Post Category → Founders

Relationships and Power in Startup Ecosystems

TL;DR: The highly unequal relationship and power dynamics in most startup ecosystems mean that what is visible publicly (on blogs, social media, etc.) is not an accurate representation of how the game is actually played, because few people are willing to speak honestly and openly for fear of being penalized by a well-connected gatekeeper. This makes off-the-record diligence, and watching loyalties of your most high-stakes relationships (including counsel), essential in order to prevent repeat “money” players (investors, accelerators) from dominating the voices of less influential “one shot” players (first-time entrepreneurs, employees) both on boards of directors and in the market generally. Hire and engage people without hidden dependencies on the money.

Background Reading:

There are a few underlying themes that have been covered in a number of SHL posts and are relevant to this one:

First, in startup dynamics there is a fundamental divide and tension between inexperienced, “one shot” common stockholders and “repeat player” investor preferred stockholders (VCs, seed funds, accelerators) that feeds into all of the most high-stakes decisions around how to build and grow a company. It has nothing to do with good v. bad people. It has to do with core economic incentives.

Common stockholders (founders, early employees) typically have their wealth concentrated in their one company (not diversified), do not have substantial wealth as a backup in the event of failure, do not have the downside protection of a liquidation preference or debt claim on the company, and have almost no experience in the subtle nuances of startup economics and governance. This dramatically influences their perspective on what kind of business to build, how to finance it, whom to hire in doing so, and how much risk to take in order to achieve a successful outcome; including how to define “successful.”

Preferred stockholders / repeat players (investors, accelerators) are the polar opposite of this scenario. No matter how “founder friendly” they are, or at least pretend to be via PR efforts (more on that below), their core economic interests are not fully aligned with one shot players. They are already wealthy, significantly diversified, have substantial experience with startup economics and governance, and have downside protection that ensures they get paid back first in a downside scenario.  In the case of institutional investors, they also are incentivized to pursue growth and exit strategies that will achieve rare “unicorn” returns, even if those same strategies lead to a large amount of failures; failures which hit common stockholders 100x harder than diversified, down-side protected investors.

And the fact that some of the repeat players are themselves former founders (now wealthy and diversified) is irrelevant to the fundamental economic misalignment; though investors will often use their entrepreneurial histories as smoke and mirrors to distract now first-time founders from that fact. They can probably empathize more with the common’s challenges, and help with execution, but they didn’t become wealthy by ignoring their economic interests. In fact, I would argue from experience that the moves/behavior of entrepreneurs-turned-investors should be scrutinized more, not less, because they’re almost always far smarter “chess players” at the game than the MBA-types are.

Second, apart from the economic misalignment between the common and preferred, there is a widely unequal amount of experience between the two groups. A first-time founder team or set of early employees do not have years of experience seeing the ins and outs of board governance, or how subtle deal terms and decisions play out in terms of economics and power.  The preferred, however, are usually repeat players. They know the game, and how to play it. This means that the set of core advisors that common stockholders hire to leverage their own experience and skillset in “leveling the playing field” is monumentally important; including their ability to trust that those advisors will help ensure that the preferred do not leverage their greater experience and power to muzzle the common’s perspective.

This second point relates to why having company counsel who is not dependent on your VCs / the money is so important; and it also highlights why repeat players go to such enormous efforts to either force or cleverly trick inexperienced teams into hiring lawyers who are captive to the interests of the preferred.  We’ve observed this in pockets of every startup ecosystem we’ve worked in: that aggressive investors work hard to gain influence over the lawyers who represent startups.  The moment we became visible in the market as a growing presence in startup ecosystems, we lost count of how many of the strongest money players reached out to us to “explore” a relationship; even though they already had “relationships” with plenty of firms. It wasn’t that they needed lawyers; it’s their power playbook.

The point of this post is how these above facts – the economic misalignment, and particularly the greater experience – of influential investors (including accelerators) plays out into how they exert power, often covertly, in startup ecosystems; not just with lawyers.

Think of any kind of business that needs to work with startups as clients: obviously lawyers, but also accountants, HR, outsourced CFO, benefits, real estate, even journalists who need access to entrepreneurs in order to write articles. All of those people need strategies for “filtering” startups (finding the more viable ones) and then gaining access to them; and they’re going to look for strategies that are the most efficient and less time consuming.

