Post Category → Startup Lawyers

Why I (Still) Don’t Make Investor Intros

TL;DR Nutshell: If in today’s connected startup ecosystems, with today’s tools and resources, founder CEOs still need their (paid) lawyers to introduce them to investors, there’s a very good chance they can’t build a company. And most investors know that.

Background Reading:

Certain law firms I come across love to use the following biz dev pitch: “our firm has close relationships with many investors, and we love helping make intros to them for our clients.” Some have even attempted to institutionalize this into an entire department within their firms.

Sounds great, doesn’t it? Lawyers are constantly interacting with investors, so they must be a great shortcut to getting intros, right? Not so fast.

A paid intro is generally worse than no intro, particularly in today’s ecosystems. 

I wrote Don’t Ask Your Startup Lawyer for Investor Intros about a year and a half ago, in which I made the following argument:

  • Early-stage investing is at least as much about betting on founders, particularly CEOs, as it is about betting on a particular business.
  • Because investors see 100-1000x more companies than they can fund, or even assess, they heavily rely on filters/signals to judge the quality of founding teams.
  • The way in which a CEO obtains an investor intro (and from whom) speaks volumes about that CEOs ability to network, persuade, and generally hustle; all of which are extremely important skills for a successful founder CEO.
  • There are far more ways, today, to get connected with investors and find true, authentic warm referrals – AngelList, LinkedIn, Twitter, Accelerators, etc. – than there were even 5-10 years ago.
  • Therefore, in a world in which there are 100s of possible paths to get introduced to an investor, the fact that your lawyer (someone you are paying) ends up making the intro can send an extremely negative message about the founding team – including that they can’t hustle, can’t convince anyone else in their ecosystem (that they aren’t paying) to introduce them, or both. Samir Kaji emphasizes this last point, about a weak intro making investors think negatively about the founders, in his post.

At the time I published that post, most people providing feedback on it agreed, but I had a few dissenters – generally lawyers arguing that they’ve made successful intros themselves. I don’t doubt that they’re telling the truth, but what was telling is that few could give examples of successful intros in recent years – and my point is very time-contextual. Even five years ago, relationships within startup communities were far more opaque than they are today, and an intro from a lawyer didn’t have nearly the level of negative signaling then that it does now.

But one pattern become obvious that relates to another point I’ve made before:

For a lawyer’s investor intro to not have a negative signal for a particular investor, the lawyer and investor must have a very close relationship, and that means you shouldn’t want that lawyer representing your company in a deal with that investor.

See: Why Founders Don’t Trust Startup Lawyers

There absolutely are particular lawyers who have very close relationships with particular investors, much more than other lawyers who simply run into those investors on deals and on boards (professional acquaintances). The issue is that those close relationships develop, nine times out of ten, from those lawyers working for those investors. And for reasons that should be obvious (but if they aren’t, read the above post), the last lawyer you want representing your company in a VC deal is the lawyer who is BFFs with the VCs you are negotiating with.

So maybe some lawyers can make a decent intro… but you shouldn’t work with them… which makes it significantly less likely that they’ll make the intro. Life is complicated.

Other founders, particularly well-respected ones and especially those who’ve been funded by an investor, are the best source of referrals. Other well-respected, non-service providers (advisors, accelerators, angels, etc.) are the second best. Anyone you are paying comes dead last.

Jeff Bussgang has a great post on how to ‘rank’ different potential paths to investors – Getting Introductions to Investors – The Ranking Algorithm. His hierarchy makes a lot of sense. And aside from other founders being the best source of referrals, they are absolutely the best source of intel on investors, when you’re diligencing them. If a group of VCs have provided you a term sheet and you aren’t actively (but discreetly) talking with their portfolio founders to understand what working with those VCs is actually like, you’re doing it wrong.

As ecosystems become more transparent, and prospecting tools become more sophisticated, investors may be relying less on referrals anyway.

