Early v. Late-Stage Common Stockholders in Startup Governance

TL;DR: While the preferred v. common stock divide gets the most discussion in startup corporate governance, and for good reason, the early v. later-stage common stock divide is also highly material. Given their different stock price entry points, early common stockholders (like founders and early employees) are not economically aligned with common stockholders added to the cap table in Series B and later rounds. This has important power implications as to who among the common stock gets to fill the Board’s common stock seats, or vote on other key matters. Clever investors will often put in subtle deal terms that allow them to silence the early common stock in favor of later-stage common stockholders who are far more likely to agree with the interests of the money.

Background reading: The Problem with “Standard” Term Sheets

The Common Stock v. Preferred Stock divide is the most important, and most discussed, concept in corporate governance as it relates to startups. The largest common stockholders are typically founders, followed by employees. Preferred stockholders are investors. Sometimes in growth rounds investors will dip into the common stock via secondary sales, which muddies the divide, but for the most part the divide is real and always worth watching.

Investors (preferred) are diversified, need to generate high-returns for their LPs, prefer to minimize competition in rounds where they have the ability to lead, and have downside-protection in the form of a liquidation preference. Common stockholders, particularly founders and early employees, are far more “invested” in this one company, want to maximize competition among potential investors to increase valuations, and don’t have downside protection. That creates fundamental incentive misalignments.

This divide becomes extremely important when discussing the two key “power centers” in a company’s corporate structure: (i) the Board of Directors, and (ii) veto rights at the stockholder level. The latter usually takes the form of overt veto rights (often called protective provisions) spelled out in a charter, but there are also often more subtle veto rights that can have serious power implications; like when a particular party’s consent is needed to amend a contract that is essential for closing a new financing.

When founders (and their legal advisors) actually know what they’re doing, they’ll pay extremely close attention in financing terms to how the Board composition is allocated between the common v. preferred constituencies, and whether either group is given “choke point” veto rights that could be utilized to exert inappropriate power over the company. Unfortunately, because founders are often encouraged (usually by clever investors) to mindlessly rush through deals, and even sign template documents produced by investors, extremely material nuances get glossed over, with the far more experienced VCs benefiting from the rushing. It gets even worse when the lawyers startups use are actually working for the VCs.

As just one example, founders will often focus exclusively on high-level Board composition, because it’s the easiest to understand. They’ll say something like, “well, the common still controls the Board, so everything else doesn’t matter.” But that’s simply not true. You may have control over your Board, but if your preferred stockholders have a hard veto over your ability to close any future financing – if the preferred have to approve any amendments to your charter, you can’t close new equity – then your investors are really in control of your financing strategy. The Board is important, but it’s not everything.

The purpose of this post is to highlight another important “divide” among constituencies on the cap table: early-stage common stockholders (founders and employees) v. later-stage common stockholders (later hires, C-level execs who replace founders). While less relevant Pre-Series A, this divide becomes much more important in growth-stage financings, and plays into the power dynamics of company governance in ways that early-stockholders are often poorly advised on.

Any party’s “entry point” on the cap table has an extremely material impact on their outlook for financing and exit strategy. If I got my common stock in Year 1, which is the case with founders and early employees, the price I “paid” for that stock is extremely low. But if I showed up at Year 4, I paid much more for my stock, or I have an option exercise price that is substantially higher.

Fast-forward to Year 5. The company’s valuation is tens or hundreds of millions of dollars. The Y1 common stockholder is sitting on substantial value in their equity. Multiples upon multiples of what they paid for their stock. They’ve also been grinding it out for years. The Y4 common stockholder, however, is in a very different position. They only recently joined the company, and their equity is only worth whatever appreciation has occurred in the past year.

Now an acquisition offer for $300 million comes in. Put aside what investors (preferred stockholders) think about the offer. Do you think the “common stock” are all going to see things in the same way? Is the Y1 common stockholder going to see the costs/benefits of this offer in the same way that the Y4 common holder will? Absolutely not. Later-stage common stockholders have far less sunk wealth and value in their equity than early-stage common stockholders do, and this fundamentally changes their incentives.

