Using your lawyer as a hammer
When your startup is raising venture capital or an angel financing round you will have plenty of tough points that need to be negotiated. Some of these are easy for a founder to understand, such as valuation or number of board seats. Other points will represent more of a challenge and startup CEO will be at a significant disadvantage vs. and experienced investor – even if the startup CEO has raised capital in the past. An investor, be it a VC or an active angel investor, will simply have executed more private capital rounds than the typical CEO, and thus will better understand the terminology and implications of different deal terms. Thus,
You will need an experienced lawyer on your side when raising venture or angel financing
Your attorney needs to be up to speed on current standard “best practices” for deal structures and terms. These terms tend to change over time based on IRS and SEC rulings, crazy (highly publicized) happenings at other venture backed companies, industry-wide investor vs. entrepreneur power dynamics, etc. If your lawyer hasn’t done a number of private, VC investments recently they are likely to be behind the curve. Some deal terms, such as a strategic investor demanding a last look on any acquisition offers on the startup or certain blocking rights held by your preferred shareholders, can make selling the company or raising the next round of financing difficult to impossible. You need someone experienced looking for these sorts of issues on your side!
Some key terms you need to be very involved with – in particular the company’s valuation and the vesting schedule for the current employees’ shares (there are obviously other items – consult your attorney!) You will need to discuss these sorts of items directly with the investor. That’s not to say that you shouldn’t get advice from your advisers… but these are issues you need to deal with directly with the investor. If these negotiations become testy, well, that’s too bad. As the leader of your company talking to investors these items are your responsibility, and they are also things that you can easily understand without a law degree.
Your attorney should be a hammer (or shield) in negotiating (some) tough points during your financing
For more complicated/technical issues you need your attorney’s advice. You can (and should) let your attorney negotiate with the investors’ counsel directly on a number of these points – mainly the smaller technical points (this usually happens in the stock purchase agreement drafting stage, less so during the term sheet stage). There will likely be some major items that you will need to get involved with. If these issues are ones that are technical in nature than you should use your lawyer as a hammer and say “my attorney will not allow me to accept that term.” I’m not talking about points like valuation – who gives a crap what an attorney’s position is on that. I’m specifically referencing technical provisions of preferred stock or convertible notes or certain things like items in an indemnification agreement. An investor should not get too annoyed if your HIGHLY EXPERIENCED attorney thinks a particular provision is non-standard or that it will likely cause issues in your next round of financing. (However, if an inexperienced company counsel is making mountains out of molehills then you are simply wasting the investors’ time and money.)
Preserving a positive relationship with your potential investor is critical. But, this should not mean that you get screwed over during the investment process. Seek advice from the right lawyer early in the process. Break the points that you want to negotiate into two different buckets: 1) the items you need to have a fair deal – things like valuation, board representation, etc. and 2) items that you need to have a legally intelligent financing. Use the lawyer as a shield when negotiating the legal points, and use the confidence that you have in your startup in negotiating the first category of points.
I think I’m going to do a whole post later on attorney management. You don’t want your lawyer derailing your transaction or running up outrageous fees. However, you need to make sure your interests (and the interests of your employee-shareholders) are correctly represented. I’m going to try to put some ideas on this in a post later, but I’d welcome any ideas on this topic in the comments!