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.

 

Startup Legal Fee Cost Containment (Safely)

Given the COVID-19 crisis, every startup (every company really) is laser-focused on cost-containment. The below are some guidelines for getting legal work done efficiently, without relying on low-quality providers who will ultimately cost you far more in the long-run because of mistakes and missteps.

Related reading: Lies About Startup Legal Fees

1. Consider working with experienced, specialized lawyers in lower-cost geographies.

Bay Area and NYC lawyers have the highest rates, for obvious reasons like that the cost of living in those cities is much higher, and the firms in those markets tend to cater to unicorns with very large, multi-national transactions requiring extremely high-cost infrastructure. While it’s already been happening for years, I suspect more startups are going to realize that ECVC (Startup) lawyers in places like Seattle, Austin, and Denver have just as much visibility and specialization, but have rates that are more accessible.

In case it hasn’t already been made clear, there is nothing about corporate/securities legal work that requires you to meet in person with your legal team. You can usually shave a few hundred dollars per hour off your bills by simply using lawyers in smaller tech markets who still have the right experience.

2. Ensure your lawyers have the right specialization, and precedent/template resources for minimizing time burn.

While parts of the ecosystem have exaggerated the extent to which a “standard” startup financing really exists – stay away from Post-Money SAFEs – every serious Startup/VC lawyer has precedent and template forms they can use as starting points to avoid reinventing the wheel. A “Corporate Lawyer” is not good enough here. There are corporate lawyers who specialize in healthcare, energy, and other industries that will have no clue about ECVC norms. Read their bio, talk to clients, and/or ask about their deal experience. “Emerging Companies” and “Venture Capital” are key words to look for, unless you’re talking about an M&A deal, in which case obviously you want an M&A lawyer.

3. Unless you really are on a unicorn track, use boutiques instead of BigLaw.

“BigLaw” refers to the largest, multi-national law firms in the country; often with armies of staff and resources designed for the most complex and largest deals in the market. For the vast majority of the startup ecosystem, these firms are overkill. We’ve closed countless VC and M&A deals where the Partner on our side was $300 per hour leaner than the Partner on the other side of the table, and their bios were virtually indistinguishable.

Using a high-end boutique can dramatically lower your overall legal costs. The key issue is assessing the background/expertise of the boutique firm’s lawyers to ensure the drop in rates isn’t resulting in a drop in quality. Top-tier boutiques achieve their efficiency by eliminating infrastructure (overhead) that non-unicorn clients don’t need; not by recruiting B-player lawyers.

4. Leverage non-Partner staff (paralegals, junior and mid-level attorneys).

Some startups think they’re going to save fees by hiring a highly-seasoned solo lawyer, but this can backfire, because that solo doesn’t have any lower-cost staff. Maybe 10-30% of the legal work a typical VC-backed startup needs will require true Partner-level attention. The rest can be safely and far more efficiently handled by well-trained and monitored lower-level staff (paralegals, and non-Partner attorneys). You want a firm that has these resources available, while still having an accessible Partner that you can go to for the most high-level strategic issues.

Having a single lawyer with 10-20 years of experience do all of your legal work is like expecting a cardiologist to take your temperature, collect your insurance info, and treat your toddler for their sniffles. It’s inefficient and unnecessary.

5. For financings, opt for “simplified” deal structures if feasible.

I suspect that during the worst of the COVID-19 crisis, you’re going to see a lot more investors opting for convertible notes, because they’ll value the downside (debt) protection in case the outlook doesn’t improve in the mid-term. Convertible notes are also far simpler (lower cost) to negotiate and close than an equity round.

This is fine, and convertible notes are used hundreds/thousands of times across the country every year without problems. Just ensure you are working with specialized counsel who knows what to accept, and what to reject, in the terms. Maturity, conversion cap economics, and what happens in a down-round scenario are all key things they’ll need to pay close attention to.

