The Race to the Bottom in Startup Law

TL;DR: There is a long-standing race to the bottom occurring in startup law, led by certain firms who’ve chosen to ignore the ethical standards of the profession in order to maximize revenue. The end-result of that race is damaged startups who are being led to believe that they’re getting “efficiency,” when what they’re really getting is biased garbage advice and a time bomb.

Background Reading:

Regulated professions are regulated for a reason. In the case of law, much like healthcare, you are dealing with significant information asymmetries on very high-stakes issues where decisions have permanent consequences; where malpractice or bad ethics can seriously and irreversibly damage a “client.” That is undeniably the case in high-growth Startup Law, where you very often have inexperienced business people (founders, early employees) navigating very complex and high-dollar issues; and to make it even harder, on the other side of those issues are often misaligned money players who are 30x as experienced at the entire game than founders/employees are.

The world of early-stage startup businesses is quite unique in this respect from the rest of the business world. In most high-dollar business contexts, there’s an equal balance of experience and influence on both sides of the table. Company A has seasoned execs, and Company B has seasoned execs. But not so in early-stage. Company X often has entrepreneurs who are doing this thing for the first time, and have very few connections to the broader business ecosystem. Investor Y, whom they are negotiating with and who influences decisions on their Board, has been in the business for 10-20+ years, has done 50-100 deals, and has spent all of that time becoming fabulously networked with other investors, accelerators, serial executives, lawyers, advisors, mentors, etc.

This imbalance presents an opportunity; an opportunity to use the experience/power inequality to push deals and high-level business decisions in the direction that the money players want, often without the inexperienced players really even understanding what is happening. Now, what is the role that lawyers (counsel) are supposed to play in this game? Lawyers serving as company counsel are supposed to take their broad level of experience and market understanding – surpassing that of most investors – and use it to “level” the playing field for the common stock (founders and early employees). Experienced, talented corporate lawyers are supposed to be the “equalizers” that early-stage companies (particularly common stockholders) rely on to ensure no one takes advantage of them on deals and corporate governance. Great for the common stock. Not so great for the clever money; which would obviously much prefer to keep the field slanted in their favor.

So let’s say I’m a very smart money player, and if I can find a way to neutralize the role of independent company counsel, to maximize my leverage, what should I do? Negotiating very aggressively against the lawyers and startups is a failed strategy. It’s too visible. Early-stage capital has become more competitive, and money players rely on personas of “friendliness” for deal flow. Angrily pounding the table would quickly shatter that persona. You need to me much smarter than that at this game.

You start with asking yourself: what do these lawyers need in order to fully do their job as strategic advisors? The answer is two-fold: (i) clients, and (ii) time. Without clients (referrals), lawyers can’t stay in business. And without time to study issues and negotiate, and ability to charge for that time, they can’t advise companies properly. That’s where the strategy lies. I often refer to this strategy as the “Race to the Bottom” in Startup Law.

Buy counsel’s favor with referrals.

As a repeat player with “access” to lots of deals and potential clients, investors can “buy” the favor of law firms by simply channeling referrals to them. First-time entrepreneurs have absolutely no counter-balancing resource in this area, because they just aren’t that well-networked or influential. Pay close attention in startup ecosystems and you’ll often realize how many of the most prominent lawyers built their practices by riding referrals from a few repeat players. Doing a great job for companies certainly can get you business, but doing a great job for investors (so that they refer companies and deals to you) can get you 20x that, because of the volume they touch.

So Step 1 of the Race to the Bottom is to make it clear to law firms that those who “behave” (by biasing the advice they give to inexperienced startups) will get business, and those who don’t won’t. The lawyers/firms most motivated by maximizing their business, and most willing to flout conflicts of interest in order to get that business, start competing at how far they can go to win the favor of these juicy referral sources, while minimizing the visibility of this game to inexperienced outsiders.

Squeeze counsel’s time.

For a company lawyer to do their job in advising a startup, they need time. Answering questions, explaining issues, and negotiating all take time, especially when the executives you’re working with are completely inexperienced (which in early-stage startups, they often are). Seasoned investors, however, don’t need nearly that much time from lawyers, because they’ve played the game 30 times already. So startups need a lot of lawyer time, but investors don’t. Opportunity? You bet.

But again we reach the “visibility” problem. If an investor simply tells the founders, “stop talking to your lawyers,” that’s too easy to read into. A far more successful narrative is: “let’s save some legal fees.”

“Your lawyer is just over-billing. Their request isn’t “standard” and is a waste of time.”

“This deal is all standard/boilerplate. Let’s move quickly to close without lawyer hand-waiving.”

“We really don’t have the budget to get lawyers involved on this Board issue.”

“I’m saving you some legal fees. Cap your legal bill at X.”

“Here, just sign this template (that I created). It’ll save you fees.”

I’ve often found it very amusing how certain aggressive investors, happy to write you large checks for funding talent wars and expensive bay area offices, suddenly have lots of (air quotes) “insights” to share when discussion turns to the legal budget. Increasing your burn rate makes you more dependent on the money, which they often like; but heaven forbid you spend capital on a service that reduces their influence/leverage. Thank goodness they’re ever so generously “looking out” for the bottom line.

