Post Category → Startup Law Firms

Why BigLaw Over-Automates Startup Law

TL;DR: BigLaw’s very high operating costs require it to charge 3-4x of what its typical lawyers actually earn. This makes rates often stratospherically high. While billion-dollar companies that use BigLaw can afford those rates, early-stage startups often cannot. BigLaw is responding at times by hyper-standardizing and hyper-automating early-stage work. This has significant downsides, as companies lose out on flexibility, advocacy, and strategic guidance for very high impact projects, like financings. Much of this standardization ends up favoring VCs over startup teams. Elite lean boutique law firms offer an alternative approach, in which lower overhead allows for lower costs without requiring substantial inflexibility. In the end, this trend toward over-automation is leading many clients and lawyers to balk, and alternative approaches for achieving efficiency (while remaining flexible) are rightfully emerging.

Lawyers are not cheap. Elite lawyers – the kind with very extensive top-tier training, experience, and ability to handle high-stakes complexity – are in fact quite expensive.

Then again, elite human talent of all sorts is quite expensive. Top doctors make over half a million a year. Top software developers can make into the millions, and their “bugs” are much more easily corrected than bugs in contracts; which by design often can’t be “fixed” once they are signed.

I candidly find it amusing when “tech people” criticize elite lawyers for the amounts they earn, given what similarly elite talent in other industries (tech included) makes. If you’re expecting an apology, it’s going to be a while.

That being said, criticizing what people earn is not the same thing as criticizing what firms charge. There are in fact quite a few firms in “BigLaw,” including those who work with startups, where a lawyer charging over $1,000 an hour is in fact earning only a small fraction of that, maybe $200 or $250. “The beast” (the bloated institution) absorbs the rest. That, in my opinion as a leader of an elite lean boutique firm precisely designed to address this problem, is a very valid criticism.

Traditional elite law firms in “BigLaw” have virtually all designed themselves, with minor variances, around a similar high-overhead business model. They charge 3-4x+ what their typical lawyers are actually earning. That overhead pays for extremely posh offices designed to signal “prestige,” armies of non-lawyer staff, lavish events and other programming, as well as a small cadre of equity partners who absorb millions, sometimes tens of millions, in profits every year per partner without doing much of the actual billing.

The fact that BigLaw has entrenched itself in this way of doing legal business makes it very difficult, even impossible, to meaningfully address “efficiency” at an institutional level. It would require sacrificing too many sacred cows with political leverage in the firms’ bureaucracies. Thus when BigLaw does try to do something to become more efficient, or at least appear more efficient, its options are constrained. One option that is always on the table is adopting (often pricey) automation software, because it ostensibly allows charging less without actually having to do human legal work (contextual, flexible, strategic) any more efficiently.

Don’t deliver more efficient lawyers. Instead, make clients use dumbed-down, inflexible, and often quite clunky software. They can talk to professionals only once they can afford $900/hr for an associate and $1400/hr for a partner.

I’ve written about this issue before, such as in Vaporware Technology Won’t Hide Your Firm’s Business Model Problems (on Above the Law). Lean elite boutique law firms are about what I call substractive innovation. Finding efficiency by removing unnecessary (for clients) costs, and re-designing a firm’s operations around that leaner operating model. Yes, this does involve technology, but a particular kind of technology meant to replace unneeded overhead and traditional processes; not to simply layer on new software without otherwise changing much at all about the firm itself.

BigLaw, for the above reasons, is usually incapable of this kind of innovation. It virtually always leans more towards additive so-called “innovation” – buying more and more things that purportedly bring efficiency.

Tying this all together. BigLaw – which in 99.9% of cases works with billion-dollar multinational high-stakes projects for whom charging over $1,000 an hour is not a budget problem – has to charge a lot for its lawyers. 3-4x what those lawyers actually earn. The portion of BigLaw that actually touches early-stage startups – 0.1% of what BigLaw as a whole category really does – faces a problem. Early startups are not billion-dollar multi-national entities.

That’s a big constraint on what BigLaw as it relates to startups can really charge. Startups are constantly balking at what they are charged by BigLaw. The way some of BigLaw is addressing this is by removing their elite lawyers almost entirely from that segment of work. Automation – I would say over automation – combined with what is often called in industry circles “de-skilling” (delegating to lower-level staff).