I found the data reported by First Round Capital in their 10 year Project to be pretty interesting, including the data suggesting that First Round’s referred investments significantly underperformed relative to investments that First Round hunted on their own. Honestly, this isn’t that surprising.

A lot of studies on investor performance emphasize that, while many people get lucky with one or two home-runs, the people who consistently outperform the market are those who actively take a process, data-oriented approach, and try their best to counteract their biases. That doesn’t mean success in VC is about number crunching, but it does mean that if your personal relationships are the main way that you find companies, you’re going to have a lot more sources of bias in your decision-making than someone who takes a broader, but more calculated approach.

In short, we live in a very different world from the one in which VCs sat in their offices relying on proprietary, somewhat opaque deal flow sources. In that world, lawyers were a better source of investor intros. That world no longer exists. Investors fund hustlers, and (today) hustlers don’t need their lawyers to introduce them to investors.

Navigating Referrals in a Connected Startup Ecosystem

Nutshell: Referrals and recommendations from influential people in your startup ecosystem, or from people you trust, are an extremely important way to build your startup’s set of advisors, mentors, service providers, investors, etc.  But there’s a wide gap between an authentic referral made on merit v. one made because of quid-pro-quo business relationship hiding in the background.

Background Reading:

Cheap “Networking” v. Respect

I have never set foot on a golf course, and really don’t care to any time soon. I honestly don’t know anything about wine other than that I’d generally prefer a good beer over it. I have no idea what anyone on ESPN is talking about every time I’m sitting in my barber’s chair. And I still need someone to explain to me why everyone on there is so dressed up, to talk about sports? Why, might you ask, would any ambitious lawyer who cares about biz dev make zero effort at improving his game on what many consider to be the core pillars of business networking?

In short: when I recommend anyone to a client: an advisor, a service provider, an investor, even a specialist lawyer, I believe it should be solely because that person actually deserves the referral – meaning that I think they are the best for the task – and not because I expect to gain something personally from making that recommendation, or because I “like” them. I don’t care about anyone’s golf game, sports knowledge, or whether they will refer anyone back to me – and I expect the same in return.

I have pissed off and/or disappointed a lot of people because of this mindset, but in the arc of your own career, particularly in a career based on serving as a trusted advisor, respect will sustain you far more than dozens of superficial connections purchased with steak dinners and side deals.

Build Your Inner Circle

As a founder, the moment you show even the slightest sign of building a strong company, you’ll find yourself inundated with people who want to connect with you. One of your first jobs is to learn, quickly, whom to (politely) say “no” to. You can only have so many coffee meetings before they get in the way of actually building a real company. And if you spend enough time at a few startup events you’ll quickly realize how many “startup people” aren’t actually building real companies. Avoid noise. Find signal.

Building your network (quality over quantity) is extremely important, especially if you’re CEO. But it’s (at least) equally important to build and maintain your inner circle.  More than people with great resources, money, or advice, these are smart, helpful people whose character you’ve judged to be a cut above everyone else’s; meaning that they can be trusted in a way that your broader group of connections cannot.  There is no magical formula for finding these people, or sorting them out from others. Your ability to “read” people will improve over time.

In general, your inner circle should be made up of experienced, smart people who (i) consistently speak their mind more freely than others, (ii) often make recommendations that run against their financial interests or personal connections, and (iii) will give you opinions/feedback that others in the ecosystem don’t have the personal brand independence to give.  Referrals from those people are gold.

Your inner circle can be made up of advisors, investors, experienced founders at other companies, etc. What matters most is that you have one to turn to when faced with those inevitable, high-stakes moments where people with all kinds of incentives are pushing you in different directions, and you need cold objectivity. And as I’ve mentioned before and will repeat here: build diversity of perspectives into your inner and outer circle. The smaller the ecosystem, the harder this is to do – and often times connecting with true outsiders (geographically) can be very valuable.

