Point of order: Standardised termsheets are not the answer for startups

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This is a guest post on TechCrunch Europe by Barry Vitou and Danvers Baillieu, lawyers at London firm Winston & Strawn. Vitou and Baillieu run Bootlaw (@bootlaw), a free monthly meet-up for start ups covering the legal issues they face.

The humble termsheet has been the subject of a fair amount of debate and comment over the past few weeks. VC Chris Dixon got the ball rolling with his post on the ideal termsheet, then Fred Wilson weighed in and finally the mighty Michael Arrington, no less, on TechCrunch, following up the story that TheFunded.com had released a standard termsheet for use in series A rounds. As Arrington said, the aim of the TheFunded.com’s “plain” termsheet is to reduce legal fees on a VC round “which average $50,000 or more per venture round”. In the interests of full and frank disclosure, we’re lawyers – and here’s our take.

In our experience, it isn’t the termsheet which drives the time and cost of doing the deal. As a result, the standardisation of termsheets is a red herring. The truth, like so many things in life, is a bit more complicated.

We’d love it if the entire universe of VCs, angels and other assorted tech investors could agree on a standard set of terms for first round investment. It would mean no more reviewing for elephant traps, no unworkable mechanics or terms which work in one market, but not another. Chris Dixon says it should all come down to price – valuation and amount, as he puts it, and all the other “standard” stuff.

It’s a very attractive argument. But there are a couple of challenges: firstly, investors often compete with each other for deals, and secondly, investors and start-ups want to secure the best deal they can. These factors alone (and there are plenty of other variables, like country specific terms) frequently drive different deal terms between the investor and the start-up. Or, to put it another way: one size does not fit all.

As Fred Wilson said in the comments thread to his post: “There are some reasons why we might not want to share our standard set of terms. That becomes the baseline for negotiation and we just give from there. I don’t like negotiating very much and would love it if everyone started with their bottom line. But that’s not the way life works.”

So, while any lawyer who routinely does these deals frequently sees same terms or a variation on a theme in the deal documents, the termsheet is not itself the expensive piece of the puzzle. This is why law firms are able to give away term sheets for free, or even have bespoke term sheet generators on their websites – because this is not where the time is spent or the fees earned.

We advise our clients that if they want to secure the best deal possible they need to obtain more than one termsheet. This gives the founders a sense of the “market” for investment in the start-up and the parameters of the likely terms of investment in their company, which is not simply a matter of valuation and amount. It also gives the start up some leverage to negotiate the best possible deal.

Once the best deal has been secured, it is our experience that, when advising a founder on an investment, our time is principally spent making that deal actually happen. For first time investee companies, there is usually a steep learning curve and so some time is spent explaining to the client what different terms mean (regardless of whether they are standard or not) and discussing what the impact of those terms might be, in relation to other terms in other documents.

A significant proportion of time is spent on any disclosure exercise which might be necessary. The more nascent the company, the easier this is as there is less that can be disclosed. Sadly though, gone are the days when two geeks and a couple of weeks produced a web app that could attract significant funding. Most investment in these chastened times is going to companies which have made it out of the bedroom/garage and which have already got employees, customers and business contracts. Some of them, stretching the definition of “start-up”, will have been running for a number of years. Inevitably, time is spent cleaning up things which have been put on the back burner until the funding is imminent.

We would love to see more tailored warranties. Often, untailored warranties drive a disproportionate disclosure exercise when taking into account the developmental stage of the company and the level of risk being taken on by the investor. But even when tailored warranties are provided, the disclosure process is always a bespoke exercise.

Finally, room always has to be given for the quirks and complications which are thrown up by almost every deal: the former employee with 2% of the equity who must be bought out; the last minute indemnity given for a late-breaking, potentially deal-breaking, liability; a final switcheroo in the angel investor line-up – these are all things we’ve dealt with in the final stages of a transaction, none of which would be made any easier by starting off with standard terms.

So good luck to all those who want to standardise how deals are done, but until VCs and venture-backed companies are also standardised, we’re not convinced that the saving is all it is cracked up to be. In the meantime, if you’re a start up looking to raise funding, try to get more than one offer and make sure you pick the best one!

  • http://azeemazhar.com/ Azeem

    Good points with a few thoughts:

    There is simply not an infinity of structures or outcomes any more than there is any infinity of species.

    A taxonomy (or decision tree) could be created which would, at its endpoints define the various and several points in a term sheet.

    I researched startup legal fees last year and found that the lowest legal fees were £4-5k for the first round of investment; rising slowly in proportion to the investment. Getting away with less than £6k seems to be tough.

    But for a £200k or £100k seed round this is an absurdity. £5k buys you an iPhone app for your start-up which is clearly of more value than the legals.