BigLaw is thus heavily incentivized to over-automate Startup Law. As I’ve written before in many contexts, automation in law is not a free lunch. Not even close. It relies on heavy standardization and inflexibility for it to be workable at all. The problem is that a lot of what founders ask lawyers to do in early-stage Startup Law is extremely high-stakes from a financial perspective. Even minor tweaks to language in docs can have 8 to 10+ figure implications. We are not talking about parking tickets or coffee shops.

The extremely myopic way in which pockets of Silicon Valley have over-adopted YC’s Post-Money SAFE is a perfect example of this. Only now are many founders coming to realize how much of an “own goal” it was to let YC pretend their terms were founder friendly and “efficient.” In that article I show how literally adding a single sentence to the Post-Money SAFE can have tens of millions of dollars in improved economics for founders, and yet the vast majority of so-called “efficient” automated startup financing tools to do not allow for this tweak. People are pretending they are saving founders money. What they are really doing is “saving” a few hundred dollars (at most) in legal fees while letting VCs (including YC) take millions from startup teams.

There are countless ways in which over-standardization and over-automation in Startup Law are costing startups and founders enormous amounts of money. Every attempt to create a so-called “standard” term sheet for equity rounds ends up with VC-favorable economic and power terms that simply are in no way, shape, or form a universal “standard.” See also Standardization v. Flexibility in Startup Law.

Because VCs (and accelerators) are “repeat players,” whereas individual founding teams are not, they have the market leverage to heavily bias so-called “standards” in their favor. And the software companies intending to profit from all of this legal hyper-automation are happy to help them in the process. I wrote about the outsized leverage and influence that repeat players have in startup ecosystems, including over many law firms, in Relationships and Power in Startup Ecosystems.

These automated financing software companies – who need law to become hyper-standardized so that they can ever-so-generously step in to charge for the automation – are heavily incentivized to publish biased “data” about so-called “standards.” For example, they’ll build a software tool offering only 2 or 3 ways to do a seed funding, all heavily standardized and therefore inflexible. They’ll market this tool, and then publish data saying things like, “80% of seed deals are Post-Money SAFEs, and so it is a standard.” Actually (if you read the footnotes), 80% of seed deals on your half-baked automated platform are Post-Money SAFEs. Selection bias. That is not the same thing as saying 80% of all seed deals in the country or world are.

These tools are lying with so-called “data” to promote their own wares. For that, who can really blame them? Everyone’s got to make a buck. But let’s please stop pretending that they actually care about what’s best for startups, or their founders and employees. I don’t criticize people for talking their book. I criticize people for pretending to be far more benevolent and selfless than they really are.

Lawyers should be telling startups and their founders whenever they are facing these sorts of issues. They should be telling founders that the Post-Money SAFE is not a universal standard, and that many many deals end up customized, or even with entirely different structures, to make the economics better. They should be negotiating term sheets to better position the governance of their client, instead of letting some VC dictate what “standard” means. Instead, many of them are over-standardizing and over-automating. Why? Because they’re in BigLaw, and that’s what BigLaw does for startups.

Because of its institutional inability to actually do human legal work more efficiently (see above paragraphs), which involves assessing context, negotiating, tweaking, advising, etc., and the fact that Startups cannot pay over $1,000 per hour for extensive advisory, much of BigLaw is choosing to delegate the entirety of early-stage startup law to software. In my opinion, this is an abdication of the responsibility of lawyers to actually advise their clients as to what is best for them. If I were a paranoid BigLaw lawyer, I’d at least worry a little about the malpractice implications of practicing law this way.

On top of the fact that this is not actually in the best interests of startups or their stockholders, many lawyers are themselves starting to balk at the machine-like evolution of BigLaw’s way of operating. Boutique law firms, where the ratio of billed rates to lawyer earnings is more like 2x instead of BigLaw’s 3-4x (dramatic efficiency) are not just about lower rates. In many segments they are emerging as refuges for lawyers who want to step off the assembly line and actually think for their job.