Lawyer Referrals: Merit v. Kickbacks

With respect to the legal services required for a scaling tech company, a group of corporate lawyers (what we are) generally serve as the quarterbacks of a broader team of specialist lawyers; much like how an internist or general practitioner physician quarterbacks specialist doctors in treating a complex condition. For that reason, the main types of referrals that we (at MEMN) find ourselves making are to specialist lawyers – patents, trademarks, immigration, IP licensing, privacy, import/export, etc.

As I’ve written before, every law firm has built in financial incentives to “cross sell” their own lawyers. If I’m at a law firm that follows the traditional “one stop shop” full service approach, I make money if I can convince you to use our specialist lawyers. It’s called “origination credit.” If you use another firm’s lawyers, perhaps because they have more domain expertise for my type of technology (often the case for patent lawyers in particular), I get nothing. Given this fact, it should not shock you at all when your BigLaw corporate lawyer always refers work to his in-house specialists, without suggesting more appropriate alternatives.

A network of specialized, focused boutiques and solo lawyers should, at a structural level, have a far more merit-based referral system. And it does.  But even among smaller firms there are lawyers who’ve set up kickback relationships that usually aren’t disclosed to clients – and yes these are often on shaky legal ethics grounds. They’re often structured in the form of a referral fee, or % of fees resulting from the referral. While I’m not going to say definitively that these arrangements should automatically invalidate the trustworthiness of a referral, they should at a minimum give founders reason to do their own diligence on the referral before moving forward with it.

It never hurts to ask a referring lawyer: “is there a referral fee arrangement in place here?” If it’s some kind of startup program (accelerator, incubator, etc.) making the referral, I would ask “is the lawyer/firm you’re referring me to sponsoring your program?” ‘Sponsorships’ often mean the firm is, effectively, paying for referrals. This is actually becoming a mechanism by which large firms entrench themselves, through accelerators.

Again, I’m not going to criticize lawyers who monetize their legal connections. I understand the reason behind it.  But with that being said, MEMN’s specialist network does not have any built in kickback arrangements. When I tell a client “you should use X lawyer because she’s the right person, and at the right billing rate, for the task” I value being able to say it with total objectivity. Back to the point made earlier in the post, make your money by becoming awesome at what you do, not by trying to cut shady side deals that taint your trustworthiness.

Financially motivated referrals work great in a lot of product and service vendor-oriented marketplaces, but in the world of top-tier advisors – where trust is your most valuable asset – they should, in my opinion, be avoided. One of the largest benefits of properly functioning ecosystems is how transparent they are compared to large, top-down organizations.  That transparency means meritocracy, if enough people with backbones are able to resist the urge to “cut a deal.”

A Startup Lawyer is Not a Founder’s Lawyer

TL;DR Nutshell: It’s extremely important to hire independent counsel who isn’t incentivized to favor, because of existing relationships, the interests of your investors above those of the company.  But it’s also important to understand that company counsel represents the best interests of the company, including all stockholders, and that can often conflict with the personal interests of individual founders.

Background Reading:

A core message that I’ve focused on via SHL can be summarized as follows: many influencers for a startup, particularly investors, will often push founders to use their own preferred lawyers as company counsel, but given the amount of confidential information your lawyers will have access to, and the degree to which you will rely on their counsel for key strategic decisions, ensuring your lawyers’ impartiality is extremely important.  Naval Ravikant put it well in Lawyers or Insurance Salesmen?

“Don’t just go with the lawyer that the VCs insist upon. These lawyers will work with the VC on a hundred financings and with you on only one. Where do you think their loyalties lie? Get your own lawyer, and don’t budge.” -Naval Ravikant

This post is about a related, but very different point: hiring a law firm that impartially represents the company is not (and cannot be) the same thing as hiring a firm that represents the founders. Company counsel is not founder counsel.  An analogy may be helpful for explaining the difference:

Imagine a family that is going through some tough times – the spouses are in constant disagreement over issues like work-life balance and parenting responsibility, and it’s starting to impact their children. They seek the advice of a family therapist.

