signaling alternatives, should accelerators themselves not be subject to market forces?

I’m not an investor, nor do I even represent investors. I’m a lawyer who represents companies, including in lots of financing rounds. Read my lips: relationships matter, and smart relationship-oriented money can really make a difference. Want to know what a possible end-result is of startups pursuing a naive, hyper-competitive, relationship ignorant fundraising strategy that treats getting a high valuation as the only goal; long-term relationships and “value add” VCs be damned? Failed unicorns (getting SoftBanked) and thousands of employees burned because people guiding the company in the earliest days were just lottery-ticket chasers instead of smart players who know how to build viable businesses. Treat investors like it’s all just about numbers, and you’ll inevitably surround yourself with people for whom you are just a number.

As I’ve written many times before, it’s extremely important that new entrepreneurs entering startup ecosystems understand the power dynamics operating in the background. See Relationships and Power in Startup Ecosystems. Different market actors compete for access and control over pipelines of entrepreneurs; and they “trade” access to deals with people who serve their interests. Startups are much better served when they are in the driver’s seat for what relationships they build in the market, as opposed to allowing repeat players (like accelerators or VC funds) to trade access to them as currency. Don’t let your company become a pawn in another power player’s game.

The smartest investors in the market have realized that outsourcing their business development to a handful of “sorters” (accelerators) is a losing strategy, because those sorters have their own agendas. One of those agendas is to make the earliest money in the market “dumber,” so that the accelerators can continue giving startups $125K for 7-10% of their cap table (which translates to as low as a $1.25 million valuation) when many smart early funds would offer multiples of that. It is an own-goal for founders to help accelerators do this.

Scout programs, pre-seed funding, exclusive “meet and greet” events, open “application” processes for intro meetings, and many other activities are ways in which smart money is moving earlier in the startup life cycle, to find early startups that they can “accelerate” themselves. That can be useful to founders, saving them both time and equity. Competition with accelerators is why most elite VCs no longer require warm intros. 

All of these ecosystem players are here, in one way or another, to make money; endless PR about friendliness, “positive sum” thinking, and saving the whales notwithstanding. Frankly, so are you, and so am I. The more they can cut off competition, the more money they can extract from the market that would otherwise go to entrepreneurs and their employees. That means the most logical strategy is: become beholden to no one. Nothing better ensures good behavior by your business relationships than a little optionality.

That does not mean treating everyone as a means to an end, nor does it mean preventing serious VCs from taking lead positions on your cap table. To the contrary, it means slowing down and building a diverse set of long-term and durable relationships, with a mix of value-add and “dumb,” that you can leverage toward your company’s goals. The emphasis, however, is on the diversity of your relationships, so no particular group has more leverage than is justified. Diversify your network.

Let everyone offer their service, but don’t naively become over-dependent on any single channel. If you have access to smart early money, take it, nurture that relationship, and respect the fact that smart money deserves a better price than party round “dumb” checks. Just don’t agree to any terms that cut you off from raising from alternative money later if it makes sense. Independent counsel will help ensure that.

If you’re in an elite accelerator, fantastic. Use them. But don’t let them push you into myopic fundraising approaches that just increase their control over the market, which keeps their “prices” high relative to where the market should move. Keep connecting with smart money, and diversify your network. Understand that it’s in founders’ interests to not let a handful of very expensive accelerators cut off smart money from competing on the same playing field (the earliest checks); often at much better valuations.

Startups thrive best in actual ecosystems, where market players aren’t able to gain so much control that they start to “charge” more than their real value proposition justifies. Let the smart money and accelerators compete, and build your long-term relationships accordingly.

Note: a few examples of elite value-add VCs competing head-on with traditional accelerators include Sequoia Arc, a16z Start, Accel Atoms, as well as the Neo Accelerator, which “costs” less dilution than traditional accelerators. Examples of elite VCs who haven’t formed formal accelerators but invest very early (pre-Seed) include Nfx and First Round Capital. Many founders are finding that, after weighing all the factors, entering these kinds of pipelines or programs leads to substantially less dilution relative to going into a traditional accelerator (paying 7-10% in dilution for that) and then doing a seed round.

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. Classic disintermediation. 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.

After-note: see Why Startup Accelerators Compete with Smart Money for some observations on how early-stage VCs are eroding the value proposition of accelerators further by bundling new roles/services alongside their investments, and moving up-stream.