When lawyers are able to charge, say, $500 per hour instead of $1100, they have time to actually negotiate for their clients. On top of this being good for the client (See: Negotiation is Relationship Building), from an intellectual standpoint it’s legitimately more enjoyable. Many ECVC lawyers prefer this way of practice over acting as if every deal before Series B should just be a cookie-cutter template.

The elite boutique law ecosystem (of which Optimal is a part) is thus emerging as a win-win countertrend to BigLaw’s tendency to over-automate and over-standardize. Many elite lawyers are tired of half-baked over-technologized (air quotes) “efficiency” that isn’t really efficient at all because of what the client loses. In moving to boutiques, lawyers get to drop their rates substantially without actually earning less. Clients get to pay substantially lower rates, while getting an actual elite human professional to help them navigate complexities and protect themselves; which many prefer over clicking a few buttons on software without ever being told what their options really were.

To summarize: the traditional cost structures of BigLaw require charging 3-4x+ of what their typical lawyers actually earn. This makes their rates, including for startups, extraordinarily high. Above $1,000 per hour in many cases. Sometimes $2,000+ per hour. Startup clients, who do not fit the billion-dollar mold of BigLaw’s average client, obviously cannot afford stratospheric legal bills. BigLaw is responding by accepting hyper-standardization and hyper-automation for its earliest stage work. Clients spend more and more time interacting with junior professionals and software that operate only in very narrow, inflexible lanes; depriving clients of real advocacy or negotiation on high-stakes issues. As a result of all this, inexperienced startup teams are increasingly pushed into these myopic inflexible fundraising approaches that are costing them enormous amounts of money and governance leverage.

There are ways to avoid this problem. The one I’m obviously an advocate for is to move a lot of this legal work to leaner elite boutiques. Some of the top boutiques in ECVC can deliver real legal horse power, especially in earlier-stage deals (pre-unicorn), at half the rates of BigLaw.

There’s another option: if you absolutely are going to use BigLaw, let them charge you for what the work really takes. Why pay BigLaw at all if you’re not using the real legal talent it is designed to house? If you’re raising a $75 million equity round, yeah, you’re going to pay a few hundred thousand dollars in legal fees with BigLaw if you let them actually do their job. As a percentage of the actual raise, it’s really not that much (under 1%). The alternative – over-automation and over-standardization – will be far worse.

If that doesn’t work for a $5 million or $15 million round, then again I suggest looking into elite boutiques. Their lower rates, but still elite rosters, will produce lower legal bills without compromising on the quality of the actual advisory you’re getting. See How Much Seed Rounds Cost – Lowering Fees and Expenses Safely to understand why boutique law is an increasingly popular option among top startup teams for earlier financing rounds. Boutiques are not doing pre-seed deals all day. We have clients closing Series A, B, C, even later, and exiting at 8-9-figure valuations. As I often say, the B in BigLaw is for billions. There’s a lot that happens before billions.

Straw-man prevention disclaimer – Let me be very clear here. I am not just a Partner at Optimal. I am also its Chief Technology Officer. I work with a lot of legal tech startups. I love legal tech, and I even like targeted, thoughtful automation. I’m particularly interested in upcoming ways to integrate AI to enhance lawyers’ productivity.

Some people with very loud microphones like to pretend that the legal profession is full of nothing but luddites who want to milk the entire world for fully bespoke, terribly inefficient work product. In startup ecosystems, this attitude is most often peddled by (i) VCs who want your lawyers to shut up, because when lawyers shut up VCs get what they want, and (ii) software automation tools; because they want you to use their inflexible software instead of an actual human.

What I am advocating for here is a more balanced perspective on when automation really is in the best interests of legal clients, and really is streamlining things, relative to when it is hiding all sorts of biases and costs because the real driver isn’t what’s best for the client but some extraneous factor like institutional constraints. I’m a big fan of automating basic option grants, which no serious professional wants to waste their time on anyway. But raising millions or tens of millions of dollars, and setting permanent power & governance terms that will influence huge segments of the modern economy? Hold the F up.