The family therapist does not represent one spouse or the other, nor does she represent the children. She represents the family, as an entity/unit that exists apart from the individuals that make it up. Like a family therapist whose priority is the well-being of the family above the individual members, company counsel’s responsibility is the interests of the company as a whole unit, including all of its stockholders, not just the interests of the founders, or the CEO who hired the lawyer.

At Formation

At the very early stages of a startup, this company counsel v. founder counsel distinction is often not terribly relevant, because the founders, as a fact, are the entire company; they make up the entire cap table. Though I have been in situations where disagreement among founders requires me to drive home the fact that, as company counsel, I do not represent one particular founder over another. Company counsel represents the pie as a whole, not any particular slice of it.

In a Financing

In negotiating a financing, the company v. founder counsel distinction is typically far less important than the company v. investor counsel distinction (the first point discussed above). Investors (who should hire their own lawyers) have a desire to maximize their ownership of the company and secure as much potential exit value as they can, at the expense of the ownership stake of the remaining cap table. Company counsel’s primary role in a financing is to advise the existing stockholders of the Company (particularly the common stockholders, making up founders and employees) on balancing their desire for investment with their desire to not give up significant ownership or control to outsiders.

Post-Financing and Exits

It’s after a financing that the company v. founder counsel distinction becomes very important. One of the primary fiduciary duties of a company’s Board of Directors is to maximize aggregate shareholder value (the entire pie), and Company counsel’s role, apart from day-to-day general counsel, is to advise the Board on various matters (like acquisition offers, strategic partnerships, etc.) that influence shareholder value. The reality is that advising the company/board on maximizing total shareholder value is often very much aligned with the interests of the common stockholders (including founders); more so than with investors.

Investors will have a liquidation preference that allows them to be paid something in an exit before any value goes to the common, so there are many scenarios in which they (investors) may favor an exit that the common stockholders do not support. A company counsel that is focused on advising for what maximizes exit value for all is usually indirectly working in the best interests of the common stockholders. Delaware  corporate law actually acknowledges this, by asserting that a Board’s primary fiduciary duties are to the common stockholders lacking liquidation preferences or special liquidation rights.

Nevertheless, there can be a number of situations in which company counsel’s focus on the best interests of the company and all stockholders (preferred and common) is not aligned with the personal interests of a particular founder. For example, a founder CEO may want to negotiate for an employment agreement that makes it extremely expensive, almost impossible, to fire her. While providing some protection to a CEO, so that she can focus on value creation and not her personal financial security, can be value maximizing for everyone (that’s why employment agreements are signed), there is definitely a point after which you’re giving too much to the CEO and just unjustifiably entrenching her.

In that kind of scenario, company counsel’s role is to make it clear to the founder that he’s looking out for the company, which certainly includes the founder, but also includes other stockholders. If the founder wants to negotiate heavily for an employment agreement that is biased in her favor, knowing that entrenching herself isn’t the best option for the company, she may want to hire her own lawyer (apart from company counsel). Many times in these scenarios (I’ve experienced) founders are fine not hiring their own personal lawyers, because on some level they too are interested in what’s good for the company as a whole.  There’s a certain dysfunctionality that tends to sink companies when founders have detached their personal motivations from the well-being of the company generally. But it depends heavily on the circumstances, including the composition of the cap table and the Board, the stage of the company, and the personal dynamics between the founder, investors, and even the lawyer(s).

In the same sense that we, as a firm, have a established a policy of not representing early-stage Tech VCs who invest in our clients (to preserve trust), we also avoid representing founders as their personal counsel. Apart from the fact that law firms are often overkill for that kind of personal representation (solo lawyers are usually a better fit), we prefer to make it clear to all parties that we are company counsel from Day 1.  When high-stakes situations require us to advise on what’s best for the company, we don’t want any side phone calls (from either side) asking for favors.

Quality founders who build strong companies should want company counsel who will speak with a high level of objectivity on key issues involving corporate governance, even if it’s not exactly what the founders would, personally, prefer to hear. No truly successful family has ever been built by people all fighting for their own interests at the expense of the whole. The same goes for startups and their founders.