If you’re able to convince investors to do an equity round, and it’s less than $2 million in total investment, you might consider a “seed equity” structure. Seed equity docs are much simpler than the classic NVCA-style VC docs, and are about 75% cheaper to close on, in terms of legal fees. They can include a provision that will allow your investors to get more robust “full” VC rights in a future round.

“Cost cutting” tips that don’t work

A. Solo lawyers won’t save you money. As mentioned above, using solo lawyers for corporate/securities (deal) work rarely results in that much efficiency. While the solo’s rates might be lower than a firm’s, the savings will be burned up by the absence of paralegals/lower-level attorneys. You also risk running into serious bottlenecks that will slow-down urgently needed work, because solos don’t have a team to help triage projects. See: Startups Scale. Solo Lawyer’s Don’t.

B. Fixed fees are more likely to result in mistakes/weak counsel than cost-saving. Fixed fees aren’t magical. Ultimately a firm has to charge a fee that aligns with what it costs to do the deal, and using a fixed fee won’t change that. But the real danger with fixed fees is that they incentivize lawyers to cut corners, because by rushing work (not negotiating/reviewing), the lawyers make more money. Ask for budget ranges, and you can talk with other founders to ensure the cost is aligned with what’s been delivered. See: The Race to the Bottom in Startup Law.

C. DIY work with fully-automated tools or templates found online will blow up in your face. Are you building a plumbing business or coffee shop? Great. Go use one of those $39.99 automated templates you can find online. Investor-backed startups are not cookie-cutter companies, and thinking you’re actually going to save money by using a fully automated template is delusional. You’re simply turning on a time bomb in your legal history that will eventually go off.

D. Do not let junior lawyers run your legal work. A huge mistake startups often make is hiring BigLaw (very high-cost firm) but thinking that by using a junior lawyer for virtually everything, they’re saving money. You do not want a junior negotiating your financing, or giving you high-stakes advice. They are great for doing checklist-oriented tasks while a Partner oversees things and interacts with the client, but not as the main legal contact. Their inexperience will cost you 10x in the long-run of whatever you think you’re saving today. If you’re struggling to cover BigLaw’s rates, the answer is to use a high-end boutique where you can still access senior lawyers but at leaner rates; not to use the most inexperienced person on BigLaw’s payroll.

There are a lot of good strategies for getting lean, but still high-quality legal counsel. The key thing is to ensure you are trimming fat from your legal budget, but not muscle.

Crisis, Relationships, and VCs

TL;DR: Startups who resisted building durable relationships with professional institutional investors, and instead pursued the “party round” competitive fundraising mindset promoted heavily by certain SV voices, are going to get a rude awakening in this current crisis. But the same may be true of startups who failed to reasonably diversify their funding options. The easiest money in good times is the first to leave the stadium in scarier times.

In talking with various market players in startup ecosystems, you’ll hear a wide spectrum of philosophies on how early-stage startups should engage with investors, particularly institutional investors (VCs). On one end of the spectrum are, of course, the VCs themselves. Predictably they tend to favor fundraising philosophies that minimize competition between investors, emphasize qualitative over quantitative (valuation, ownership %) variables, and keep the number of players on the cap table low; which improves their leverage and ability to get a bigger piece of the limited pie. Terms like “marriage” “value add” and “partnership” tend to dominate this perspective. We’ll call this “relationship maximalism.”

On the other end of the spectrum are players who might be called “competitive maximalists” as it relates to VC funding. From their perspective, there is so much capital chasing deals, and the true “value add” of institutional investors is minimal, so any smart set of founders will focus on maximizing valuation, and minimizing control given to investors. This often means “party rounds” in which lots of funds write smaller checks with no true lead. This perspective finds its greatest proponents in Silicon Valley, where the largest concentration of capital (and therefore competition among capital) can be found.

It’s important to point out that there are “money players” in the market who, at least historically, have themselves promoted the competitive maximalist view of early-stage fundraising. Prestigious startup accelerators are, effectively, a service provider whose “bundle” of value is in many ways competitive with “smart” relationship-oriented venture capital, which encourages them to promote a narrative that downplays relationship-based fundraising and promotes competitive processes. See: Why Startup Accelerators Compete with Smart Money.