As I wrote here, the “values” of the legal industry and the software industry are very different, and both serve a very important purpose in the economy. In legal, it’s expertise, context, flexibility, negotiation, leverage, compromise, trusted advocacy. It’s about having a perspective, and pushing for it, while the other side does the same.

There can be no single answer or “standard” in this value structure, because the decision-makers and process for setting it are suspect, as conflicts of interest and subjectivity abound. Companies are different. Investors are different. Goals, industries, values all vary organically across institutions and contexts. It’s contextual “truth” arrived at via a decentralized adversarial process, as opposed to a centralized proprietary one. This concept is not entirely alien to many engineers.

In software, it’s broadly about standardizing, automating, universalizing, cutting costs and centralizing data. It’s about scale and speed, reducing “friction.” In this worldview, customization and “verification” via independent review is seen as inefficient and pointless. But is it always? When the stakes are really high?

Analogies about making private startup equity operate like “frictionless” liquid public markets are spectacularly flawed. In the latter, the transactions are impacting small percentages of the company’s capitalization, and rarely altering their fundamental governance. What happens in a startup’s earliest days sets the stage for the company’s entire growth. The present dollar value may be small, but the derivative long-term impact is massive. Post-IPO, very little of what’s being negotiated fundamentally changes anything.

Nowhere am I saying here that the legal industry’s values should take full precedence over those of the software industry. Again, I’m a big fan of productivity tools in legal. We just need to avoid myopia in letting the software industry’s values (automation, standardization) steamroll over legal’s as it relates to high-stakes legal work simply because clients think (wrongly) that they have to use BigLaw, and BigLaw can’t make its actual lawyers cheaper. Automation and standardization can be good. Automating and standardizing everything, because we won’t consider alternative possibilities for achieving efficiency, most certainly is not.

Legal Tech for Startup Lawyers: Deal Closing Software

TL;DR: Deal closing software for collecting and tracking signatures, then compiling closing sets, is a great legal tech category for law firms to streamline administrative tasks on deals, saving clients money and time. Based on my research of the available options in adopting legal tech for our own elite boutique firm (Optimal Counsel), Closing Folders and Litera Transact are the closing tools that other firms should take a look at. Bigger picture, law firms need to think deeply about the proper balance of legal industry values (flexibility, advocacy) v. tech industry values (speed, standardization) as new legal tech hits the market. There are potentially serious negative consequences for companies (clients) if we thoughtlessly let one industry’s values dominate the other.

After publishing How Much Seed Rounds Cost – Lowering Fees and Expenses Safely, which ended up getting way more traction than expected, a number of lawyers from other firms reached out to me politely asking for recommendations as to what tools we use at Optimal for streamlining administrative tasks on deals. I sometimes forget that, even though this blog is targeted toward founders, quite a few lawyers and firms in the industry follow SHL as well. I also occasionally hear from law schools planning their course curricula.

Given that our firm is built around a thoughtful balance of blending lean legal tech with elite lawyers, I can understand other players in the industry looking to us for recommendations. My view has always been that the “optimal” blend of legal and tech ensures that the core values of neither industry get shoved down the throats of clients; who ultimately should be the ones getting better served. Rather, it’s about balancing the positives of both, while counteracting their negative tendencies.

Balancing Legal and Tech Industry Values

Key values of the elite tier of the legal industry are flexibility and trusted advocacy for a client, and (in the case of startups) a client led by executives (founders) often at a substantial informational disadvantage relative to players they are negotiating with. See Negotiation is Relationship Building for a deep-dive on just how much founders and startup teams lose when trusted and experienced legal counsel is pushed out of the picture by misaligned market players who profit from displacing lawyers at the negotiation table.

Legal: Trusted, Flexible Strategic Advocacy with Professional Liability

Having a relationship with a highly experienced and trusted senior lawyer, without ties to your investors, is one of the best “equalizers” for founding teams navigating the fog of an opaque market full of much more experienced players. Unlike regular vendors of services and tools, lawyers have professional ethical obligations to their clients, as skilled fiduciaries advocating for their interests. Paying for counsel is not just paying for a neutral product or service, it’s paying for an experienced advocate reviewing terms and negotiating specifically for your team’s context and priorities.