If an experienced investor knows the lawyer across the table needs time to explain to inexperienced founders why the terms or decisions such investor is pushing for should be resisted, and such investor prefers that the lawyer stay quiet, the answer is not to explicitly tell the lawyer to shut up. Too visible. The investor instead gets the founders to do it themselves, by suggesting that they should focus on minimizing their legal bill. Nevermind that the issues a great (and independent) lawyer will bring up are 10-20x+ more consequential long-term than the rate the lawyer is charging. By getting founders to myopically think that legal advisory is just empty hand-waiving, and therefore be unwilling to pay for real counsel, investors are able to silence counsel by making it unprofitable for them to speak up. With no one else at the table who actually knows the game, the money then gets free rein to set the rules.

One particularly clever strategy here is worth highlighting: fixed or subscription fees. Most high-end lawyers bill by time, and for good reason. See: Startup Law Pricing: Fixed v. Hourly. The highly contextualized needs of varying businesses are simply too diverse for high-end outside corporate counsel to set broad standardized costs for legal work. High-growth businesses across diverse industries and contexts are far more diversified in their legal needs than the medical needs of patients (fixed fees in healthcare can work), and so there’s just no neat bell curve to enable a viable general flat fee system without setting serious (and dangerous) constraints on what a corporate law firm is able to do.

Investors who push company lawyers to work on fixed/subscription fees know exactly what the end-result of that fee structure’s incentives will be: staying quiet about negotiation points, rushing work, and delegating to cheaper, inexperienced people who just follow standardized checklists/scripts. Market competition sets constraints on how much law firms can charge while remaining competitive, but in an hourly rate structure a law firm still has to at least do the work to get paid. Under a flat or fixed subscription fee, the incentives are reversed. Every extra minute of advisory or customization is lost margin, so cut every corner imaginable, as long as the client can’t see it. And because in the case of early-stage startups the client is often led by an inexperienced founder with no in-house general counsel to vet work product or know what questions outside counsel should be asking, hiding all the shirking/corner-cutting from the client is quite easy.

Firms who simply don’t care about ethics and quality are happy to have you pay them for doing the absolute bare minimum of work, via a flat or subscription fee; and clever investors will happily reward their weak company-side advisory with continued referrals.

The Race to the Bottom.

So what is the predictable end-result of this race to the bottom in startup law, where massive conflicts of interest with the investor community are conveniently overlooked, and lawyers are incentivized to keep their mouths shut and rush work in a standardized assembly-line built to the specifications of unethical investors? In terms of a law firm’s operating structure, it looks like this:

A. The law firm has deep ties to, and referral dependencies with, very influential money players in the startup ecosystem, including VC funds and high-profile accelerators; rendering it completely uncredible to suggest that those investors don’t influence the firm’s advisory. A significant portion of the firm’s business comes from investor referrals, ensuring the firm follows the investors’ preferred protocols.

B. Highly experienced, true Partners and Senior Lawyers are virtually non-existent at the firm, with minimal contact with early-stage startups. It’s only lawyers with many years of specialized experience and vetting who know how to navigate significant high-stakes complexity. Juniors – like lawyers who’ve only practiced for a few years, or paralegals – are only able to safely handle legal work that fits within narrow parameters. Often referred to as “de-skilling” in professional circles, this ensures that when a startup is negotiating against a highly experienced player, the person advising the startup is minimally skilled (and cheaper to the firm). They’ll basically check boxes and fill in forms. Investors will love it. The most highly experienced and talented lawyers (Senior Partners) are the most expensive people on a law firm’s payroll. By eliminating them, a firm can improve margins under a flat or subscription fee model, while torpedoing quality and flexibility. Firms that care most about growing revenue, whatever the impact on quality/ethics, are OK with that.

C. The firm vocally touts the purportedly enormous benefits of standardization, inflexible automation technology, speed, and fixed/subscription fees. By pushing a message that founders should just focus on minimizing legal bills and fixing their costs, the firm hopes they’ll overlook the quality issues with their weak, cookie-cutter counsel. This firm is happy to pretend that it’s in startups’/founders’ best interest to just handle legal work as quickly and automatically as possible. The fixed/subscription fees ensure that the firm is rewarded for cutting corners, delegating work to inexperienced people, and just filling in templates with minimal negotiation or advisory. They’re happy to peddle the templates/form documents, and follow the protocols, that certain aggressive investors (falsely) claim are “standard,” particularly those investors whom the firm depends on for referrals.

D. The firm attracts lawyers who are less interested in actually practicing high-stakes law for the long-term, and the quality accountability that entails, and instead care more about finding future job opportunities with high-growth startups or VC funds. The fact that the firm’s incentive structure totally constrains their ability to actually practice high-level law (and properly advise clients) doesn’t bother them, as long as they get paid and have access to good networking opportunities.

I’ve seen different law firms reach different levels of this race to the bottom. Without a doubt, Silicon Valley culture, with its historical “move fast and break things” approach to raising as much money as possible as quickly as possible in hopes of being a unicorn, has reached some of the most extreme points. Entrepreneurs who fully understand the implications of this race to the bottom, and want to avoid them completely for their business, should read: Checklist for Choosing a Startup Lawyer.