Now apply this early-stage v. late-stage common stock divide to Board composition. Simplistically, founders often just think about “common stock” seats. But who among the common stock gets to fill those seats? Investors who want to neutralize the voice of the early common stock on a Board of Directors will put in subtle deal terms that allow them long-term to replace early common stockholders with later-stage common stockholders on the Board, because the later-stage holders (often newly hired executives) will be more aligned with later-stage investors who want to pursue “billion or bust” growth and exit strategies. A Y1 common stockholder has far more to lose in turning down an exit offer, and instead trying for an even bigger exit, than a Y4 common stockholder does.

The most popular way that this shows up in terms sheets / equity deals is language stating that only common stockholders providing services to the Company get to vote in the common’s Board elections, or in approving other key transactions. Once you’re no longer on payroll, you lose your right to vote your stock, even if you still hold a substantial portion of the cap table.

Through the natural progression of a company’s growth, founders and early employees will usually step down from their positions, or be removed involuntarily. Whether or not that should happen is entirely contextual. However, it is one thing to say that an early common stockholder is no longer the right person to fill X position as an employee, but it is an entirely different thing to say that such early common stockholder should have no say at the Board level as to how the company should be run. Whether or not I am employed by a company has no bearing on the fact that I still own part of that company. The entire point of appropriate corporate governance is to ensure that the Board is properly representing the various constituencies on the cap table. Early common stockholders are a valid constituency with a valid perspective distinct from executives hired in later stages by the Board.

Deal terms that make a common stockholder’s voting rights contingent on being employed by the company are usually little more than a power play by investors to silence the constituency most likely to disagree with them on material governance matters, and instead fill common Board seats with later-stage executives who will toe the line. Importantly, aggressive investors will often rhetorically spin this issue as being simply about “founder control,” to make it easier to dismiss as self-interested, but that is flatly inaccurate. Many Y1 or Y2 common stockholders are not founders, but their economic incentives are far more aligned with a founder, who also got their stock very early, than with an executive hired in Y5+.

Yes, the largest early common stockholders will often be founders, but the reason for giving them a long-term right to fill Common Board seats is not about giving them power as founders, but as representatives of a key constituency on the cap table that is misaligned with the interests of investors and later-stage common holders. This isn’t “founder friendliness.” It’s balanced corporate governance.

The message for early common stockholders in startups is straightforward: don’t be misled by simplistic assessments of term sheets and deal terms. It’s not just about the common stock v. preferred, but whether all of the common stock gets a voice; not just the common holders cherry-picked by investors.

The Carta SAFE for Seed Rounds

Background reading:

As I’ve written in various places (see above), a significant problem that has emerged in startup ecosystems involves certain investor organizations pushing startups to adopt their preferred financing templates. Predictably those templates are often riddled with issues that favor the interests of the money. Of course these organizations are far too clever to come out and state transparently, “we want you to use this document because it makes us and other investors more money,” so they spin other narratives about saving founders time, or reducing legal fees; even though the “cost” to founders is often orders of magnitude higher than whatever they might be “saving” by mindlessly signing the templates.

This dynamic was most visible with YC’s announcement of the Post-Money SAFE, which implemented economic concepts exorbitantly favorable to seed investors (including YC of course), but was marketed as a way to (air quotes) “help” founders have more “clarity” about their cap table. YC, their long list of positive impacts on the ecosystem notwithstanding, is still an investor with lots of mouths to feed. No one should’ve been surprised that it would use its brand leverage to push a more investor-favorable document onto startups, particularly now that, with its brand having significantly matured, it no longer needs to rely as much on “founder friendliness” to attract startups.

Carta, the dominant (by far) capitalization SaaS used by startups, recently announced that it is enabling automated SAFE financing on its platform. Interesting news, and I’m sure it’ll save teams planning on closing SAFE financings a bit of hassle. But automated SAFE closings have been available on other platforms, like Clerky, for some time, and realistically the technology behind it is hardly earth-shattering. Given that SAFEs are utilized far more in California than in the rest of the market, that’s probably where the automation will have the most impact.