What many of these service providers come to realize is that an obviously efficient strategy is to work through VCs and other influential investors/accelerators. They’re doing the filtering, and because they’re repeat players, have relationships with lots of companies.  So the service providers reach out to the prominent repeat players (investors, accelerators), who immediately recognize the power that this role as “gatekeepers” and brokers of relationships gives them over the ecosystem.

And when I say “power over the ecosystem,” what I mean is power over what people will say publicly, what they won’t say, and what “support” businesses become successful (or not) via the direction (or restriction) of referral pipelines. It heavily plays out into what gets written and not written on social media and in tech publications, and said at public events; because people are terrified of pissing off someone who will then cut them off from their lifeblood of clients.

“One shot” players are, by virtue of not being repeat players and lacking significant relationships, unable to counterbalance this dynamic.  Put together a system of highly influential and wealthy repeat players and inexperienced, less influential “one shot” players, and you can bet your life that it will inevitably tilt itself toward those who can exert power; with strategies to obscure the tilting from the inexperienced. The ability to offer (and restrict) access to valuable relationships is the leverage that repeat players use to exert power in startup ecosystems and ensure their interests are favored; even when they aren’t formally the “client.”

So let’s tie this all together. Founders and other early startup employees are significantly misaligned from the repeat player investor community in a way that has nothing to do with ethics, but core incentives and risk tolerance; and this is independent of the more obvious misalignment re: each side’s desire for more ownership of the cap table. They’re also totally lacking in experience on how to navigate the complexities of startup growth and governance, and therefore rely heavily on trusted outside advisors to level the playing field. Finally, the most aggressive repeat players will position themselves as gatekeepers to the ecosystem (or at least a valuable portion of it), exerting significant control over the market of advisors available to founders by their ability to offer, or deny, access to startups.

What’s the conclusion here? There are two:

A. What you often see written or said publicly in startup ecosystems is not an accurate representation of how the game is actually played, because very few people are willing to talk openly about it, for fear of being cut off by gatekeepers.  Others will say positive things publicly because of a quid-pro-quo understanding in the background. This significantly increases the importance of off-the-record “blind” diligence to get the real story about a particular repeat player. If you are diligencing an influential investor or an accelerator, it is important that said entity not know whom you are contacting (or at least not everyone) in conducting that diligence.  That is the only way that they cannot retaliate against any particular person who says something negative; and you’re therefore more likely to get an honest answer.

You will absolutely encounter people who will say that the whole idea of “retaliation” is some kind of paranoid fabrication, but remember how the chess game is played: the appearance of “founder friendliness” is often a marketing tool. Of course the smartest users of that tool are going to wave away all this talk of bad actors, doing heavy diligence, and protecting yourself as unnecessary. Come on, they’re good guys. Just trust them, or their tweets. We’re all “aligned” here, right?

When you have an inherent and substantial power advantage, it is an extremely effective strategy to create a non-adversarial, “friendly” PR image of yourself, downplaying that power.  Inexperienced, naive first-time players then buy into this idea that you’re not really about making money, and come to the table with minimal defenses; at which point you can get to work and surround them with relationships you “own.”

The money players with truly nothing to hide won’t be dismissive or defensive at all about the common’s need to conduct blind diligence and ensure the independence of their key relationships. Reactions are often a key “tell.”  If you truly have a great reputation, and you have no intent to use the common’s inexperience and unequal power against them, then what exactly is the problem with respecting their right to be cautious and protect themselves?

There are definitely good people in the market, including those who put integrity and reputation above money, but only idiots navigate a highly unequal and opaque world under the premise that everyone is an angel, and you should “just trust them.” Being a “win-win” person is not in tension with ensuring your backside is covered. Anyone who says otherwise is trying to cleverly disarm you, and is defending an approach that has clearly served them well.