In order to get more control over their pipelines, institutional VCs have moved much earlier-stage in their investing, often writing seed checks for a few hundred K as a way to get a meaningful foot in the door on a promising but very early startup. If you manage to build strong relationships very early on with VCs and “value add” angels whose brand/signal can give you access to a helpful network of talent, resources, and other investors, then your need for an “accelerator” is reduced significantly. The whole point of an accelerator is to make it easier to access talent, money, and other resources. That means your willingness to pay their “fee” of 6-8% of your cap table goes down if you can access that “bundle” via smart money, or other people, that you’ve hustled connections to on your own.

Naturally, those accelerators don’t like that, so they’re incentivized to promote a philosophy that makes founders believe all institutional investors are effectively the same, and that relationship-oriented early-stage VCs who resist competitive fundraising processes and very high valuations are largely blowing smoke. They want to, in the eyes of startups, marginalize a potential substitute (smart VCs with their own networks and value add) and promote a complement (dumb money).

Now how does this all relate to the current environment, in which the COVID-19 market shock has clearly slowed down early-stage funding? The length and intensity of the slow-down is still of course an open question with all the uncertainties around how long quarantines/lock-downs will last, and the fact that many funds are sitting on cash that they still need to deploy; but it is certainly real. How should founders approach VCs? As a venture lawyer who doesn’t represent a single institutional investor – see: Relationships and Power in Startup Ecosystems if you want to understand why – my opinion from experience is that the correct approach for most startups lies somewhere in the middle.

I have seen “party round” culture result in so many blowups that it clearly is reckless and should be avoided. Even some of its most vocal evangelists find themselves back-tracking on the approach as the results play out in the market. But I’ve also seen the extremely negative consequences from becoming too dependent on a single VC or syndicate of closely affiliated VCs, which increases their ability to play power games on Boards and extract value that they otherwise wouldn’t have if the cap table were slightly more competitive.

Relationships matter, and it is unquestionably the case that some institutional investors truly are worth accepting a lower valuation, a larger “lead” check, and giving more control away to, in order to “partner” with them long-term. This is obviously the case in a bear market, but it’s also true in a bull market because even in bull markets no founder team ever knows when a crisis – personal or systemic – will slap them in the face. A VC with a sizable percentage of your cap table has “skin in the game” to help you through a crisis. A party round investor for which you are one of 40 investments is far more likely to sit out a crisis and play it safe.

That being said, you can still build strong relationships with VCs, and give them meaningful skin in the game, without being foolishly over-dependent on them. It is wise, if you have options, to include on your cap table a sufficient diversity of un-affiliated investors such that if one group becomes unreasonably “uppity” you have other supporters to turn to. Too much optionality turns into a party round, but some optionality is wise and valuable.

Clearly the startups that will have the easiest time in this crisis, however long it lasts, are those with enough cash in the bank to weather the storm. But for those who will need to enter the fundraising market in the next 3-6 months, without a doubt the competitive maximalists who’ve filled their cap tables with lots of small checks, and refused to let anyone participate in governance and build a relationship with the executive team, are going to be in for a rude awakening. They’re going to learn the hard way how “easy come, easy go” applies to early-stage fundraising.

Build meaningful, durable relationships with professional investors with the character and resources that can provide valuable insurance when an unpredictable crisis hits. Just ensure you’re well-advised throughout the process, so the “relationship” develops in a way that is balanced, and your company isn’t over-exposed.

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 the same value proposition offered by high-priced startup accelerators: signals, coaching, and a network. That means smart early money and accelerators can be substitutes, and the accelerators know this; which may lead them to recommend financing strategies to entrepreneurs that, from the perspective of the startup are counterproductive, but enhance the market power of the accelerator relative to investors who can offer similar resources. Entrepreneurs should understand the game everyone is playing, and become beholden to no one.