What I find much more interesting, and relevant to topics I write about, is that Carta chose to tweak the YC SAFE docs and create a “Carta SAFE.” Companies can still close on YC’s Pre-Money or Post-Money SAFE templates, but they also have the option of a Pre-Money or Post-Money “Carta SAFE.” The changes themselves are fairly innocuous, but helpful and balanced. More importantly, I think it’s worth recognizing the valuable role that an organization like Carta could play in promoting various template financing structures to startups.

YC is a venture capitalist, and thus highly biased in the terms it purports to offer as “standard.” They lost tremendous credibility among the legal and startup community – although surely gained favor among VCs – with their 180 on the Post-Money SAFE. They absolutely deserve respect for their track record of picking successful startups, but lines have been crossed with respect to any facade of “founder friendliness” in their template standards.

Carta, however, is a technology company that (as far as I know) is not investing in dozens of startups every year. Carta has far less reason to favor an investor-biased document, and thus potentially has far more credibility in swaying market “standards” in a more balanced direction. This is visible in how they’ve implemented their automated seed financings and templates, relative to how YC pushed out the Post-money SAFE.

Go to YC’s website, and you can’t even find the old pre-money SAFEs with more company-favorable economics and terms. All you have is the new (profoundly investor-biased) Post-Money docs for download. This simple fact has actually caused huge confusion among inexperienced founders, who often aren’t even aware that YC dramatically changed their forms and economics, and thus (thinking they are doing themselves favors) simply download and execute the forms on YC’s site. YC could’ve very easily offered up the new Post-Money SAFEs, while leaving the old forms also available for download, with clear prompting to founders to work with advisors to decide which form they prefer. Instead, YC consciously chose to promote only the new forms, signaling a clear desire to change the market “standard” in favor of investors.

Contrast that with Carta. The Pre-Money v. Post-Money distinction is front and center in their UI, with both types of forms easily accessible to startups, and with helpful tools for comparing dilution from the different structures. This is a far more honest and transparent way for helpful templates to be offered to startup teams, without shady gimmicks or marketing spin to nudge them in favor of the money. It should be applauded.

Of course, I’m not going to wrap up this post without acknowledging that Carta still has bias. Who doesn’t? As an automation tech company, they are obviously biased toward automation and templates that enable automation. There are countless ways in which financing documents can (and often should) be negotiated and tweaked to make them a better fit for the unique context of a particular company raising money from particular investors. Sometimes convertible notes of various flavors make more sense. Other times seed equity. Other times the full suite of NVCA equity docs.

Despite growing traction among public templates, an enormous amount of investors and startups still take advantage of flexibility and customization in their deal docs, because the stakes are so high, the context and people involved so nuanced, and the terms so permanent, that it’s worth doing a bit of negotiation. If a few thousand dollars of legal fees can save you a few million in the long-run on your cap table, it doesn’t take advanced calculus to arrive at a decision.

In saying that, I’m obviously reflecting my own bias as company counsel to startups (and not investors). My job is to ensure startup teams are aware of all the options on the table for their financings and corporate governance. That of course includes bringing up when an automated template might make sense. Sometimes it does, often times it doesn’t. We can all stop pretending that serious lawyers are in any way threatened by tools like Carta or Clerky. I love these tools, because the last thing I enjoy spending my time on is shuffling cookie-cutter forms. Use the cookie-cutter when it makes sense, but make sure you really understand the tradeoffs and limitations, because a lot of very smart teams decide to put the cookie-cutter down and take a more “custom fit.”

Venture capitalists, together with Startups, are biased in favor of their own bank statements. Automation tech companies, like Carta, are biased in favor of hyper-standardization and automation. And high-end ECVC (Startup) lawyers, like me, are biased in favor of flexibility and customization. There’s no need to hide any of this. Every party has an important role to play in the ecosystem, and the interaction of all the moving parts ensures we all arrive at a reasonable equilibrium. All of that being said, I’m glad an organization like Carta has entered the template financing arena, because a well-branded but less biased player was sorely needed.