To be crystal clear, I am a big believer in efficiency, and the thoughtful use of well-applied technology to stay “lean” on legal. It’s why I left BigLaw years ago to build out an unapologetically high-end boutique firm, where top-tier lawyers’ rates are hundreds of dollars an hour lower than the conventional firms they left. Their lives are also far healthier because they bill fewer hours. Legal technology is a part of our model, and we are definitely early adopters, but I’m not going to over-hype its significance. The truth is at the top tier of emerging tech/vc law, there’s too much complexity, contextual diversity, and massively high error cost for software to make a huge dent; with deep non-apologies to the software engineers hell-bent on “disrupting” lawyers with an app. We’re talking about highly complex, highly unique companies navigating serious decisions and 8-10+ figure transactions involving very sophisticated players; not a coffee shop or plumbing company.

We’ve grown profitably and sustainably every year since I got here, with 2019 being our best year yet. But I also care deeply about professional ethics, and doing the actual job that inexperienced and vulnerable clients pay me to do. That means cutting out fat from the legal industry, but not muscle. It means delivering highly experienced, specialized strategic counsel capable of flexibly addressing clients’ varying needs as they come up, while leaving out the many other layers of unproductive overhead that traditional firms are often burdened with. See: When Startup Law Firms Don’t Sell Legal Services. Top-tier law can be made leaner and more accessible, but it requires leadership/stakeholders that take professional ethics and quality standards seriously, rather than treating legal work like just another product to recklessly hack and market your way into maximal growth.

We’re in an extremely exciting time for the legal industry. While BigLaw will always serve the largest and most complex deals, I believe the future of the industry (at least the segment that serves non-billion-dollar “happily not a unicorn” clients) is a diversified ecosystem of lean, specialized firms operating far more flexibly and efficiently than traditional mega firms; enabled by technology and operating structures that cut costs without cutting corners. That is the kind of innovation clients, including startups, need and deserve. Blatant flouting of conflicts of interest, and massive dilution of the quality of legal counsel, is not innovation. It’s a race to the bottom, in which the losers (inexperienced teams) are being taken for a ride.

Why Startup Accelerators Compete with Smart Money

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

Background reading: Startup Accelerators and Ecosystem Gatekeeping

First, a few clarifications on definitions. When most people speak of “smart money” they are referring to investors who bring much more to the table, in terms of useful resources, than simply raw cash. They often bring a brand that serves as a valuable signal in the market, credible insight that they can use to help founders and Boards of Directors, and a network that they can tap into for helping companies find talent and connect with commercial partners.

Classifying some money as “smart money” doesn’t necessarily mean that any money that isn’t “smart” (in the sense I’m discussing) is “dumb.” It just means that the other money isn’t useful other than to pay for things. Truly dumb money often means investors who have no idea what they’re doing, and drive up valuations and deal terms to levels unsustainable and unjustifiable in the market. There are many funds that aren’t dumb, but they also don’t bring much more than money to the table as part of their investment, so they’re also not “smart.”

Another clarification: for purposes of this topic, I am referring to high-cost, high-touch startup accelerators; meaning the traditional kind who “charge” 6-8% of equity and put in significant resources into programming, education, nurturing their network, etc. As I’ve written before, various organic market dynamics that are eroding the value proposition of traditional accelerators (see above-linked post) have produced a new “lean” form of accelerator that has dialed back its proposition, and reduced its “price” to 1-2% of equity. That latter kind of accelerator is not part of this discussion, because they behave very differently, and interact with smart money very differently.

Ok, so now to the main point. “Smart” very early-stage money (seed and pre-seed) can be viewed as a bundle of a few things:

  • Green cash money
  • Signaling and Branding – simply by being publicly associated with them, raising follow-on money, and getting meetings with other key players, will become dramatically easier.
  • Coaching – they’ve seen lots of successful (and failed) companies, and can provide valuable coaching to entrepreneurs.
  • A network – they’ve built a rolodex/LinkedIn network of lots of talented people that they are heavily incentivized to make available to you.

Now, let’s compare that bundle to the value proposition of traditional accelerators:

  • Signaling and branding
  • Coaching
  • A network

See the overlap? Startup accelerators are basically a service provider whose core service is the above bundle. In exchange for equity and the right to a portion of your funding rounds, their “service” is that they’ll (i) apply a brand on your company that makes it (at least for the good accelerators) easier to access money, (ii) provide you some coaching and education, and (iii) share their network with you.

The core value proposition of early smart money can be effectively the same as an accelerator: a brand to leverage in networking and fundraising, coaching, and a network to navigate. Accelerators and smart early money are, therefore, substitutes; and substitutes inevitably compete with each other. Some might argue that the “programming” (the educational content) of accelerators is a key differentiator, but realistically the smartest entrepreneurs aren’t joining accelerators to get an education. They’re joining for the brand, the network, and to make it easier to find more money and talent; all of which entering the portfolio of a resource-rich and well-respected early stage investor can provide.

The earlier in a company’s life cycle that smart money is willing to go for their pipelines (and many smart funds are going very early), the more startup accelerators will find themselves competing with lots of market players offering a very similar bundle of services. Given that smart early money can challenge the value proposition of accelerators, aggressive accelerators are incentivized to, in subtle ways, push startups away from smart very early-stage money and toward dumber money, because it increases a startup’s dependency on the accelerator’s resources, and therefore helps justify the accelerator’s cost.

How does this fact – that aggressive, elite startup accelerators want to cut off smart early-stage money from competing with them – play out in the real market? Some of the ways I’ve already described in Startup Accelerators and Ecosystem Gatekeeping, but I’ll elaborate here.