B. To prevent repeat players from dominating the perspective of “one shot” common stockholders both on startup boards of directors, and in ecosystems generally, the “one shot” players must pay extremely close attention to the relationships of their high-stakes key advisors and executive hires, to ensure they can’t be manipulated (with bribes or threats) by the money’s relationship leverage.  No rational human being who cares about being successful bites the hand that most feeds them; no matter how “nice” they are. That is the case with lawyers, with “independent” directors on boards, with other key advisors, and also with high-level executives that you might recruit into your company. Pay attention to loyalties, and diversify the people whose rolodexes you are dependent on.

In the case of lawyers, aggressive repeat players and their shills will often talk about how startup dynamics are “different” and it’s “not a big deal” for company counsel to have dependencies (via engagements and referral relationships) with the preferred stockholders. They even argue that the lawyers’ “familiarity” with the investors will help the common negotiate better and save legal fees. How generous. An honest assessment of the situation is that startups are different, but different in a way that conflicts of interest matter more than usual. Outside of the world of promising startups run by first-time executives negotiating financing/governance with highly experienced investors, you rarely see high-stakes business contexts where there is such a dramatic inequality of experience and power between groups, and such a high level of dependence on counsel (on the part of the one shot common) for high-impact strategic guidance.

Repeat players aren’t reaching across the table and manipulating startup lawyers because it’s “not a big deal.” They’re doing it because the payoff is so uniquely high, and the power inequality (reinforced by the preferred’s inherent dominance over key ecosystem relationships) makes it so easy to do. Couple a basic understanding of human nature/incentives with the fact that the Board’s primary fiduciary duties under Delaware law are to the common stock, and any honest, impartial advisor will acknowledge that experienced company counsel who doesn’t work for the repeat players across the table on other engagements, and who doesn’t rely on them for referrals (in other words, is not conflicted), is one of the clearest ways to (a) ensure the common’s perspective gets a fair voice, and accurate advisory, in key Board decisions, and (b) help the Board do its actual job.

There is a clever narrative pushed around startup ecosystems painting a picture of startup finance and governance as always full of warm, balanced transparency and generosity, with common stockholders and investors holding hands and being “fully aligned” as they build shareholder value together without bias, disagreement, or power plays. But notice how quickly the tone changes from some parts of the investor community the moment you suggest that the common be afforded even minimal defensive protections, like company counsel that investors can’t manipulate. Suddenly you’re being “overly adversarial.”

Oh, so are the transparency and generosity, and “kumbaya” sing-alongs, only available if the common stock behaves in the exact way the money demands? Funny how that works. Smart common stockholders won’t accept “benevolent dictatorship” as the model for their company’s governance. The way you address power inequality is by honestly fixing it; not by taking someone’s BS reassurances that they’ll be “really nice” with how they use it.

You should absolutely want transparency, fairness, and generosity to be the guiding principles of your relationship with your investors – that’s always my advice to founders on Day 1. Also understand that while the common’s perspective deserves to be heard and respected (and not muzzled or infantilized), it is obviously not always right. Balanced governance is good governance; and true “balance” requires real, independent ‘weight’ on both sides. Too many repeat players have manipulated the market into a charade – propped up by pretensions of “friendliness” and “cost saving” – where inexperienced common stockholders become unwittingly dependent on advisors to help them negotiate with investors 100x as experienced as they are, when in fact those advisors are far more motivated to keep the investors happy than their own (on paper) clients.

High-integrity startup ecosystem players should forcefully assert that the “friendly” ethos promoted by VCs and accelerators only has real substance if they’re willing to stay on their side of the table, and not use their structural power advantage to maintain influence over the key people whom founders and employees depend on for high-stakes guidance and decision-making. Call out the hypocrisy of those who put on a marketing-driven veneer of supporting startups and entrepreneurs, while quietly interfering with their right to independent relationships and advisory; including independent company counsel that repeat players can’t “squeeze” with their relationship leverage.

A lot of the most egregious stories of startup flame-outs that you see written about – who grew too fast chasing a unicorn exit, raised more money than a business could sustain, took a high-risk strategy that blew up, or perhaps achieved a large exit while returning peanuts to the early common – are the end-result of a complex game by which repeat players come to exert so much power over how a particular startup scales that the voice of the “one shot” players – the early common stockholders without deep pockets or contacts – gets completely silenced until it’s too late. Gaining control over key company relationships is a significant part of how that game is played. And what’s written about publicly is just the tip of the iceberg.