Moving (Too) Fast and Breaking Startup Cap Tables

Related Posts:

As I’ve written many times before, the “move fast and break things” ethos, which makes absolute sense in a software environment where fixing “bugs” is quite easy and low-stakes, becomes monstrously expensive and reckless when applied to areas where the cost of a mistake is orders of magnitude higher to fix (if it’s fixable at all). Silicon Valley got a very visible and expensive (to investors in terms of capital, and founders in terms of legal errors and terrible legal advice) lesson in this reality a while back with a very well-funded (but ultimately failed) legal startup heavily promoted as enabling (via over-hyped vaporware) startups to “move faster” and save significant costs. That legal startup was, perhaps unsurprisingly, controlled by money players with all kinds of reasons to profit from startups (that they invest in) getting weak legal and negotiation guidance. No one wants an in-experienced founder to move fast and mindlessly do what investors want more than… those investors.

That fundamental point is one that inexperienced founders need to keep their eye on throughout their entire fundraising and growth strategy. Notice how, for example, certain Silicon Valley groups adamantly argue that SV’s exorbitant rents and salaries are nevertheless worth spending capital on, and yet simultaneously they will howl about how essential it is that startups minimize their legal spend (a small fraction of what is spent on rent and salaries) in fundraising, and move as quickly as possible; usually by mindlessly signing some template the investors created? Why? Because they know that the one set of advisors most capable of “equalizing” the playing field between inexperienced startup teams and their far more seasoned investors is experienced, independent counsel. Aggressive (and clever) investors say they want you to adopt their preferred automation tools and templates because they care so much about saving you money, but the real chess strategy is to remove your best advisors from the table so that the money can then, without “friction,” leverage its experience and knowledge advantage.

At some obvious level, technology is an excellent tool for preventing errors, especially at scale when the amount of data and complexity simply overwhelms any kind of skilled labor-driven quality control mechanism. But there is a point at which people who sell the technology can, for obvious financial incentives, over-sell things so much that they encourage buyers to become over-dependent on it, or adopt it too early, under the delusion that it is far more powerful than it really is. This drive to over-sell and over-adopt tech for “moving really fast” is driven by the imbalance in who bears the cost of fixing “broken things.”

Ultimately the technology seller still gets paid, and puts all kinds of impenetrable CYA language in their terms of service to ensure that no one can sue them when users zealously over-rely on their products in ways clearly implied as safe by the tech’s marketing. Founders and companies are the ones who pay the (sometimes permanent) costs of a poorly negotiated deal or contract, or in the case of cap tables incorrect calculations and promises to employees or investors.

In the world of cap tables, automation and tracking tools like Carta (the dominant player, justifiably, by far) are enormously valuable, and doubtlessly worth their cost, in helping the skilled people who manage the cap tables keep numbers “clean.” In the early days of Carta’s growth (once called eShares), there was a general understanding that cap tables rarely “break” before the number of people on the table exceeds maybe 20-30 stakeholders as long as someone skilled at managing cap tables (in excel) is overseeing things. That last part about someone skilled is key.

There are in fact two broad sources of cap table errors:

  • Using Excel for too long, which creates version control problems as the number of stakeholders grows; and
  • Management of cap tables by people who are simply too inexperienced, or moving too quickly, to appreciate nuances and avoid errors.

Technology is the solution to the first one. But today it’s increasingly becoming the cause of the second one. The competitive advantage of technology is speed and efficiency at processing large amounts of formulaic data. But the advantage of highly-trained people is flexibility and ability to safely navigate nuanced contexts that simply don’t fit within the narrow parameters of an algorithm. In the extremely human, and therefore subjective and nuanced, world of forming, recruiting, and funding startups in complex labor and investor markets, pretending that software will do what it simply can’t do –  delusionally over-confident engineers notwithstanding – is a recipe for disaster. The combination of new software and skilled expertise, however, is where the magic happens.

The Carta folks have been at this game long enough to have seen how often over-dependance on automation software, and under-utilization of highly trained and experienced people in managing that software, can magnify cap table problems, because it creates a false sense of security in founders that leads them to continue flying solo for far too long. Sell your cap table software as some kind of auto-pilot, when the actual engineering behind it doesn’t at all replace all the things skilled experts do and know to prevent errors, and you can easily expect ugly crashes.