Demo Day – Aggressive accelerators can push entrepreneurs to not do any fundraising other than through channels that the accelerator can control, like Demo Day, and then they can restrict access to Demo Day to investors who serve the interests of the accelerator (don’t compete with it). As I’ve written before, it is not in startups’ interest to restrict their fundraising activities solely to channels that accelerators can influence (because it allows accelerators to serve as rent-seeking gatekeepers), but that doesn’t mean aggressive accelerators don’t nudge them in that direction.

Fundraising Processes that Select Against Smart Money – One thing that’s been interesting to observe in the market is how entrepreneurs who go through certain accelerators are much more likely to emerge from them with a view that early-stage venture capital has largely been commoditized. If you think that all early money is the same, and all that matters is getting the best economic terms possible, you are going to approach fundraising in a very different way from someone who better appreciates the very subtle, human-oriented dynamics of connecting with lead investors. “Party rounds” where entrepreneurs don’t allow anyone to serve as the lead are a very visible manifestation of this.

Entrepreneurs who treat fundraising as a kind of auction process, where you want to create FOMO and aggressively get the money to compete for the best price, are often creating a fundraising system that much of the smartest money will simply opt out of. Quality smart money players are looking to build long-term relationships, and that takes time. They also know that they bring much more to the table than a random investor willing to pay a high valuation, and so the end-product of a hyper-competitive fundraising process simply isn’t worth their time. The valuation will be too high.

Aggressive accelerators know this, and it’s why they often nudge founders toward engaging in these kinds of hyper-competitive fundraising processes that push out smart money, because by removing other “smart” early market players with their own networks and brands, the accelerators enhance the relative value of their own network. The strategy is to marginalize any potential substitutes, so startups see the accelerator and its own network as the only “smart” player they need.

I’m not an investor. I’m a lawyer who represents companies, including in lots of financing rounds. Read my lips: relationships matter, and smart relationship-oriented money can really make a difference. Want to know what a possible end-result is of startups pursuing a naive, hyper-competitive, relationship ignorant fundraising strategy that treats getting a high valuation as the only goal; long-term relationships and “value add” VCs be damned? Failed unicorns (getting SoftBanked) and thousands of employees burned because people guiding the company in the earliest days were just lottery-ticket chasers instead of smart players who know how to build viable businesses. Treat investors like it’s all just about numbers, and you’ll inevitably surround yourself with people for whom you are just a number.

As I’ve written many times before, it’s extremely important that new entrepreneurs entering startup ecosystems understand the power dynamics operating in the background. See Relationships and Power in Startup Ecosystems. Different market actors compete for access and control over pipelines of entrepreneurs; and they “trade” access to deals with people who serve their interests. Startups are much better served when they are in the driver’s seat for what relationships they build in the market, as opposed to allowing repeat players to trade access to them as currency.

The smartest investors in the market have realized that outsourcing their business development to a handful of “sorters” (accelerators) is a losing strategy, because those sorters have their own agendas. Scout programs, pre-seed funding, exclusive “meet and greet” events, open “application” processes for intro meetings, and many other activities are ways in which smart money is moving earlier in the startup life cycle, to find early startups that they can “accelerate” themselves. That can be useful to founders, saving them both time and equity.

All of these ecosystem players are here, in one way or another, to make money; endless PR about friendliness, values, empathy, and saving the whales notwithstanding. Frankly, so are you, and so am I. The more they can cut off competition, the more money they can extract from the market that would otherwise go to entrepreneurs and their employees. That means the most logical strategy is: become beholden to no one. Nothing better ensures good behavior by your business relationships than a little optionality. That does not mean treating everyone as a means to an end. To the contrary, it means slowing down and building a diverse set of long-term and durable relationships that you can leverage toward your company’s goals. The emphasis, however, is on the diversity of your relationships, so no particular group has more leverage than is justified. Diversify your network.

Let everyone offer their service, but don’t naively become over-dependent on any single channel. If you have access to smart early money, take it, nurture that relationship, and respect the fact that smart money deserves a better price. Just don’t agree to any terms that cut you off from raising from alternative money later if it makes sense. Independent counsel will help ensure that. If you’re in an elite accelerator, fantastic. Use them. But don’t let them push you into myopic fundraising approaches that just increase their control over the market. Keep connecting with smart money, and diversify your network.

Startups thrive best in actual ecosystems, where market players aren’t able to gain so much control that they start to “charge” more than their real value proposition justifies. Let the smart money and accelerators compete, and build your long-term relationships accordingly.

 

Startup Accelerators and Ecosystem Gatekeeping

TL;DR: Startup accelerators face a fundamental challenge to their value proposition: they don’t “own” their networks, and therefore struggle to continue extracting fees for accessing them. Classic disintermediation. Their responses to that challenge take a number of forms, and generally involve either dropping their price or attempts at controlling ecosystem players; the latter of which is misaligned with the interests of entrepreneurs and startups.

Related reading:

As I’ve written before in the above posts, Startup Accelerators became “a thing” in ecosystems because they were a reasonably optimal method for solving the “noise” problem faced both by startups and investors; a problem which became more visible as the cost of starting a company went down. With far more people “starting up,” early-stage investors needed someone to help them filter out duds. The solution, referred generally as “sorting,” is similar to the value prop offered by elite universities to employers needing talented labor, and students needing credible ways to signal their talent.