To put a bow on this post, healthy skepticism over what you see and hear publicly, and good instincts for understanding the importance of incentives and loyalties, are essential for any inexperienced team entering a startup ecosystem. The image of wealthy, powerful people “winning” only by loudly and aggressively pounding the negotiation table is a caricature of how complex business actually works; but it’s a caricature that often dupes inexperienced founders into thinking that everyone else who smiles and seems helpful must be aligned with their interests. Assholes are easy to spot, so the smartest winners are almost never easily visible assholes. Good people still follow their incentives; and aggressive but smart money players know how to assert their power while preserving a public image of selflessness and generosity. Navigate the market, and recruit your advisors, accordingly.

The Problem with Short Startup Term Sheets

TL;DR: Shorter term sheets, which fail to spell out material issues and punt them to later in a financing, reflect the “move fast and get back to work” narrative pushed by repeat players in startup ecosystems, who benefit from hyper-standardization and rapid closings. First-time entrepreneurs and early employees are better served by more detailed term sheets that ensure alignment before the parties are locked into the deal.

Related reading:

In my experience, there are two “meta-narratives” floating around startup ecosystems regarding how to approach “legal” for startups.

The first, most often pushed by repeat “portfolio” player investors, and advisors aligned with their interests, is that hyper-standardization and speed should be top priorities. Don’t waste time on minutiae, which just “wastes” money on legal fees. Use fast-moving templates to sign a so-called “standard” deal.  Silicon Valley has, by far, adopted this mindset the furthest; facilitated in part by the “unicorn or bust” approach to company building that its historically selected for.

An alternative narrative, which you hear less often (publicly) because it favors “one shot” players with less influence, is that there is a fundamental misalignment of interests between those one shot players (founders/employees, common stockholders) and the repeat players (investors, preferred stockholders), as well as a significant imbalance of experience between the two camps. Templates publicized by repeat players as “standard” are therefore suspect, and arguments that it’s *so important* to close on them fast should cause even more caution.

Readers of SHL know where I stand on the issue (in the latter camp).  Having templates as starting points, and utilizing technology to cut out fat (and not muscle), are all good things; to a point. Beyond that point, it becomes increasingly clear that certain investors, who are diversified, wealthier, and have downside protection, use the “save some legal fees” argument to cleverly convince common stockholders to not ask hard questions, and not think about whether modifications are warranted for their *specific* company. Hyper-standardization is great for a diversified portfolio designed for “power law” returns. It can be terrible for someone whose entire net worth is locked into a single company.

Among lawyers, where they stand on this divide often depends (unsurprisingly) on where their loyalties lie. See: When VCs “Own” Your Startup’s Lawyers.  Knowing that first-time founders and their early employees often have zero deal experience, and that signing a term sheet gets them “pregnant” with a “no shop” and growing legal fees, it’s heavily in the interest of VCs to get founders to sign a term sheet as fast as possible. That’s why lawyers who are “owned” by those repeat players are the quickest to accept this or that “standard” language, avoid rocking the boat with modifications, and insist that it’s best for the startup to sign fast; heaven forbid a day or two of comments would cause the deal to “fall through.”

I was reminded of this fact recently when Y Combinator published their “Standard and Clean” Series A Term Sheet.  It’s not a terrible term sheet sheet by any means, though it contains some control-oriented language that is problematic for a number of reasons and hardly “standard and clean.” But what’s the most striking about it is how short it is, and therefore how many material issues it fails to address. And of course YC even states in their article the classic repeat player narrative: “close fast and get back to work.”  The suggestion is that by “simplifying” things, they’ve done you a favor.

Speaking from the perspective of common stockholders, and particularly first-time entrepreneurs who don’t consider their company merely “standard,” short term sheets are a terrible idea. I know from working on dozens of VC deals (including with YC companies) and having visibility into hundreds that founders pay the most attention to term sheets, and then once signed more often “get back to work” and expect lawyers to do their thing. It’s at the term sheet level therefore that you have the most opportunity to ensure alignment of expectations between common stock and preferred, and to “equalize” the experience inequality between the two groups. It’s also before signing, before a “no shop” is in place, and before the startup has started racking up a material legal bill, that there is the most balance and flexibility to get aligned on all material terms, or to walk away if it’s really necessary.