The downside tendencies of the legal industry are, for some lawyers at least, to “overwork” projects; making unnecessary comments and mountains out of molehills. Reputational competition can put limits on this behavior, but it still occurs in some circles. Clients and Boards should be educated as to what terms are very high impact and high-risk – such as core economic terms, or governance terms influencing the power hierarchy of the business – while, especially on smaller projects, accepting “good enough” for the more marginal terms unlikely to be impactful other than in rare edge-cases.

This is why I’m a big fan of taking an “open source” approach to legal templates for early-stage work, reflected in the Seed Round Template Library. Creating a common language framework as starting points can significantly reduce unnecessary negotiation over unimpactful issues, while preserving the flexible and trusted dynamics of each side having advocates looking out for their client’s interests. Independent counsel serve as the flexible “software developers” of this market (contract language is code), with open source templates serving as the transparent and modifiable “github” repository.

This is better for clients and the market than a centralized and proprietary “no code” framework by which self-interested participants, like prominent investors or VC-backed software vendors, impose their inflexible and uneditable “code” (contract terms) onto the entire ecosystem, in part by pretending that something is a universal “standard.” A flexible “open source” approach to early-stage deal terms provides efficiency, without requiring an enormous diversity of market players to fit their businesses and investor theses within a handful of narrow structures.

Tech: Standardization, Scale, and Speed

Unlike the legal industry’s values, which heavily prioritize strategic advocacy and flexibility, the values of the software industry are efficiency, scale, and speed. These are absolutely important values that law firms need to integrate into their cultures to serve clients well, while also being very candid when these values are being exaggerated to dupe inexperienced teams. The negative side of hyper-automation is reduced optionality (inflexibility), and a tendency to gloss over nuances in order to make it easier to sell a software-based service. This downside can sometimes be astroturfed with an over-emphasis on mass-market “data,” when even data compilation and visualization requires significantly narrowing the scope of variables, quietly labeling impactful terms as “standard” or “boilerplate” when they absolutely are not.

A great example of how this plays out is the selection bias of automated tools. They’ll promote “data” suggesting that X or Y is some kind of “standard,” while glossing over the fact that X or Y are the primary options promoted by their tool, creating a self-motivated circularity. You can only choose X or Y if you use the tool, and the tool then uses its self-selected “data” to tell you that X or Y are the “standards.” Given it’s evidently all “standard boilerplate,” you’re told to just pay for their tool and avoid all that negotiation and review mumbo jumbo; even if some of said mumbo jumbo would significantly help a team.

This clever sleight-of-hand – using biased “data” to pretend that important terms are far more standardized than they really are – is looking out for the needs of a company profiting from selling simplistic software that can’t function without hyper-standardization; not the needs of the end-user (the client).

As I’ve said many times before, “don’t ask your lawyers about this” sounds very suspicious. “Let’s save you some legal fees” sounds much more benign, but the end-effect can be the exact same. A huge number of inexperienced teams get duped into signing bad terms, or taking counterproductive actions, but the smoke-and-mirrors strategy of minimizing legal fees (and thus not talking to a trusted independent advisor) provides misaligned actors plausible deniability for their (air quotes) “advice.”

Early-stage private companies building unique products and services, and gunning for 8-10 figure (or more) exits, are not standardized commodities, nor are the contracts they are signing at the foundation of their businesses. This is a total contrast to standardized shares of large public companies, which by their nature are highly liquid, have minimal governance authority, and are a part of diversified portfolios; in other words “low stakes.”

In contrast to liquid public equities, Founders’ and employees’ livelihoods, and often their entire life savings, rely on permanent deal terms tied to high-concentration illiquid assets with significant power over a company’s trajectory. Taking an inflexible, high-speed approach to the super high-stakes terms controlling a startups’ financing, ownership, and governance reflects far more the desires of market players who rely on scale and diversification – like spray-and-pray “dumb money” funds or mass-market software vendors – than on what is actually good and appropriate for each unique company with all or most of its eggs in one basket. This is exactly what happens when “tech values” are allowed to steamroll over legal’s.

