Watching Nickels And Dimes On Legal Costs In Start-Ups And Ventures

Venture capitalist Ed Sim had a good post recently that touched on a number of things ranging from principle-centered negotiation to matching the core DNA and chemistry of a team in a venture. He entitled his post, "Nickels and Dimes Don’t Add Up" to reflect his late-in-the-negotiation realization that perhaps the DNA of a prospective executive hire didn’t match up because some of the aspects of the negotiation got extended too long for little reason. Because negotiations for executive employment arrangements can be complicated and involve more layers of legal mechanics stretching into the Board-level, his post triggered some tangential thoughts I had on the costs of legal and bootstrapping these costs from garage-level operations through seed and some cases of Series A financing. I suppose I could have called this post, "Bootstrapping Legal So That Nickels and Dimes Don’t Add Up Too Much".

A core problem with bootstrapping legal costs (and following a variation of a "cash is king" strategy) is that a company may pay for things later by bootstrapping these things now. For example, if a company needs to perfect its intellectual property rights because of poor professional services agreements, this can be a sore spot to have to go back to every customer one has dealt with to perfect the agreements.

But lawyers can cost from $200/hr to $500/hr. To create additional pressure on ventures, post-bubble many legal firms
(not to mention employees and other partners) pushed down their
willingness to take stock options in lieu of portions of cash compensation. Some are willing to push off costs for a few months, but you need an in then.

Let’s face reality then. Not everyone can afford to have lawyers draft every legal document change, even if one tries to make sure that drafting is the last step after negotiating or planning business terms.

If find it useful early on to know what type of company is in the making. This way you can think about how complex the company may be in the reasonable future (e.g., 12 to 18 months). As examples of types of companies and some of the pertinent legal aspects:

  1. Services-only company – may need very basic things like NDAs, professional services agreements, and subcontracting agreements
  2. Software-only company – may need more advanced things like NDAs, MNDAs, licensing,
    maintenance, OEM inbound and/or outbound, distribution and partnership
    agreements
  3. Software and services company – may need all of the above, plus additional
    considerations for when they interrelate surrounding intellectual
    property rights and/or interstate tax, say

I’ve seen the stuff above range from $1,000 to $25,000ish. When one
talks about adding core infrastructure paperwork (e.g., equity, stock
option plan, executive employment docs) costing anywhere from $5,000 to
$25,000ish, and then adding stock purchase or recap docs (post Seed round)
costing anywhere from $25,000 to over $100,000, things add up over time. One really needs to breakdown the timing of company needs (and scope of work) to get narrower ranges on these costs (and thus to bootstrap the org along).

To weigh through some of this entrepreneurial & legal jungle, I find it useful to examine some pertinent operational considerations:

  1. Whether there will be a future for the venture  – Entrepreneurs are pioneering, experimenting, and there is high risk early on. Don’t expend too much on legal until you’ve figured out what you are doing and what works. Somewhat related to this, don’t make core foundation documents or organizational structures too complex and customized unless you really need to.
  2. How far out the next phase of the future is – Try to storyboard out the future of the firm in a rational way. Consider only structuring legal stuff to keep you rolling for 12 to 18 months. Things like getting perfect distribution, licensing, and maintenance agreements may not make sense until you’ve got more traction selling direct. Why? People may not be able to sell accounts for you until you’ve a critical or workable mass of reference accounts. Although one may pay $5K more or even $15K to fix the job in the future on a $10K job, weigh the costs systematically.
  3. What that future could look like – Will there be things like capital raises? On core infrastructure documents (primarily corporate finance documents), I would not mess around here too much. In my opinion, these problems are the most expensive to fix, and it is in part because the problems are more diffused through the legal documents. The key factor that one can control, however, is that looking for iron-clad documentation and customization can cause much $$ pain early on. Maybe some of this can be fixed if the venture makes it to the next round.