A short term sheet simply punts discussions about everything excluded from that term sheet to the definitive docs, which increases the leverage of the investors, and reduces the leverage of the executive team. Their lawyers will say this or that is “standard.” Your lawyers, if they care enough to actually counsel the company, will have a different perspective on what’s “standard.”  This is why longer term sheets that cover all of the most material issues in VC deal docs, not just a portion of them, serve the interests of the common stock. It’s the best way to avoid a bait and switch.

To make matters even worse for the common stock, it’s become fashionable in some parts of startup ecosystems to suggest that all VCs deals should be closed on a fixed legal fee; as opposed to by time.  Putting aside what the right legal cost of a deal should be, whether it’s billed by time or fixed, the fact is that fixed fees incentivize law firms to rush work and under-advise clients. Simply saying “this is standard” is a fantastic way to get a founder team – who usually have no idea what market norms, or long-term consequences, are – to accept whatever you tell them, and maximize your fixed fee margins. Lawyers working on a fixed fee make more money by simply going with your investors’ perspectives on what’s “standard” and “closing fast so you can get back to work.” For more on this topic, see: Startup Law Pricing: Fixed v. Hourly. 

When the “client” is a general counsel who can clearly detect when lawyers are shirking, the incentives to under-advise aren’t as dangerous. But when the client is a set of inexperienced entrepreneurs who are looking to their counsel for high-stakes strategic guidance, the danger is there and very real; especially if company counsel has dependencies on the money across the table (conflicts of interest). For high-stakes economics and power provisions that will be permanently in place for a long time, the fact that investors are often the ones most keen on getting your lawyers to work on a fixed fee, and also seem to have strong opinions on what specific lawyers you’re using, should raise a few alarm bells for smart founders who understand basic incentives and economics. If your VCs have convinced you to use their preferred lawyers, and to use them on a fixed fee, that fixed fee is – long term – likely to help them far more than it helped you.

Much of the repeat player community in startup ecosystems has weaponized accusations of “over-billing” and “deal killing,” together with obviously biased “standards,” as a clever way – under the guise of “saving fees” – to get common stockholders to muzzle their lawyers; because those lawyers are often the only other people at the table with the experience to see what the repeat players are really doing.  

The best “3D Chess” players in the startup game are masters at creating a public persona of startup / founder “friendliness” – reinforced by market participants dependent on their “pipeline” and therefore eager to amplify the image – while maneuvering subtly in the background to get what they want. You’ll never hear “sign this short template fast, because it makes managing my portfolio easier, and reduces your leverage.” The message will be: “I found a great way to save you some fees.”

I fully expect, and have experienced, the stale, predictable response from the “unicorn or bust” “move fast and get back to work” crowd to be that, as a Partner of a high-end boutique law firm, of course I’m going to argue for more legal work instead of mindlessly signing templates. Software wants to “eat my job” and I’m just afraid. Okay, soylent sippers. If you really have internalized a “billion or bust” approach to building a company, then I can see why the “whatever” approach to legal terms can be optimal. If you’re on a rocket ship, your investors will let you do whatever you want regardless of what the docs say; and if you crash, they don’t matter either. But a lot of entrepreneurs don’t have that binary of an approach to building their companies.

Truth is that, in the grand scheme of things, the portion of a serious law firm’s revenue attributed to drafting VC deal docs is small. Very small. You could drive those fees to zero – and I know a lot of commentators who simply (obviously) hate lawyers would love that – and no one’s job would be “eaten” other than perhaps a paralegal’s.  It’s before a deal and after, on non-routine work, and on serious board-level issues where the above-mentioned misalignment between “one shot” and repeat players becomes abundantly clear, that real lawyers separate themselves from template fillers and box checkers. The clients who engage us know that, and it’s why we have the levels of client satisfaction that we do.  We don’t “kill deals,” because it’s not in the company’s interest for us to do so. But we also don’t let veiled threats or criticisms from misaligned players get in the way of providing real, value-add counsel when it’s warranted.