Deal Closing Software

There are two broad types of work that law firms do for clients on financings: (i) actual “lawyer work” – assessing terms, educating and advising clients, negotiation, drafting and structuring – and (ii) administrative work like creating signature packets and tracking signatures or assembling closing sets. The former category is very difficult, indeed at times dangerous, to heavily outsource to third-party software because of how high-stakes and permanent it is – flexibility and trusted advocacy really matter here, but the latter category is always great to apply thoughtful technology to.

Closing Folders and Litera Transact are two deal closing tools that all corporate lawyers should review and consider adopting for their practices (one or the other). We’ve used tools like this for years, and I know a lot of ECVC “BigLaw” uses them as well. They use focused web-based interfaces for:

  • Organizing deal checklists and document sets
  • Auto-generating signature pages and packets
  • Auto-issuing e-signature requests through trusted e-signature tools like Docusign
  • Tracking real-time status of signatures, and
  • Compiling closing sets efficiently

What I love most about these tools is their focus and flexibility. If there’s one thing I’ve learned being a legal CTO for a decade, it’s to never trust sprawling “all in one” kinds of tools that show significant feature creep. The tendency for a software company to constantly expand into other features, and even industries, more often reflects a desire for monopolistic empire building than what is actually good for the end-user. They inevitably end up confusing, bloated, and over-priced.

Instead, use tools that do a focused set of tasks extremely well, with a simple interface, and customizability that integrates well into the varying needs of a law firm (the user here). Unlike signature collection features bolted onto other kinds of software, these tools are designed for lawyers and can work on an extremely diverse sets of transactions, including equity or debt financings, and M&A. The fact that no particular deal structure is imposed on them is super important so law firms can apply them to their clients’ varying needs.

Client Data Privacy and Security

While both tools started out as independent startups (Litera acquired Doxly and renamed it Transact, iManage acquired Closing Folders), they’re now owned by trusted legal software companies with robust and transparent policies around client data privacy and security. Lawyers should always be cautious about what software tools might be mining their clients’ data for other ends.

In the most egregious cases I’ve seen software companies market tools to lawyers, use those tools to mine those same lawyers’ client data, and then leverage that data by attempting to displace law firms with high-cost, high-margin legal “products” lacking the flexibility, contextual awareness, and ethical obligations of actual counsel. Sometimes that “data” is being sold directly to your clients’ market counterparties, to improve their negotiating posture.

If the tool is offered to you for “free,” then the payment is in data. What is that data going to be used for? I prefer paying directly for straightforward, well-designed and focused tools. My firm’s (and my clients’) data is not for sale.

Hopefully this is helpful. Good luck.

How Much Seed Rounds Cost – Lowering Fees and Expenses Safely

TL;DR: There are effective and efficient ways to lower your closing costs, in terms of legal fees and other expenses, for your seed round. But be mindful of the lean v. cheap distinction. A lot of founders myopically over-cut corners thinking that minimizing negotiation or deal structuring saves them money. This can easily cost 10-20x+ long-term in terms of economics (dilution) and governance power, because teams end up mindlessly signing terms against their interests. Thoughtful customization, combined with lean process and tools, gets you to a better outcome. Thinking lean – balancing flexibility, optimization, and efficiency – but not short-sightedly cheap, protects you from being penny wise but pound foolish.

Related reading:

There are two broad categories of costs for closing a seed round:

  • Legal Fees – Including whether you are using an incumbent “BigLaw” firm or a leaner boutique, and how you structure the round.
  • Post-Closing Expenses – Including state and securities filing fees, as well as 409A/cap table software costs

Seed Round Legal Fees

BigLaw v. Elite Boutique?

Without a doubt the two most significant drivers of legal fees are: (1) the type of law firm you are using, and (2) the round structure (contracts) you and your lead investors choose.  For a deep-dive on the “type of law firm” issue, see: Startup Legal Fee Cost Containment (Safely). In short, what has happened over the last decade or so is the incumbent Silicon Valley-based firms (BigLaw) have raised their pricing and grown so bloated (IMO) that they have simply overshot the needs of a huge segment of the startup ecosystem, especially at the earlier stages.

