Let's start off with a short story before we get into the meaty part of the post:
Once upon a time, in a tech valley far, far away, a company was on it's way to success. Sales were growing quarter-over-quarter, the engineering department was meeting every deadline and investors were throwing money to help the company grow.
Then all of a sudden, the good times started to become a little sour. Sales numbers were missed, projects were delayed and employees were quitting. Just when the company thought it hit bottom, one of the co-founders got into an argument with the other co-founder and she bailed - leaving the company, it's debt and problems for the remaining founder to handle, but taking the 100% vested shares with her.
Things got worse, the board of directors wanted complete control to salvage their investment, and before the remaining founder knew it, he was being sent to the unemployment line - palm planted directly in his face. You could hear him crying out, "What the heck happened?" in the distance.
And end scene...
A story like this likely happened a long time ago, and it probably had nothing to do with tech. It could have involved a land agreement between cavemen. Whatever the catalyst was that set the requirement of agreement documents, it instigated the the need for lawyers to be involved in every business deal or financing. To the business owner's dismay, an additional line-item of cost, in this case, lawyer fees, was required. If everybody was honest and fair, then agreements would never have to be used, but unfortunately this is not the case.
If you haven't involved a lawyer in your business yet, then you're lucky. However, if you're on your way to success and you see a requirement that involves the formation of your company, stock, taking on investments or even hiring an employee, you'll probably call a lawyer to hold your hand through the process.
As a startup, the last thing you want to do is to have lawyers eat up all of your bootstrapped cash or initial seed money. Here are a few tips, based on lessons learned that can hopefully save you thousands of dollars:
- Get two books: Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist and The Entrepreneur's Guide to Business Law. Read them and then read them again. The books will set you back about $100, but it's money well spent. It will teach you about forming your company, what's involved in a term sheet and it even helps you with the negotiations with your investors.
- Whether you're dealing with an investor, a co-founder or a partnership agreement, do as much negotiation away from the lawyers as possible. Keep in mind that you'll be spending anywhere from $200 to $700+ per hour with a lawyer, so every email, phone call and office visit will be tracked should you use them. You'd be surprised that a simple task such as a photocopy of a document can set you back 30 minutes or more. If you're working with an angel investor, then sit down with them and hammer out the terms of the agreement. Y Combinator has done a great job of open-sourcing their Equity Financing Documents (we hope to open-source ours soon too), so take advantage of them and go line-by-line with your investor. I'm sure they'll appreciate your honesty and the fact that you're not wasting money on non-product-related things. If the investor refuses to sit down with you, then maybe that's a signal on how your relationship will be with them. Once you have your documents set, then have your lawyer do a quick review of the docs - it should be no more than 1 hour of billed time for this.
- Oh you have a deferred payment with your lawyer, so it's not a problem? Kudos to you for negotiating a deferred payment plan. You should be able get about $20,000 in deferred fees from the bigger law firms in the Silicon Valley before they bill you. Keep in mind that you're just running on credit. So add that on top of your already accumulated Capital One credit card debt, and you're in a bigger hole that you started with. Remember that between minute 0 and the time you reach that payment cliff, they're tracking each minute. Just as your last pennies are evaporating, you'll see a big envelope in the mail with a five-figure bill enclosed. (This tip isn't necessarily saving you money, but it'll be good for your cash flow.)
- Don't waste knowledge or documents. Whenever you're with your lawyer, take careful notes so that you don't have to ask them twice. Also, if you're having your lawyer draft up the financing documents, then have them done so that you can reuse them with other investors. You'll probably be taking a lot of friends and family money at the beginning, so don't expect them to have their own legal counsel. In the early stage, you'll probably use a lot of convertible debt documents. They're pretty simple, and there shouldn't be much back and forth. Once you get into the seed stage where you're lining up your investors and it involves equity financing, then come prepared with a uniform set of documents. If you get a commitment from an investor, then it looks really impressive if you can get the documents together as soon as possible. Additionally, it reduces the risk involved in case they decide to use the cash on another Ferrari or house in hills. (This statement is assuming that your investor doesn't have their own set of docs that they want to use).
- Choose your battles. Like any relationship, it's give and take. If you're a young company with first-time entrepreneurs, that have a small customer base and little to no revenue then I hate say it, but you have almost zero leverage against your investor. Definitely take what's given to you, and be picky when necessary but don't sweat the small stuff. (Do sweat situations where control of the company (i.e. board seats) come into play). Whether it's your co-founder or an investor, don't get greedy with them. For every battle that has to go between lawyers, you're racking up hourly charges, so think twice before you red-line that agreement. I'd rather have a small stake in something big then 100% of something that's going nowhere.
You can follow Allan on Twitter @allanscu.
Image of The Simpsons' Lionel Hutz from the Wikipedia.