So while all the people pushing more templates, more standardization, more “move fast and get back to work” think that all Tech/VC law firms are terrified of losing their jobs, many of us are actually grateful that someone out there is filtering our client bases and pipelines for us, for free.

“Top Startups” Lists and Accelerators

TL;DR: “Top Startup lists” are being used as complements, and in some cases replacements, to accelerators for helping entrepreneurs signal their talent to investors. Generally speaking, the “network effects” of accelerators are diminishing over time from the simple fact that they don’t really “own” their networks; making it harder for traditional accelerators to justify their cost as the “network” detaches from the gatekeeper. Long-term, many startup accelerators run a real risk of adverse/negative selection killing their core value proposition.

Background reading:

The value proposition of elite universities is a fairly straightforward 3-part bundle:

A. Education

B. Talent Sorting / Signaling

C. Network

Data showing that top students who attend elite universities perform on average the same as those who are similarly accepted but attend lower-ranked schools proves that the actual education elite universities provide isn’t nearly as important as some people think; at least for most students. But their talent signaling and network functions are fairly important and durable, and it’s very hard for competitors to build viable business models to deliver them; though some are succeeding.

Respected employers willing to not require elite educations are, for example, talent signaling competitors to elite universities. Being  “Google Alumni” can be seen as more value determinative than being “MIT Alumni.”

Now, the value proposition of top accelerators is also a fairly straightforward 3-part bundle:

A. Education

B. Talent Sorting / Signaling

C. Network

Look familiar? Many post-accelerator founders will tell you that the actual educational content accelerators provide is hardly that big of a deal to them. I’ve definitely known some entrepreneurs who find it useful, but the more hustler autodidact types will say it’s just re-hashed versions of what you can find online and in books. But the other two propositions (talent signaling and network) are harder to build.

To the extent accelerators build respected brands – and by that I mean respected by investors and other ecosystem players entrepreneurs want to connect with – their ability to sort through the ecosystem’s “noise” and signal talent, and therefore reduce search costs, is extremely important for founders. I would say most of the founders we work with understand instinctively that the main reason to attend any accelerator is to simply make it a lot easier to connect with investors. And yes, for the right accelerators, it works. Big time. 

Sidenote: Attending a B-class accelerator can be worse than attending none at all. If the A-accelerators reject you, you can just pretend to be one of the many companies that never even try to attend them; and just find other “signals” to use. But by attending a B-class accelerator, people now know you tried and were vetted, then rejected. Can be a scarlet letter.

Education? The best information is online and in books. Network? Not proprietary. Founders who can hustle know how to access all the same top people, many of whom want to ensure their own personal brands aren’t captive to an accelerator; ensuring significant “leakage” of the network. The networks of accelerators are compilations of the personal networks of individual people, and by bringing all of those people together for a period of time, without the leverage to lock them in, they’ve made it far easier for the network to be unbundled and re-bundled without the gatekeeping fee.

But it’s the reduction in search costs for connecting with investors (the talent sorting / signaling) that is the real money maker for accelerators. And yet talk privately with many investors, and they’ll tell you they resent the “hunger games” demo day and investor herding dynamics some accelerators produce, even if it’s the price for having someone else do a lot of the company filtering for you.

A short list of accelerators have built real and durable talent signaling brands, and are worth their cost tenfold; at least for now. The challenge for some has been maintaining them, and not supplementing themselves with business models misaligned with the goal of being very selective. Accelerators heavily tied to real estate/co-working, for example, are tempted to dilute the accelerator brand by accepting a lot more people, because they can still monetize them with offices (even if their equity isn’t worth anything). Lower your standards to fill office space, and your talent signal weakens, which means fewer top people show up to your events, which dilutes your network proposition, which further weakens the quality of your startups, and now you’re in a death spiral.

One thing you’re seeing all over the place in startup ecosystems today is “top startups lists.” “Top startups to watch.” Top this, top that. Top 50. Top 25. Top 10.