By creating credible brands (signals) for quality entrepreneurs, accelerators reduced the search costs for early-stage investors who, instead of needing to filter through lots of duds themselves, had a concentrated place to build their pipeline. That value proposition attracted investors, advisors, great employee hires, etc., and over time successful “alumni,” which magnifies the value proposition to entrepreneurs who, in exchange for equity, got a fast-track to building their network and raising capital.

For some time, you had a virtuous cycle with clear “network effects.” Attract great entrepreneurs, which then attracts investors and other key people, which then attracts more great entrepreneurs, and so on and so forth; just like a classic network effect for a software platform. During this period, accelerators can build significant leverage over their ecosystems as gatekeepers to talented entrepreneurs, and use that leverage to push the market in directions the accelerator wants.

The “Network” Can’t Be Controlled

But accelerators face a distinct problem that doesn’t get talked about a lot publicly, but local market players absolutely know is there: they can’t lock in (air quotes) “their” network. It’s not proprietary. The “networks” of startup accelerators are really just compilations of individual peoples’ networks; not at all like a “network” of a tech platform for which the tech “owner” can sustainably charge access fees. Those people in the accelerator’s “network” aren’t employees of the accelerator, nor are they paid out of its returns, and so they aren’t aligned in propping up the network’s “access fee.” Inevitably, people find it worth their while to simply bypass the accelerator and makes themselves accessible to founders directly, after having built their own personal brands with a few iterations with the accelerators’ initial cohorts. If a team needs X, Y, and Z, and I know X, Y, and Z and can help them get access with my own branding/signal, why should they have to pay this 3rd-party a fee to access those people?

So after a few years of an accelerator having filtered and aggregated a network, helping great people find great founders, and great founders find great people, the network takes on a life of its own. Suddenly with a little hustle and networking, it’s not nearly as hard as it was 5 years ago to simply navigate the “network” without ever needing to pay the gatekeeper. I’ve seen this play out in a number of startup ecosystems across the country, where accelerators faced an initial golden age when they were seen as prime “sorters” of an opaque ecosystem willing to pay for the sorting, and then suddenly the quality of entrepreneurs they can get to pay their “fee” starts to take a clear downward turn. Top entrepreneurs are, by definition, fantastic hustlers. They aren’t going to pay you for something once they’ve realized they can do it themselves with a little effort, or that someone else is offering similar “access” at a lower “fee.”

Once top entrepreneurs realize that they can bypass the accelerator and access its “network” directly, and word gets around, the value proposition of the accelerator can begin to unwind. Suddenly the accelerator cohorts start to fill not with the most highly skilled entrepreneurs (those hustle it out on their own now), but with lower quality entrepreneurs less capable of making things happen “in the wild” and therefore more needy of the accelerator’s high-touch, high-priced assistance. As the quality of the accelerator’s average entrepreneur goes down, the leverage over key people on the other side of the “market” – investors, advisors, etc. – goes down, and fewer of them show up to the accelerator; which then reduces the value prop for entrepreneurs, and you get the exact reverse of the original virtuous cycle.

Seeing this dynamic play out, accelerators have three ways of responding, and I’ve seen them in different markets.

Drop the Price

The first is to simply acknowledge that the accelerator cannot maintain the original value proposition they had before the ecosystem/network had matured, and drop their price accordingly. With less significant of a signal, and less leverage over the market, the high 6-8% fee can’t be sustained, so build something leaner that can be offered at a 1-2% level perhaps. I’ve seen these “leaner” accelerators enjoy some success. Some accelerators started out with the expectation that they were going to dominate a startup ecosystem with high “access” fees, and then over time got humbled when the market delivered a reality check.

Employ the Network

Another option is to convert the accelerator into a kind of “startup studio,” where the main pieces of the network are actually employees paid by the accelerator, or at least with deeper economic ties to the accelerators’ performance; reducing their incentive to leak out of the network. The key challenge here is whether the accelerator really has the cachet/leverage, and resources, to employ those people; or whether A-players find it far better to simply stay outside and keep their pipelines more open.

Another way to “employ” certain network players doesn’t require actually employing them, but simply maintaining some economic control over them. For example, a prominent accelerator might use referral relationships with certain law firms as a way to keep those firms from questioning the accelerators’ behavior, even if it’s clearly at times not in the best interest of the startups the firms represent. That strategy is straight out of the playbook of VCs. See: When VCs “own” your startup’s lawyers and Relationships and Power in Startup Ecosystems. Offering or restricting “access” to potential investments, clients, employers, etc. has always been a currency used by startup power players to keep other market participants loyal and “well-behaved.”

Try to Lock Down the Network

This is where things start to get interesting. So I’m an accelerator enjoying success, but I can clearly see that over time my ability to keep extracting gatekeeping fees over my “network” is weakened by my inability to maintain control over the investors, founders, advisors, etc. within it. Possible solutions:

  • Lock Down Demo Day – Maintain tighter control over who gets access to demo day and, importantly, “discourage” founders from raising financing outside of demo day.
  • Lock Down Financing Structures – Maintain tighter control over how financings within the network occur, by “soft mandating” that they follow templates created and controlled by the accelerator.
  • Lock Down Network Communication with Technology – Create proprietary message boards, mail lists, and other media platforms for communicating within and navigating the network, to “incentivize” networking in ways that give the accelerator visibility and control.