Yet another strategy is to look at each of these types of documents above and figure out where they are most likely to break. If you need lawyers to focus on just getting that piece of the document iron-clad, this is another strategy to minimize costs in a somewhat "layered way".

I also find it useful to note, at least based on my experiences, that so long as one is reasonably careful, there’s little that lawyers can’t fix. Delaying costs is a key principle to look at.

Aside from actively managing legal costs and mechanics, I have another good option. Consider having a lawyer in as one of your business partners. They can save you a ton and help put your mind at ease.

Note these are insights on legal topics within start-ups from a
non-lawyer but from a person that has worked with a number of lawyers
in corporate finance and infrastructure, intellectual property, and
employment and human resources within start-ups and growth firms. I have been spanked (lightly) by lawyers for drafting stuff.

Steve Shu

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Ross Mayfield On Finding A Home And Net-Enabled Bootstrapping

Ross Mayfield (CEO of Socialtext) has a great post that places his company’s recent venture capital financing (includes DFJ) and prospects of finding new company digs in the context of fourteen stages of a high-tech startup. To be frank, I find it interesting that launching a product is stage 12 and IPO is stage 14, but I digress …

What Ross calls "net-enabled bootstrapping" is really terrific. Ross writes, "I am convinced that being virtual is the best way to start a company."

This type of bootstrapping is really reflective of how today’s startups can be really creative to minimize costs of office space and to leverage resources around the globe. Some of the productivity technologies that Ross references are pretty much post-bubble technologies. Use ’em if you can.  Face it – space planning is one of these underestimated things in growing companies. Plan for too much expansion, and the CFO can easily be writing off expenses as underutilized capacity, finding sublease tenants and negotiating contracts, etc. Plan for too little space, and people can be too disrupted by noise due to close proximity, intra- and inter-office moves, and support issues like telcom or network access. While people like myself are used to working out of a carry-bag (I call my bag "the football" like the President’s football) and in the hallways of client sites when space considerations get tight, not every one can work productively when strapped from a ceiling or to the walls when the company is busting from the seams.

All said, in past companies I’ve worked for that implement virtual teams (and I’m working for some now on the reverse end of the stick outside of HQ), some amount of face-time is necessary regardless of technology. Instant messaging, conference calling, email, etc. are all great things, but I find that the multi-party discussions of complex matters are often the things that suffer the most. Having a meticulous person involved in key multi-party, virtual working sessions is a must in my book. One should also be sensitive to how technology use (such as IM) in a bootstrap may discriminate against extroverts, salespeople, unstructured thinkers, technology shy people, or even those with repetitive motion injuries.

Ross also makes a great point that it is hard to celebrate victories with a remote team. Ross relates a cool idea of ordering pizza for colleagues. In company headquarters, I have seen many companies ring a gong or bang a cowbell when sales come in. So in the spirit of the virtual world, I would reference SNL’s episode of "More Cowbell" (as referenced by VC and blogger, Fred Wilson of Union Square Ventures). Ring that baby in toast of Socialtext’s financing and search for a home!

Why Entrepreneurs Need To Wear Their Decoder Rings When Talking With VCs

Venture capitalist Bill Burnham describes in his blog why venture capitalists never say "no" to entrepreneurs. Some insightful ways of describing why such behavior is so, Bill writes (bracketed text is mine):

… The issue with saying “no” in the venture business is that there’s really isn’t any upside to saying “no” …

… You might be saying “no” to providing the initial funding to the next Google or Cisco or Yahoo … you risk [getting] shut out of their next round of financing …

… Saying “no” to any entrepreneur is not fun and creates enemies.  It’s
like telling someone their baby is ugly or their child is stupid …

… Net, net: no one likes to make enemies and saying “no” is a pretty easy way to do it …

For entrepreneurs not wearing their decoders rings when talking with VCs, the pursuit can seem like playing "hard to get". Although Bill describes his use of language as an "art", it’s really a "craft". Art is for show, craft is for dough. VCs are in the business of making money, and saying "no" doesn’t help that cause.

Steve Shu

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