That’s why Carta very quickly stopped promoting itself as a DIY “manage your cap table by yourself and stop wasting money on experts” tool and evolved to highly integrate outside cap table management expertise, like emerging companies/vc law firms and CFOs; who spend all day dealing with cap table math. They realized that the value proposition of their tool was sufficiently high that they didn’t need to over-sell it as some reckless “you can manage cap tables all by yourself!” nonsense to inexperienced teams who’ve never touched a cap table before. The teams that use Carta effectively and efficiently see it as a tool to be leveraged by and with law firms, because startup teams are rarely connected to anyone who is as experienced and trustworthy (conflicts of interest matter) in managing complex cap table math better than their startup/vc law firm.

But as is often the case, the cap table management software market has its own “race to the bottom” dynamics – but a better name may be the “race to free and DIY.” If I’m a company like Carta, and I know that truthfully very few companies need my tool before maybe a seed or Series A round (excel is perfectly fine, flexible, and simple until then), I’m still extremely worried that someone will use the time period before seed/Series A to get a foothold in the market and then squeeze me out as their users grow. That someone is almost always a “move fast and break things” bottom-feeder that will, once again, over-sell founders on the idea that their magical lower-cost DIY software is so powerful that founders should adopt it from day 1 to save so much money by no longer paying for expertise they don’t need.

Thus Carta has to create a free slimmed down version, and they did. But they’ve stuck to their guns that cap tables are extremely high-stakes, and even the best software is still extremely prone to high-cost errors if utilized solely by inexperienced founders. That’s why Carta Launch has heavy ties to a network of startup-specialized law firms. It’s free as in beer, but honest people know that it still needs to be used responsibly by people who fully understand the specific context in which it’s being used, and how to apply it to that context.

But the bottom-feeders of cap table management are of course showing up, with funding from the same people who were previously happy to impose costs (errors, cleanup) on inexperienced teams as long as their software gets adopted and their influence over the ecosystem therefore grows. The playbook is tired and predictable.

Why are you using that other (widely adopted and respected) technology that still relies (horror of horrors) on skilled humans? It’s 2020, you need :: something something automation, machine learning, AI, etc. etc. :: to stop wasting money and move even faster. Our new lower-cost, whiz-bang-pow software lets you save even more time and manage your cap table on your own, like the bad ass genius that you are.

We know where this is going. Many of us already have our popcorn ready. While before I might run into startups who handled only a formation on their own, and show up with a fairly basic and hard-to-screw-up cap table, I’m increasingly seeing startups who arrive with seed rounds closed on a fully DIY basis, and totally screwed up cap tables involving investors and real money. They also often have given up more dilution than they should’ve, because no independent, skilled expertise was used to help them choose and negotiate what funding structure to use. Clean-up is always 10x of what it costs to have simply done it right, with a thoughtfully chosen (responsible) mix of technology and skilled people, on Day 1.

Technology is wonderful. It makes our lives as startup/vc lawyers so much better, by allowing us to focus on more interesting things than tracking numbers or inputting data. The stale narrative that all VC lawyers are anti-technology really gets old. We were one of the first firms to adopt and promote Carta, along with numerous other legal tech tools. Not a single serious law firm views helping their clients manage cap tables as a significant money driver. But that’s like saying no serious medical practice views X or Y low-$ medical service as a significant money driver. Something can be a small part of a professional’s expertise, and yet still way too contextual, nuanced, and high-stakes to leave to a piece of software pretending to be an auto-pilot.

When the cost of fixing something is low, move as fast as you want and break whatever necessary. But that’s not contracts, and it’s not cap tables. In those areas, technology is a tool to be utilized by still-experienced people who regularly integrate new technology into their workflows, while maintaining skilled oversight over it. Be mindful of software companies, and the clever investors behind them, who are more than happy to encourage you to break your entire company and cap table as long as you utilize their half-baked faux-DIY tool. Their profit is your – often much larger than whatever money you thought you were saving – loss.

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.