Of course, none of this will ever be communicated openly as mechanisms for the accelerator to maintain power over an ecosystem/network, including founders. They’ll be spun as ways to provide efficiency and value for founders and other people. But as with much spin, there is a point at which it fails to pass the laugh test.

Listen in the market (what gets said privately rarely mirrors what is said publicly), and it becomes clear that the more aggressive accelerators have for some time been building local resistance; irritating investors who resent having a “big brother” dictating how to do biz dev and deals, irritating founders who don’t want to pay a gatekeeping fee for accessing specific ecosystem resources, and irritating other market players who don’t want a rent-seeker standing in-between them and potential business.

When an accelerator “discourages” a startup team from fundraising outside of demo day, it’s going to offer some paternalistic platitude about how having a controlled process helps “protect” the entrepreneurs, but what it’s really about is ensuring the accelerator has (i) leverage over the investor community via ability to deny and control access to its founders, and (ii) leverage over founders by controlling the venue in which they fundraise; which sustains the power of the accelerator to charge high gatekeeping fees.

Once I’ve publicly announced my cohort, the sorting is done and the signal is out. Investors don’t need me (the accelerator) anymore, and in many cases nor do the founders whose main purpose of joining the accelerator was to get “branded” to make getting meetings with investors easier. That threatens the power of the accelerator, which wants to charge not just for sorting/signaling, but for access to a network. “Locking down” outside fundraising, with some clever spin as to why it’s good for startups, is the response.

If an accelerator builds proprietary communication channels for alumni to utilize, maybe that’s to be helpful. Or maybe it’s a way of preventing the network from doing exactly what networks do organically, which is resist gatekeeping and build multiple nodes/channels to prevent a single point of entry through which a rent-seeker can extract access fees. Accelerator’s don’t hold monopolies on brands/signals that startups can leverage to get funding, and therefore other people (like angels, seed funds, and respected founders) within a “network” who can connect founders to money/other resources (offer cheaper “signaling”) are, in a sense, competitors whom the accelerator has a strong incentive to control. Maintaining control / visibility over communication channels is a way for accelerators to prevent leaner competition.

Accelerators are Service Providers, Like Everyone Else

The general conclusion from all of the above should not be that startup accelerators are bad or good; on an individual level many are of course full of great people. Instead, it should be that accelerators are profit-driven service providers and political actors, just like everyone else. They want to charge a higher price, and will do what they can to maintain their power to charge that higher price. Other market players will attempt to build alternatives, and drop that price, and the accelerators will respond by trying to compete with, block, or control those other market players. It’s just like VC, Law, and any other industry that caters to startups.

When transparent meritocracy and markets start to challenge a player’s ability to charge high fees, they often turn to politics; using backdoor relationships to build loyalties and amplify supportive messaging. Accelerators who maintain tight referral and economic relationships with specific funds, firms, and other market players do so in order to ensure there’s a loyal base of people out there toeing the party line, even as opposing voices in the ecosystem start to emerge.

For entrepreneurs, the message is simply to understand where their interests are aligned, and where they’re misaligned, with the interests of accelerators. Branding and signaling are useful. To the extent they are useful to you, use them, at the appropriate price. But by no means allow them to dictate how or when to fundraise, or how to navigate the network. It’s in startups’ interest (and that of ecosystems generally) to stay flexible and keep their options open, even if accelerators would prefer having a tight grip. The golden era of accelerators is almost certainly over, as startup ecosystems and networks have begun to mature, offering multiple accessible paths to networking and investment. But they will still have a place and function for a pocket of the ecosystem that needs them.

To the extent accelerators use politics and leverage to lock down ecosystem resources that founders could otherwise access on their own just fine, or demand that startups and investors do things in a specific way favored by the accelerator, they are no longer transparent market players; they’re rent-seeking gatekeepers. If there’s anyone that startup entrepreneurs love painting a bullseye on, it’s gatekeepers.

After-note: see Why Startup Accelerators Compete with Smart Money for some observations on how early-stage VCs are eroding the value proposition of accelerators further by bundling new roles/services alongside their investments, and moving up-stream.

Startup Cap Tables

TL;DR: Just use Carta, and spend your time on more important questions. Before your seed round closes, Excel is usually OK too.

Years ago we were one of the first early-adopter firms to promote what was then-called eShares, and now Carta, as an option for reducing costs on 409A valuations and also getting scaled cap tables in order. See: 409A as a Service: Cash Cows Get Slaughtered (from early 2014). Today, Carta is a much bigger company, with far more adoption across the country and world. Brief humblebrag about my track record at early-picking legal(ish) tech winners. Doxly also just got acquired by Litera.

Over time, I’ve seen cap software competitors come and go. Sometimes it’s fun listening to the arguments they make for why you should use their whiz-bang-pow tool over something that’s easily becoming a market standard.  Let’s keep this simple: there are very few pieces of technology that lend themselves to fundamental network effects like cap table software. Cap tables are math. Math, unlike subjective and contextual human-oriented things, scales very well with technology and automation. You want the cap table tool that is most recognizable, and most widely adopted, because every single person on your cap table is going to have to interact with it. That’s A LOT of people who might bug you because some random feature isn’t working, or they simply don’t understand the interface.