Initially, my reaction was to judge these lists as just PR plays. Politics/brand driven founders who want a bit of an ego stroke pander to publications to get on them, and in turn the publications get eyeballs and visibility, and can make money off of ads.

But analyze what these lists are, or could be, from the perspective of the talent sorting/signaling function of accelerators, particularly at early stage. To the extent some publications can build highly credible “top startup lists” – the kinds that investors and other players pay close attention to, they could prove to be viable (and far cheaper) competitors to the talent signaling proposition of accelerators.

I actually think many entrepreneurs understand this, and it’s why they care so much about getting on these lists, and why the lists are proliferating. If your ultimate goal is just to connect with investors, “top startup lists” that get real brand credibility could, much more cheaply, get you the “signal” you need to get meetings with selective investors.  Of course, it boils down to whether the right publications are willing to put in the time to build the needed credibility, and not make them simply politics or “pay to play” schemes. I suspect many won’t, but some will.

By no means am I under the delusion that accelerators and top startups lists are direct competitors; especially not at the highest tier. Many smart founders use them, wisely, as complements. The most important thing is for founders to understand what their real purposes are, and to judge them accordingly.  If many founders view accelerators as simply fast-tracks to getting the attention of investors (and they do), then you can fully expect there to be demand for cheaper alternatives, and players willing to experiment in delivering them.

The challenge long-term for many startup accelerators is going to be maintaining/justifying their value proposition, and therefore their cost. As alternatives to their educational and talent-sorting functions proliferate, and as their non-proprietary networks detach from the gatekeeping fee, many run the risk of adverse/negative selection. By that I mean that the top, most resourceful entrepreneurs will realize they don’t really need to pay the gatekeeper. At that point, the accelerator becomes a signal not of a top entrepreneur, but actually a less resourceful and more “needy” one. The emergence of leaner, lower cost accelerators in specific markets (asking for 1-2%, not 6-7%) is clear evidence of this. The price may just have to adjust.

Don’t be an Asshole.

TL;DR: You probably can’t afford to be one.

Background Reading:

A regular theme of SHL involves different ways for founders and executives to protect themselves from bad actors – often via advice that I’m able to give by being in a position of not representing any institutional investors, deliberately. If you want more on that, see: How to avoid “captive” company counsel. 

The purpose of this post is to flip the topic, and discuss why there are very real, non-warm-and-fuzzy, reasons why entrepreneurs/execs should be very careful not to behave like bad actors themselves.

If you apply Maslow’s Hierarchy of Needs to the business world, you arrive at one very real truth: the most talented, value-additive people in any industry are virtually never in it just for the money. They have enough, and trust their ability to earn more. Their talent allows them to care about other things: like challenging work, trust, friendship, impact, fun, respect, etc. By no means does this suggest they don’t care about money at all – in some cases money is a way for them to ensure they are being valued and respected for what they deliver. But it does mean that anyone who approaches these people with a kind of opportunistic cost-benefit analysis is likely to get ice cold water poured on them, very fast.

Startup ecosystems are full of these kinds of people. If all they cared about was money, they’d never touch early-stage.  If they’re working with startups (and your very early-stage risky startup), there are non-financial motivations higher on the hierarchy of needs at play, and you need to be mindful of that as you interact with them.

When you’re building your brand new or very early-stage company, unless you have a LinkedIn profile that screams “winner,” people all around you are going to be risking their time and money in working with you. There are 1,000 reasons why they might say no, and move on to someone else with a different risk profile. The absolute last thing you want to do is give them a reason to walk away, because they smell an asshole. And trust me, they will walk away. 

“Startup people” react much more viscerally to assholes than “corporate people” do, because the startup world often selects for people who won’t do or tolerate anything for a big payout. The large hierarchies of corporate environments enable, naturally, more hierarchical behavior among peers. In contrast, the “flatter” nature of startup ecosystems generates, and enforces, more “democratic” (respect everyone) norms.

As startup lawyers, we’re often in a position to see firsthand who the assholes in the entrepreneurial community are. They treat lawyers and many other service providers as line items to be deferred, discounted, and written-off to the very last dime, as much as possible; and will play games to manipulate people into giving them more for less. Thinking extremely myopically, these assholes think they’re doing what’s best for their company by grabbing as much as possible on the table – but played out over time, they’re actually whittling down the number of people who will work with them to those who simply don’t have other options. And when someone doesn’t have options, it’s often for a reason. Interestingly, assholes have a way of ending up stuck with other assholes. 

