Managing the Legal Process in an Early Stage Startup

Managing the Legal Process in an Early Stage Startup

by Carlos Eduardo Espinal 
@cee

One of the most time consuming things founders have to do other than raise money is deal with all the legal paperwork pre and post termsheet that fundraising typically generates. Not only can the legal process be time consuming, but also it can be emotionally difficult depending on how many items are being discussed before finalizing.

While there is no standard process (largely due to the variability in deal types and jurisdictional issues) that can be outlined for how to deal with your unique legal situation, I’d like to propose a few tips that might help you navigate your process along the way. As such, read this post not so much as a how-to, but more-so as a list of things to consider while going through your investment documents.

0) Always be mindful that the most important thing you have at your disposal is your word. If you make promises, keep them. Create trust between everyone you deal with. Say what you mean and mean what you say, and ask questions if you’re not sure. This will help build you a good reputation that will greatly help you along your way.

1) If you aren’t incorporated yet, or if you’ve just started working on an idea with friends, have a pre-founder and advisor arrangements (relating to splits and vesting) agreed before lawyers start drafting stuff later. Lawyers often need to change docs several times to accommodate founders changing their minds or negotiations taking a different turn before the legal docs. We’ve put up a document on our Seedhack site called the Founder’s Collaboration Agreement, which you can use if you don’t have something like this. I assume that for most of you this is not a relevant point, but perhaps for some of the newer teams that haven’t incorporated yet.

2) Always check what your legal responsibilities with existing shareholders are before taking any decisions with or without them. When you have existing shareholders, involve them (including the distribution of information about the new round) as per whatever rights they may have agreed with you as part of their investment documentation. If this means you need to inform them, then inform them, if this means you need to ask them something, then ask them, but don’t leave it to the last minute. Generally speaking, they’ll try and be helpful, but depending on how busy they are, they can take a while, so don’t leave it for the last minute.

3) Don’t be annoying:

a) Lawyers cost money for both sides of the table. Do as much research as possible on your own and try and aggregate your questions as much as possible so that you use your lawyers and their lawyer’s time efficiently.
b) Make sure you have a position on items that are being discussed so that you don’t go back and forth on stuff on the phone or after decisions have been made. Nothing is more annoying than backtracking in legal processes.
c) Don’t let your lawyer get annoying or overly aggressive with your investor. The investor can always walk away if you and your lawyer are coming across as overly difficult and asking for stuff that might actually be destructive for the company in their view. Be assertive for sure, but don’t be divisive. Seek to understand the issues and always think creatively on how to solve them rather than letting the lawyers get into a stalemate or in an argument with your potential investor. Always feel free to say “let’s park this point for now and return to it after we’ve had to consider it”.
d) Don’t let paranoia of what others could do to screw you get the better of you. It is OK to be slightly paranoid (I know I am), but don’t let it be so bad that you make the legal process feel painful as you come up with bogus reasons by which to reject perfectly common clauses in an investors proposed documentation.

4) Legal documents have two parts, the commercial stuff (like valuations, percentages, etc) and legal stuff (like which jurisdiction, which filing/reporting procedures, etc). Get all or as much of the commercial points agreed between you and the investor before involving the lawyers (this is effectively what the termsheet is, but sometimes some stuff slips into the subsequent docs to keep the termsheet ‘light’) so that the lawyers are just left with representing these on your documents. If you need to have a discussion on a commercial point, do it with the investor alone and offline (even if you had to ask your lawyer or another shareholder for advice) you shouldn’t spend time on the phone with lawyers negotiating commercial points. Lawyers will help you through the technical points.

5) Always ‘red line’ any changes you make to documents. Keep track of all changes. Use track changing on Word. Google Docs may have this, but lawyers don’t use Google Docs generally.

6) Generally speaking.. and this is just a general rule… conversations are Founder <> Investors and Lawyer <> Lawyer.. meaning, you rarely speak to the counsel of the Investor directly or the Investor with your counsel directly without you guys being on the phone with them.

7) Keep CALM AT ALL TIMES. If you lose it, you will lose it.

8) Always seek solutions. There are multiple ways to skin a cat. Any issue can usually be solved via some creativity. The lawyers aren’t there to come up with stuff for you, you have to sometimes be the one (along with the investor) that can come up with solutions and then the lawyer’s articulate it legally. Although.. Don’t get too creative too, cause that can burn you.

9) Most of you are using lawyers that have been recommended and are experienced, but maybe you are struggling with your current counsel and are looking to switch. It is important that you get good counsel (read my post on this here). Don’t be cheap on this one. You’ll regret it later.

10) Do propose using standard documentation that other lawyers have frequently seen, in the USA consider using the Series Seed docs, or here in Europe, the Seedsummit docs which are based on the US Series Seed docs, or the BVCA ones, etc. there are probably a few more out there, just familiarize yourself with a few to ask them if the ones they send you are based on ‘standards’ as that will reduce everyone’s workload.

11) Managing the closing process. This is a difficult one and in the UK, with deed execution requirements can be difficult, but when there are multiple angels involved lawyers often spend a lot of time getting signatures and it increases the costs that founders don’t want to pay (I just heard of a deal that had 9 angels and the lawyer spent 20 hours managing that process for the entrepreneur, thus ended up overall 3x over budget).  Sometimes, you as founder, can handle this but best case is if one of the leading angels takes charge of this process, we have seen this and it has been really good but you can’t count on having that organized person being on board, so be prepared to be ‘that guy’.

12) Do your due diligence homework. Get your IP agreements, employment agreements, etc organized to help the process go by faster and smoother for your new investor as they will likely have to review these documents.

Hope that helps, and feel free to add your suggestions in the comment section below!