Less-known options, no matter how incrementally better they may be at this or that little nuance, are just full of enormous headaches. There are a few candidates, most of them concentrated in Silicon Valley, that have tried to use their connections to some well-known accelerator or law firm to corner a distribution channel, but tech nepotism (which seems to be surprisingly common in Silicon Valley and other tech ecosystems) is a poor substitute for facts. When clients ask us what cap table software they should use, we say Carta, and move on. It’s a tool for tracking routine math at scale; not a financing or M&A deal contract with tons of variables to consider. Not that complicated of a decision, and if founders start to make it complicated, that’s often a red flag.

Start with random B-player cap table tool just because your accelerator’s leadership knows a guy who knows a guy (they’re usually guys) at another cap software company, and there’s a 99% chance someone will eventually make you switch to Carta; which will cost you money and waste time relative to having just made the right decision from the start. Buying the nonsense advice of people who in the background are just referring startups to each other in a self-interested tech bro circle often gets founders into huge problems.

All that being said, I’m not going to lose an opportunity to share some love for our tried-and-true old friend, Excel. Yes, it’s old and isn’t in the cloud, and it doesn’t give you that slick “cutting edge” feel that techies love so much, but where Excel has won, and will continue to win, is its simplicity of use and flexibility when the number of parties involved is fairly small; or when you’ve got some really nuanced situation that requires maximal flexibility to model future scenarios and a universal template isn’t going to work fast enough. There is always a fundamental tension between automation and flexibility, and sometimes flexibility really matters; particularly on high-stakes legal issues.

While Carta has started offering their new pre-seed free tool (in Beta) through law firms (of which we are one) – which I know is in response to other bottom-feeder tools offering free versions – Excel isn’t going anywhere. We will continue to use it for pre-seed companies who don’t need outside valuations, and really just have a handful of people for whom a basic excel model is perfectly fine. Excel goes off the rails at scale. At very early-stage, it works, and keeps things super simple. I don’t expect Carta to fully agree with me here, and the incentives there make that disagreement perfectly reasonable. As a power user unencumbered by economic loyalties, I can talk freely about when tools are useful, and when they’re not.

But once you’re closing a seed round and/or need a valuation, and it’s definitively time to get off the Excel train, Carta is the only realistic option for anyone who knows what they’re talking about; and how the dynamics of cap table software require there to be one dominant player.

This is not a sponsored post or paid advertisement for anything. Don’t hate me if I just disappointed your friends offering that random cap table tool you’ve been shilling for. This market has been won.

Trust, “Friendliness,” and Zero-Sum Startup Games

Background reading: Relationships and Power in Startup Ecosystems

TL;DR: In many areas of business (and in broader society) rhetoric around “positive sum” thinking and “friendliness” is used to disarm the inexperienced, so that seasoned players can then take advantage. Startups shouldn’t drink too much of the kool-aid. Smile, but CYA.

An underlying theme of much of my writing on SHL is that first-time founders and employees of startups, being completely new to the highly complex “game” of building high-growth companies and raising funding, are heavily exposed to manipulation by sophisticated repeat players who’ve been playing the same game for years or even decades. There are many important tactical topics in that game – around funding, recruiting, sales, exits – all of which merit different conversations, but the point of this post is really a more “meta” issue. I’m going to talk about the perspective that should be brought to the table in navigating this environment.

A concept you often hear in startup ecosystems is the distinction between zero-sum and positive-sum games. The former are where there’s a fixed/scarce resource (like $), and so people behave more competitively/aggressively to get a larger share, and there’s less cooperation between players. In positive-sum games, the thinking goes, acting competitively is destructive and everyone wins by being more cooperative and sharing the larger pie. Sports are the quintessential zero-sum game. Someone wins, and someone loses. Capitalism is, broadly, a positive-sum game because in a business deal, both sides generally make more money than if the deal had never happened.

The reality – and its a reality that clever players try to obscure from the naive – is that business relationships (including startup ecosystems) are full of both positive and zero-sum games, many of which are unavoidably linked. It is, therefore, a false dichotomy. In many cases, there are zero-sum games within positive sum games. In fact, rhetoric about “positive-sum” thinking, friendliness, trust, and “win-win” is a common tactic used by powerful players to keep their status from being threatened.

For a better understanding of how this plays out in broader society (not startup ecosystems), I’d recommend reading “Winners Take All: The Elite Charade of Changing the World” by Anand Giridharadas, who deep-dives into how, in many cases, very wealthy and powerful people (i) on the one hand, fund politicians/legislation that cut taxes and funding for democratically solving social problems while (ii) simultaneously, spending a smaller portion of the saved money on “philanthropic” or “social enterprise” initiatives aimed at addressing those same social problems, but in a privatized way where they are in more control. The latter of course comes with a hefty share of feel-good messaging about “giving back” and helping people.

The net outcome is that those powerful players direct discussion away from the full spectrum of solutions that may require addressing some unavoidable zero-sum realities, and instead get society to myopically focus on a narrower segment of purportedly “win-win” options that don’t actually threaten the power and status of the elite priesthood. There is much room to debate the degree to which Giridharadas’ perspective is an accurate representation of American philanthropy/social enterprise, but anyone with an ounce of honesty will acknowledge that it is definitely there, and large.