Granted, the market has historically not done a very good job of offering viable, credible alternatives to BigLaw in this space. What we’ve more often seen is (what I lovingly call) “shit firms” full of cheap but poorly-qualified lawyers, or peddlers of half-baked legal automation software that simply can’t handle the contextual nuances of high-growth companies. Lean but still elite boutique law firms, like Optimal (our firm), offer a more balanced package of highly-trained and credible professionals, including top-tier Partners, but lower costs derived from a more efficient firm operating structure.

To put this into more concrete numbers: a Partner in an incumbent “BigLaw” SV-based law firm will typically cost at least $900-1400 per hour, often more. At an elite lean boutique firm, the Partner will have an extremely similar background in terms of credentials, training, and experience, but be more like $450-650 per hour. Certainly not cheap – remember Partners don’t do most of the work in early-stage, they oversee things (quality control) and strategize with the C-suite and Board – but dramatically leaner than BigLaw. What allows leaner law firms to do this, while retaining top talent, is that they “burn” so much less money than firms built on traditional operating models. They can pay lawyers extremely well, but at lower rates.

Convertibles (Note or SAFE) v. Equity (Seed Equity or NVCA)?

The second big driver of legal fees in a seed round is the contract structure you and your investors use. Certain market players like to pretend as if this decision is very easy and simple, often because they make money nudging you in one direction, but it really is not that universal or clean cut.

Convertible instruments (convertible notes or SAFEs) are most certainly cheaper to close on and negotiate. Even within that category, however, there are key nuances. For example, whether there’s a valuation cap or not, whether that valuation cap is post-money v. pre-money, and of course whether you’re using convertible debt (notes) or SAFEs. Good reading on this: SAFEs v. Convertible Notes and A “Fix” for Post-Money SAFEs. These nuances can have enormously consequential (economically) impacts on a company.

While the big positive of convertible notes and SAFEs is speed and simplicity, their primary downside is uncertainty. They do not harden economics or governance rights the way that an equity round does, but instead deliberately punt on various hard questions to the future –  this is precisely how they simplify things. In many cases, this is a feature and not a bug, but not always. A huge number of startups are feeling these downsides in this heavy post-pandemic post-ZIRP economic downturn that the ecosystem is experiencing.

So many founders drank the “click click close” kool-aid suggesting that seed rounds are all “standard” and they should just sign YC’s default post-money SAFE. The main peddlers of this perspective were specific investors, who profited from pushing a contract structure designed for their economic interests, and automated financing companies who need you to not negotiate your deals, and believe it’s all “boilerplate,” so that you can let their software tool close everything for you. Obviously, automation software breaks down when confronted with any meaningful level of flexibility or structure nuance.

Now that these startup teams need to raise more money in hard times, they’re feeling the pain of having failed to do a bit more negotiation up-front, including by hardening investor economics when valuations were higher instead of simply relying on a moving valuation cap with no floor. The harsh anti-dilution mechanics of YC’s default SAFE are also imposing significant dilution on founders, whereas if they had just done a tad more thinking and structuring up-front they could’ve saved themselves potentially tens of millions of dollars worth of dilution. Losing millions in dilution in order to save a few thousand in fees is a perfect example of penny-wise, pound-foolish judgment.

See Myths about Seed Equity Rounds for a deep-dive into when equity, instead of a convertible, can make sense for your seed round. Choosing a simplified “seed equity” structure, instead of the longer, more complex NVCA-based equity deal contracts, can save tens of thousands in legal fees, and safely (without material hidden risks). You and your counsel will just need to get your investors comfortable with it, if possible.

Concrete Legal Fee Numbers:

If you’re using a lean elite boutique law firm, closing a convertible note or SAFE round is at most a few thousand dollars in legal fees ($2.5K-$5K). A little more if it’s heavily negotiated, but rarely more than $10K. BigLaw, with often double the rates, will naturally be more. This is for company-side costs. Investors usually pay their own fees in convertible rounds.

For simplified seed equity (not NVCA), a more typical range from a boutique law firm is $15K-$30K if we’re thinking of a 10%-90%-ile range, with below that range being zero negotiation super-fast closing, and above that range being when more heavy negotiation or cleanup diligence issues are involved. Again, BigLaw with its higher rates is probably twice that.

