

VCs & Tech Lawyers: Innovate, Automate, Simplify - shedd
http://500hats.typepad.com/500blogs/2007/09/vcs-tech-lawyer.html

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grellas
Funding deals are only as complex and formal as the parties choose to make
them.

The world of VC fundings, for example, is almost surreal in its complexity and
formality. A typical deal starts with a term sheet from the VC's lawyers that
tells the company it will have to slog through the standard range of
(typically) preferred stock issues and will need, by the way, to reimburse the
VC for its lawyer fees along the way (a typical price tag: $25K to $35K). This
is then followed by "definitive documentation" that is fairly stacked against
the company and from which the company needs to have its own lawyers work
backwards to bring it to a more balanced state. This in turn causes the
company to incur its own set of lawyer fees, often amounting to something akin
to the amount it is reimbursing to the VCs. The net result: a small startup
raises a few million dollars and spends $60K or $70K in processing costs for
the privilege of having it properly documented. Of course, this is for a
standard Series A-style funding. It only gets worse in later rounds, where
potentially intricate rights may need to be adjusted among different classes
of preferred shares or where downrounds may be involved or where internecine
fights among disparate company factions may color large aspects of the terms
finally negotiated. In such cases, when it comes to complexity and cost, we
arrive at a stage that might even be called byzantine.

Now that is the working model that is so often criticized and about which so
many ask, "Isn't there a better way?"

The answer is yes and no.

With VC deals proper, simplicity will never become the norm because the
investor goals will always be animated by a strong desire to impose control
and formality upon the target startup. There is a reason why all those
seemingly oppressive terms are in the deal in the first place. And such terms
do require elaborate documentation and lots of back and forth to sort through.

Given that simplicity in deal terms is not really achievable in this sort of
deal, the answer often sought at this level is to push for the widespread use
of "standard" documentation in hopes of streamlining these deals and limiting
their costs. The model legal documents of the National Venture Capital
Association represent this sort of effort. These are well-drafted documents
that are highly useful in their own way.

Model forms, however, only go so far. In the working model described above,
after all, the VC lawyers _begin_ every such deal with the equivalent of model
forms used by the particular law firm and those deals go down a path where
they invariably generate much process and attendant large fees. Anyone who has
been around awhile in such situations knows that a lot is gained by having
skillfully drafted paperwork with which to begin a deal. But this does not in
itself lessen the costs in any material way. Such model forms are in effect
already part of the standard process, then, and it is no answer to the issues
of complexity and cost to say that adopting such forms in some super-
standardized way and putting them in some central online location will
materially reduce costs by standardizing the deals. All this is another way of
saying that high levels of complexity, and costs, are an _inherent_ part of
such deals.

Of course, it is theoretically possible to simply have companies sign
"standard" paperwork prepared by the VC groups in its unaltered form and this
might give us a sort of LegalZoom for funding documentation. But to view this
sort of deal in this fashion is to ignore reality. When presented with such
paperwork, companies do need to negotiate to bring balance to the
documentation and, if they don't, they will find themselves often signing on
to highly unfavorable terms.

As with every deal, there is really no such thing as "standard" paperwork
unless one wants to accept potentially loaded terms.

In my judgment, when it comes to VC deals, some improvements can be made in
terms of process but inherent complexity will always remain. There is too much
money at stake, and too many varied interests, for the parties simply to sit
down and sign without slogging though a whole variety of issues, many of them
inherently complex. Yes, by all means, use graphs when it will help explain
things. Use standard forms to start the process. Make them widely available
for all parties to use. Put them online so people can log in to see and
manipulate them in one location. Yes, do all this and more, and in the end you
will still wind up with a complex process that cannot be automated beyond the
superficial process level.

When one gets beyond the VC deal, and turns to angel-style funding, then the
potential to simplify funding documents (and the funding process) is very
real. It is possible to do a simple funding round for up to $1M or so with
processing costs that do not exceed $5K or so. Series A or Series AA fundings
can be documented with pretty vanilla terms (standard 1x liquidation
preference, balanced anti-dilution protection, a few basic protective
provisions, some investor participation in management such as one Board seat).
The key to such simplified terms is having "friendly" investors who are
content to accept basic protections but who also do not want to push for
control.