Once you’ve successfully won enough zero-sum games (acquiring wealth and influence), it can be in your self-interest to cleverly get everyone around you to now only think about “positive sum” perspectives, because by staying on only those topics, you’re guaranteed to never lose your status as a power player. Warm-and-fuzzy rhetoric and “friendliness” are often not a reflection of some newly discovered moral high-ground among the dominant wealthy, but instead a self-interested strategy for wealth and power preservation.

While the details are clearly different, this dynamic plays out all over startup ecosystems. They are full of influential market actors (accelerators, investors, executives) acting as agents for profit/returns driven principals, and in many cases legally obligated to maximize returns, and yet listen to much of the language they use on blogs, social media, events, etc. and an outsider might think they were all employees of UNICEF. This is especially the case in Silicon Valley, which seems to have gone all “namaste” over the past few years; with SV’s investor microphones full of messages about mindfulness, empathy, “positive sum” thinking, and whatever other type of virtue signaling is in vogue.  Come take our money, or join our accelerator, or both. We’re such nice people, you can just let your guard down as we hold hands and build wealth together.

Scratch the surface of the “kumbaya” narratives, and what becomes clear is that visible “friendliness” has become part of these startup players’ profit-driven marketing strategies. With enough competition, market actors look for ways of differentiating themselves, and “friendliness” (or at least the appearance of it) becomes one variable among many to offer some differentiation; but it doesn’t change any of the fundamentals of the relationship. Just like how “win-win” private social enterprise initiatives can be a clever strategy of the wealthy to distract society away from public initiatives that actually threaten oligarchic power, excessive “friendliness” is often used by startup money players to disarm and manipulate inexperienced companies into taking actions that are sub-optimal, because they lack the perspective and experience to understand the game in full context.

With enough inequality of experience and influence between players (which is absolutely the case between “one shot” entrepreneurs and sophisticated repeat player investors) you can play all kinds of hidden and obscure zero-sum games in the background and – as long you do a good enough job of ensuring no one calls them out in the open – still maintain a public facade of friendliness and selflessness. 

As startup lawyers, the way that we see this game played out is often in the selection of legal counsel and negotiation of financings/corporate governance. In most business contexts, there’s a clear, unambiguous understanding that the relationship between companies and their investors – and between “one shot” common stockholders v. repeat player investors – has numerous areas of unavoidable misalignment and zero-sum dynamics. Every cap table adds up to 100%. Kind of hard to avoid “zero sum” dynamics there. As acknowledgement of all this misalignment, working with counsel (and other advisors) who are experienced but independent from the money is seen, by seasoned players, as a no-brainer.

But then the cotton candy “kumbaya” crowd of the startup world shows up. We’re all “aligned” here. Let’s just use this (air quotes) “standard” document (nevermind that I or another investor created it) and close quickly without negotiation, to “save money.” Go ahead and hire this executive that I (the VC) have known for 10 years, instead of following an objective recruiting process, because we all “trust” each other here. Go ahead and hire this law firm (that also works for us on 10x more deals) because they “know us” well and will help you (again) “save money.” Conflicts of interest? Come on. We’re all “friendly” here. Mindfulness, empathy, something something “positive sum” and save the whales, remember?

Call out the problems in this perspective, even as diplomatically as remotely possible, and some will accuse you of being overly “adversarial.” That’s the same zero-sum v. positive-sum false dichotomy rearing its head in the startup game. Are “adversarial” and “namaste” the only two options here? Of course not. You can be friendly without being a naive “sucker.” Countless successful business people know how to combine a cooperative positive-sum perspective generally with a smart skepticism that ensures they won’t be taken advantage of. That’s the mindset entrepreneurs should adopt in navigating startup ecosystems.

I’ve found myself in numerous discussions with startup ecosystem players where I’m forced to address this false dichotomy head on and, at times, bluntly. I’m known as a pretty friendly, relationship driven guy. But I will be the last person at the table, and on the planet, to accept some “mickey mouse club” bullshit suggesting that startups, accelerators, investors, etc. are all just going to hold hands and sing kumbaya as they build shareholder value together in a positive-sum nirvana. Please. Let’s talk about our business relationships like straight-shooting adults; and not mislead new entrepreneurs and employees with nonsensical platitudes that obscure how the game is really played.

Some of the most aggressive (money driven) startup players are the most aggressive in marketing themselves as “friendly” people. But experienced and honest observers can watch their moves and see what’s really happening. Relationships in startup ecosystems have numerous high-stakes zero-sum games intertwined with positive-sum ones; and the former make caution and trustworthy advisors a necessity. Yes, the broader relationship is win-win. You hand me money or advice/connections, and I hopefully use it to make more money, and we all “win” in the long run. But that doesn’t, in the slightest, mean that within the course of that relationship there aren’t countless areas of financial and power-driven misalignment; and therefore opportunities for seasoned players to take advantage of inexperienced ones, if they’re not well advised.

Be friendly, when it’s reciprocated. Build transparent relationships. There’s no need to be an asshole. Startups are definitely a long-term game where politeness and optimism are assets; and it’s not at all a bad thing that the money has started using “niceness” in order to make more money. But don’t drink anyone’s kool-aid suggesting that everything is smiles and rainbows, so just “trust” them to make high-stakes decisions for you, without independent oversight. Those players are the most dangerous of all.