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!