Background reading: Startup Accelerators and Ecosystem Gatekeeping

First, a few clarifications on definitions. When most people speak of “smart money” they are referring to investors who bring much more to the table, in terms of useful resources, than simply raw cash. They often bring a brand that serves as a valuable signal in the market, credible insight 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” (in the sense I’m discussing) is “dumb.” It just means that the other money isn’t useful other than to pay for things. Truly dumb money often means investors who have no idea what they’re doing, and drive up valuations and deal terms to levels unsustainable and unjustifiable in the market. There are many funds that aren’t dumb, but they also don’t bring much more than money to the table as part of their investment, so they’re also not “smart.”

Another clarification: for purposes of this topic, I am referring to high-cost, high-touch startup accelerators; meaning the traditional kind who “charge” 6-8% 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’ interest to restrict their fundraising activities solely to channels that accelerators can influence (because it allows accelerators to serve as rent-seeking gatekeepers), but that doesn’t mean aggressive accelerators don’t nudge them in that direction.

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 from them 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 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 want to create 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. They also 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 simply isn’t worth their time. The valuation will be too high.

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.

I’m not an investor. 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 to trade access to them as currency.

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. 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.

All of these ecosystem players are here, in one way or another, to make money; endless PR about friendliness, values, empathy, 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. To the contrary, it means slowing down and building a diverse set of long-term and durable relationships 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. 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. Keep connecting with smart money, and diversify your network.

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.

 

A Convertible Note Template for Startup Seed Rounds

TL;DR: We’ve created a publicly downloadable template for a seed convertible note (with useful footnotes), based on the template we’ve used hundreds of times in seed convertible note deals across the U.S. (outside of California). It can be downloaded here.

Background reading:

I’ve written several posts on structuring seed rounds, and how for seed rounds on the smaller side ($250K-$1MM) convertible notes are by far the dominant instrument that we see across the country. When SAFEs had pre-money valuation caps, they gained quite a bit of traction in Silicon Valley and pockets of other markets, but outside of SV convertible notes were still the dominant convertible instrument. Now that YC has revised the SAFE to have harsher post-money valuation economics (see above linked post), we’re seeing SAFE utilization drop significantly, though it was never close to the “standard” to begin with; at least not outside of California. For most seed companies, convertible notes and equity are the main options. 

For rounds above $1-1.5MM+, equity (particularly seed equity) should be given strong consideration. We are also seeing more founders and investors who really prefer equity opting for seed equity docs for rounds as low as $500K. The point of this post isn’t to get into the nuances of convertibles v. equity. There’s a lot of literature out there on the topic, including here on SHL.

What this post is really about is that many people have written to me regarding the absence of a useable public convertible note template that lawyers and startups can leverage for seed deals; particularly startups outside of SV, which has very different norms and investor expectations from other markets. Our boutique firm, Egan Nelson (E/N), specializes in emerging companies work outside of California: markets like Austin, Seattle, NYC, Boston, etc. We see a lot of seed deals every year across the country. Here is a list of funds our lawyers have worked across from in negotiating financings. Here is my personal bio to confirm I’m not just some random guy with a blog.

Cooley actually has a solid convertible note available on their Cooley GO document generator. I’m a fan of Cooley GO. It has strong content. But as many readers know, there are inherent limitations to these automated doc generator tools; many of which law firms utilize more for marketing reasons (a kind of techie signaling) than actual day-to-day practical value for real clients closing real deals. Your seed docs often set the terms for issuing as much as 10-30% of your company’s capitalization, and the terms of your long-term relationship with your earliest supporters. Take the details seriously, and take advantage of the ability to flexibly modify things when it’s warranted.

The “move fast and mindlessly sign a template” approach has for some time been peddled by pockets of very clever and vocal investors, who know that pushing for speed is the easiest way to take advantage of inexperienced founders who don’t know what questions to ask. But the smartest teams always slow down enough to work with trusted advisors who can ensure the deal that gets signed makes sense for the context, and that the team really knows what they’re getting into. Taking that time can easily pay off 10-20x+ in terms of the improved cap table or governance position you get from a little tweaking. The investor trying to rush your deal isn’t really trying to save you legal fees. They’re trying to save themselves from having to negotiate, or justify the “asks” in their docs.