All of this applies just as well to top investors, particularly angel investors (with more freedom than VCs) who know they deliver a lot more than money. God help you if you give them even the slightest reason to think you’re an asshole. Information travels fast.

The definition of a mercenary is someone whose every decision is cost-benefit calculated for money. The fact is that if you build a reputation in a startup ecosystem for being a mercenary – always maximize the valuation, minimize the equity grant, discount the bill – you’re dramatically reducing your chances of making money, simply because of the personalities and values you tend to find in the startup world.

Be careful out there. Don’t be an asshole. On top of it being simply wrong, you probably can’t afford it.

Startup Employee Offer Letters

TL;DR: A few simple principles can help founders avoid big legal landmines in making offers to their employees.

Background Reading:

Hiring an employee is one of the first areas in which I see poorly advised founders really start messing things up from a legal perspective; exposing themselves to liability and errors that can have very long-lasting effects.

Here are a few simple principles to keep in mind as you hire people and paper their employment.

An Employee Offer Letter is NOT the same thing as an “Employment Agreement.”

In the United States, the default for employer-employee relationships is “at will” employment, which means broadly speaking an employer can fire the employee for any reason, even without warning, apart from a narrow set of discriminatory reasons that violate labor laws. This is very different from other countries, which typically have more robust statutory defaults for employees.

When most people speak of an “employment agreement” they are referring to a negotiated document, usually reserved for high-level executives, that provides more robust protections to the employee/executive; including protections around how that executive can be fired, and the consequences of firing her/him. True employment agreements are quite rare in the very early days of startups.

When a startup hires a typical employee, they provide an Offer Letter that states high-level details like their position, compensation, etc., but also makes it clear that the relationship is at will; in other words, they don’t have the protections a high-level executive’s “employment agreement” would often provide. Offer Letters are not Employment Agreements. Know the difference, and that you should start with the assumption that an offer letter is what you need.

Everyone who works for you is not an Employee. Know the difference between a contractor and employee.

I often see founders casually, without really thinking about it, call everyone who does work for them an “employee.” It seems harmless, but in labor law the word “employee” can have very material implications for what you owe them, how you treat their compensation, how easily you can modify their terms or terminate them, etc. Don’t use that word indiscriminately.

Don’t forget IP / Confidentiality, which is not covered in the offer letter (usually).

The conventional structure of startup employee documentation is (i) a simple offer letter, and (ii) a more robust agreement covering confidentiality, intellectual property ownership, and (unless you’re in California or a few other states) a non-compete. This second document is usually called something like a Proprietary Information and Inventions Agreement (PIIA), Confidentiality and Inventions Agreement, or some variant of that. Missing this document can be a huge problem, and in some states fixing it is not as simple as having an employee sign it later. Don’t forget it.

Unlike most legal issues, local state law tends to govern in employment relationships. Docs vary by state.

Most tech startups are incorporated/organized in Delaware, and if they have a national footprint, a lot of their agreements will be governed by Delaware law. With respect to employees, however, that is rarely the case, unless the employee is actually located in Delaware. In employment documents, the location of your employee will often determine the documentation they have to sign, and that means the documentation can vary significantly by state. Work with your lawyers to ensure you don’t use the wrong forms.

Your offer letter might promise equity. But you still need to issue it, which is more complicated.

If you’re promising options or some other form of equity, the offer letter will usually cover that. But you need to understand that the letter is only promising the equity. To actually grant/issue the equity, more steps need to be taken, including a Board Consent and other processes.

Early-stage founders often get in hot water by signing lots of offer letters thinking that’s all they need to do for employee equity purposes, and then waiting a long time (as the value of their stock continues to go up) to be told by lawyers that the equity was never issued. Then they end up (for tax reasons) having to issue the equity at a much higher price than they would’ve if they had done it sooner, and the employees are understandably angry. Promise, then quickly grant. The offer letter is just the first step.