Some VCs will insist on structuring “seed rounds” in the exact same format as a Series A, using NVCA-based forms. This adds significant complexity and drafting time, as it’s a rejection of the simplified seed equity structure. For this structure, with a lean boutique a reasonable 10/90 range is $25K-$45K assuming the round is $4-6 million-ish raised. A larger round closer to $10M+ or higher may be closer to $50K due to more legal work demanded by the VCs, and will look more like a Series A. Again, BigLaw’s rates will drive that higher if you go that route. Often 2x. But importantly, a small minority of seed rounds are structured this way, as using this structure is more a response to a particular fund’s idiosyncratic preferences, and not some inherent necessity of seed financing.

Only perhaps 10-15% of these cost ranges boil down to what might be called “administrative” work – paralegal-esque mechanics like coordinating signatures, inputting numbers, etc. The real drivers are high-impact legal work of negotiation (including educating executives and Boards), structuring, drafting, and integration of the “code” (contract language) for the deal and planned corporate governance arrangement.

Sidenote to law firms: See Legal Tech for Startup Lawyers for some experienced advice on helpful software for reducing administrative time on financings. 

The key takeaway is how much seed rounds cost to close is heavily driven by the type of law firm you’re using, and the contract structure. My point here is not to pretend there is some formulaic, straightforward answer as to what any particular company should choose. It depends on context. My suggestion, however, is that founders actually act like executives and exercise some judgment – weighing the pros and cons, balancing flexibility v. speed, negotiation v. automation – instead of biting into X or Y peddler’s nonsense as to whatever a “standard” seed round looks like. We’re talking here about selling 10-30% of your cap table. Don’t be a myopic fool.

Other Seed Round Expenses

While not as meaningful as legal fees, there are a few other expenses that still impact the bottom line in a seed round. State filing fees, along with securities filings, can run you anywhere from $750-2,000 as a 10/90 range.

Carta or Pulley?

Higher than state or filing fees will be the cost of adopting capitalization table software and getting a 409A valuation; the latter of which is usually recommended if you intend to grant options after closing your round. Before a seed round, adopting any kind of cap table tool apart from MS Excel has always struck me as pointless. At under 10-20 cap table stakeholders, it’s not hard for a competent team, in collaboration with competent counsel, to maintain a spreadsheet. In fact, when very early founders introduce third-party cap table software into the mix, I sometimes see more mistakes, not fewer ones.

Historically, Carta has been the big incumbent player in this space, and deservedly so. But as is the case with many incumbents, there are growing concerns in the market about feature creep and excessive (rising) pricing. Sentiments like:

A big concern among law firms and VCs has been that no other leaner alternatives seemed to be gaining sufficient market share to counteract the network effect advantages that Carta has. But from what we’ve been observing, Pulley (Founders Fund Series B-funded) appears to be reaching a threshold where, at a minimum, founders need to be aware of them as a significantly less costly and simpler cap table + 409A option to the tune of thousands of dollars per year. Most serious law firms in this space are growing comfortable and familiar with it. Its simpler, more focused interface is certainly helpful.

We also published The Open Startup Model for founders who (understandably) want to avoid the cost of a third-party capitalization tool entirely until later in their company’s trajectory. A lot of lean companies get by just fine during seed stage, and sometimes even Series A, relying on a simple but well-organized excel model.

Summary

All smart founding teams are rightfully concerned about not over-spending to close their seed funding. But there’s a lot of opaque, and sometimes patently false, information available in the market as various commentators “talk their book” instead of laying out all the factors honestly.

On legal fees, law firm type and deal structure are big drivers. For the former, it’s BigLaw v. elite boutique. For the latter, the decision matrix is multi-variate. If convertibles: SAFE or Note, and within those categories, type of valuation cap. If equity: simplified seed equity or NVCA. Where you land on deal structure has millions of dollars in implications long-term. Take the time to exercise real judgment on this issue. Remember: lean, not cheap.

On post-closing cap tables and 409As, Carta is the quite expensive but solid incumbent, and Pulley is the increasingly attractive lean alternative. Assess both. Also consider just leaning on an Excel-based cap model.

Good luck.