As a firm focused on smaller ecosystems that typically don’t get nearly as much air time in startup financing discussions as SV, I realized we’re well-positioned to offer non-SV founders a useful template for convertible notes. The fact that, to avoid conflicts of interest, we also don’t represent Tech VCs (trust me, many have asked, but it’s a hard policy) also allows us to speak with a somewhat unique level of impartiality on what companies should be accepting for their seed note deals. There are a lot of players in the startup ecosystem that love to use their microphones to push X or Y (air quotes) “standard” for startup financings, but more often than not their deep ties to certain investors should raise doubts among founders as to biases in their perspective. We’ve drafted this template from the perspective of independent company counsel. 

So here it is: A Convertible Note Template for Seed Rounds, with some useful footnotes for ways to flexibly tweak the note within deal norms. Publicly available for download.

A few additional, important points to keep in mind in using this note:

First, make sure that the lawyer(s) you are working with have deep (senior) experience in this area of law (emerging companies and vc, not just general corporate lawyers), and don’t have conflicts of interest with the people sitting across the table offering you money. When investors “recommend” a specific law firm they are “familiar” with they’re often trying to strip startup teams of crucial strategic advice. See: Checklist for Choosing a Startup Lawyer. Be very careful with firms that push this kind of work to paralegals or juniors, who inevitably work off of an inflexible script and won’t be able to tailor things for the context. You want experienced, trustworthy specialists; not shills or novices.

Second, be mature about maturity. You’re asking people to hand you money in a period of enormous uncertainty and risk, while getting very little protection upfront. As long as maturity is long enough to give you sufficient time to make things happen (2-3 yrs is what we are seeing), you shouldn’t run away from the most basic of accountability measures in your deal. Think about how bad of a signal it sends to investors if a 3 year deadline terrifies you.

Third, do not for a second think that, because you have a template in your hand, it somehow means you no longer need experienced advisors, like lawyers, to close on it. Template contracts don’t remove the need for lawyers any more than GitHub removes the need for developers. The template is a starting point, and the real expertise is in knowing which template to start from, and how to work with it for the unique context and parties involved. Experienced Startup Lawyers are incredibly useful “equalizers” when first-time entrepreneurs are negotiating with experienced money players. Don’t get played.

Fourth, pay very close attention to how the valuation cap works, particularly the denominator used for ultimately calculating the share price. We are seeing more openness among investors to “hardening” the denominator at closing, either with an actual capitalization number, or by clarifying that any changes to the option pool in a Series A won’t be included. These modifications make notes behave more like equity from a dilution standpoint, allowing more clarity around how much of the company is being given to the seed money.

Finally, don’t try to force this template on unwilling investors. It can irritate seasoned investors to no end to hear that they must use X template for a deal because some blog post, lawyer, or accelerator said so. There is no single “standard” for a seed round. There never has been, and never will be, because different companies are raising in different contexts with investors who have different priorities and expectations. We’ve used this form hundreds of times across the country, but that doesn’t mean there aren’t other perfectly reasonable ways to do seed deals.

Have a dialogue with your lead money, and use that dialogue to set expectations. See: Negotiation is Relationship Building. If they’re comfortable using this template, great. If they need a little extra language here or there, don’t make a huge fuss about it if your own advisors say it’s OK. And if they prefer another structure, like seed equity or even more robust equity docs, plenty of companies do that for their seed round and it goes perfectly fine, as long as you have experienced people monitoring the details.

If any experienced lawyers out there see areas of improvement for the template, feel free to ping me via e-mail.

Obligatory disclaimer: This template is being provided as an educational resource, and is intended to be utilized by experienced legal counsel with a full understanding of the context in which the template is being used. We (myself or Egan Nelson LLP) are not responsible at all for the consequences of your utilization of this template. Good luck.