Of course, only early-stage deals will fit this category but that is my point:
the complexity of a deal is directly tied to what the parties are trying to
accomplish - if you have simple, friendly terms, you can have simple, friendly
process and paperwork and, if you don't, you can't. None of this will change
by calls to "automate" or to "get with it" concerning modern technology. It is
not a technology issue. It is a people issue. If there is a will toward
simplicity by friendly parties, there is a way. If there is an inherent
adversity, and a lot of money involved, simplicity will only exist in
idealized discussions having little to do with real-world deals.

------
skmurphy
I think McClure is pointing out an opportunity for law firms that exists for
both startup and established customers. One of the major barriers to lower the
friction in the process is defining the value based on billable hours. What
you really want from your attorney is a risk assessment and recommendations.
The value of which is proportional to the size of the opportunity you are
contemplating and the likely effect of the risk mitigation strategies offered.
You have to change the business model to effect a transition to some of the
technologies that McClure is talking about.

Some suggestions:

o Subscription models for legal services and cloud storage of all of the
relevant documents might convert much of the due diligence process into a
"configuration management" problem where you are always ready for a
transaction because you maintain your relevant agreements and contracts in a
known (and hopefully good) state to minimize the need for a fire drill before
a transaction.

o Subscription models for advisory services would encourage attorneys to use
more secure IM, document generators, cloud storage...We need to move beyond a
billable hour model.

o for public agreements like privacy policies and terms of services there is
an opportunity for a subscription service to monitor changes in posted
policies, and perhaps for an additional fee provide customized interpretation
of the significance. I had suggested this to the Legal River folks for their
<http://privacy-policy-generator.legalriver.com/> and <http://terms-of-
service-generator.legalriver.com/> that it might be as useful to classify the
existing agreements already posted on the net. This would extend what EFF is
doing with <http://www.tosback.org/> (in itself a valuable service).

There is an event coming up Wed-Mar-3 at Churchill Club on "Innovation &
Change, a "New Normal" for the Legal Industry?" (see
<http://www.churchillclub.org/eventDetail.jsp?EVT_ID=853> ) that explores what
Cisco has done to leverage current technology and new business models in
managing legal work (internal and outsourced). Hopefully some of these
techniques trickle down to the startup world as they gain more acceptance in
Fortune 500 / AmLaw 100 relationships.

George Grellas makes some excellent points in
<http://news.ycombinator.com/item?id=1090615> that the more adversarial the
negotiation the less impact technology can have on cutting costs.

------
tom_pinckney
someone needs to build a web app that asks a few basic questions, gives you
some check boxes to click and then generates all the standard PDFs you need
for seed funding, employee agreements, etc.

~~~
sachinag
You probably don't want it totally turnkey - I mean, you can - LegalZoom is
the most well-known, but Wilson will incorporate you and give you the whole
kit and caboodle for just $5k. Plus, if they like you, they'll make intros to
angels and VCs for you when you're ready.

That said, there are some reputable forms and sample documents; here are some:

Wilson's Term Sheet Generator:
[http://www.wsgr.com/WSGR/Display.aspx?SectionName=practice/t...](http://www.wsgr.com/WSGR/Display.aspx?SectionName=practice/termsheet.htm)

YC's Series AA documents (also by Wilson):
<http://ycombinator.com/seriesaa.html>

Yokum's walkthrough of the Series AA docs (he's the Wilson partner
responsible): [http://www.startupcompanylawyer.com/2008/08/23/how-do-the-
sa...](http://www.startupcompanylawyer.com/2008/08/23/how-do-the-sample-y-
combinator-series-aa-financing-documents-differ-from-typical-series-a-
financing-documents-or-whats-the-difference-between-seed-and-venture-
financing-terms/)

The incorporation docs for Founders Fund companies were once available on
TheFunded.com, but I can't seem to find them in my thirty seconds of poking
around.

~~~
tom_pinckney
I guess I just object to paying Wilson $5k to run search-and-replace for me.
And I certainly wouldn't trust LegalZoom to actually have documents written by
people who understand startups.

And the other sources don't seem to provide offer letters, NDA/invention
rights docs, board motions, option grants and all the other boiler plate stuff
that's needed.

That all said, I suppose making it too turn-key risks entrepreneurs not really
understanding the legal issues involved and getting nasty surprises later on.

~~~
sachinag
I'm pretty sure Wilson's $5K includes all those other docs you list. At least
that was my understanding when I spoke to Yokum a while ago.

I did request that Wilson make a full list of what you get as part of an
incorporation "package" and post the list and plain vanilla price publicly on
their site. The non-transparency of legal fees is only matched by the non-
transparency of health care prices.

------
aditya
Note: 2007 - not much has happened in 3 years, has it...