    The other thing that has surprised me has been the absence of structured project management in closing deals. This adds to the cost and time of closing these deals.

    So yes there may be more than one set of terms but there is no reason why they can’t be highly structured, accessible via a decision tree, and with extremely clear timelines around when documentation, signatures and other collateral is required.

  • http://rodolfo.weblogger.com Rodolfo

    Lawyer says “you need lawyers!”.

    The point of having a standard term sheet is to have a reference point that is out in the open for comments.

    It also fills the sub 500k investment space for which using a law firm might be anti-economical (alas the work involved in a 500k or 5m series A is pretty much the same in the UK)

    Negotiating a deal is not rocket science. In fact it’s pretty dumb even if you take into account “quirks and complications”. The reason why you want a lawyer with nuts coated in iron sitting next to you is that they do deals like that every day and have the pulse on the situation and have seen multiple term sheets from the same investor and know the state of the market out there. That information alone has a direct impact on your bottom line during a liquidity event.

    Which is also the reason why you should steer away from firms who do “VC” when in fact what they did was some private equity deals (honestly? it’s London, everybody has done a few).

    My 0.02

    • gordon

      I never thought that I would ever hear two lawyers tell us that we needs lawyers!


  • Loopy

    Here, here,

    I remember selling one of my companies and the great work done by Bird & Bird in London. I totally agree that what you buy with lawyers is not a standard document but it is the shepherding of the process. Although ours was a company sale I would still rely [in the future] on the lawyers expertise to help me through the term sheet [I have seen some shit one’s in my time]. I do entrepreneur, I don’t do legal. My lawyer saves me money in the long term.

  • http://bootcycle.com Jonathan Markwell

    So what do you do when you are fresh out of university with a great idea and a great team with no cash. All you need is £15K to cover 3 months living expenses and roll out a first version of your app. You manage to convince some friends / family / fools to part with just enough to get you going.

    The deal breaker is that everyone involved wants something on paper that they can trust covers their best interests. What goes on that piece of paper when there is no cash available to pay for a lawyer?

    • http://www.facebook.com/people/Danvers_Baillieu/727182253 Danvers Baillieu

      The simplest answer must be: “issue the shares”. Ultimately at that level there has to be a high degree of trust going on and the result is binary – success (further funding) or failure (everyone loses). If further investors come in then the FFF crowd should then be protected by a new agreement.

      • http://www.bootlaw.com BarryVitou

        Hi Jonathan, Couldn’t agree more. We encourage bootstrapped start ups like this and their investors to adopt a proportionate approach. They do. All the time. In examples like this we would hope that the investors take a pragmatic view of the level of risk they are assuming. By definition people investing in start ups at any level accept risk. If they don’t they shouldn’t be doing it. The cheapest way of investing as Danvers says would be for the start up to just issue shares without any further paperwork. This basically costs nothing (ie the start up could do it itself with some basic research). A basic set of articles to cover off very basic protections is very cheap. The key at this early stage is, as you say, to get going. If investors want to gold plate something by going beyond the bare minimum level of protections at this level then they will have to accept that they will need to pay for it!

      • http://bootcycle.com Jonathan Markwell

        Danvers, Barry,

        Thank you for your replies this makes a lot of sense. However I think we still need something like: http://friendda.org to ensure that expectations are set in at least some form.

        A few common sense paragraphs would make a big difference. I’ve seen companies start in the way you describe and then get way more complicated than they should when one founder fails to take the leap of going full-time. This is probably more important when there are two cofounders vs. three or more.

  • http://www.crowdstorm.co.uk Philip Wilkinson

    Great article guys. It’s definitely true that different investors are going to want different levels of term sheets. At the beginning you can argue that you don’t really need something too complicated but if the business starts to be a success, you may have to go and revise it all again to cover the holes you left before. Bigger value deals will of course need much more complicated terms where a standardised term sheet can at the very least help educate entrepreneurs into what to start looking for.

    My preference: read and and learn about lots of different term sheets to get your own knowledge improved as an entrepreneur. Use one as a starting point with your potential investors, and then bring the lawyers in to clean the rest up, standardise anything, and as you say, bring the deal to completion!

    It’s the ironic world of the entrepreneur that at the time you have the least money and most risk of your startup going anywhere, that you actually need the most work doing!

  • http://www.startupcommons.org valto

    We have started a nonprofit to tackle this problem with following approach:

    1. create categorizing model to separate different types of start-ups
    2. find/build/attach high level sets of terms for different categories
    3. develop efficient web tool to better manage the logistics and communication of the agreeing process (start with high level term sets by category with “blog style” commenting per each term)

    As a non-profit we will make all of our work freely available to our members.

    Anyone wanting to participate, you are welcome to join us. We need plenty of resources.

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